Advertisement

A real option application for emission control measures

  • Carmen Schiel
  • Simon Glöser-Chahoud
  • Frank Schultmann
Original Paper
  • 61 Downloads

Abstract

Real Option analyses are broadly discussed in economics and finance and different analytic and numeric calculation methods for option values have been presented and successfully implemented in theoretical case studies and practical applications. However, real option analysis has not yet been applied for mandatory investments without monetary revenues, e.g. investments in pollution reduction and emission control installations in large industrial plants enforced by political regulation. The assessment of the timing of the investment, i.e. whether to invest immediately or to delay the investment in the future, is the main scope of this work. A difficulty of the underlying type of investments with regard to option valuation is that not to invest is not an option. Therefore, the frequently applied optimal stopping approaches based on investment thresholds are not applicable to this work. In the first part of the paper, specific features and characteristics of the regarded investments are analyzed and translated into financial terms of option valuation, accompanied by an overview of several relevant option valuation methods. The most appropriate methodology for the application, the Monte-Carlo-Analysis, will be assessed in more detail. Based on a two perspectives approach that analyzes possible savings and losses of a delayed investment, a case study displays the calculations and results of the developed methodology in several scenarios. The case study reveals possible influences of policy schemes and the impact of the degree of uncertainty on mandatory investments. The work has a strong methodological focus and the calculation methodology provided can be of use for investors and policy-makers, particularly with regard to investment decision-making in the real options framework and the design of political instruments such as funding schemes.

Keywords

Real option analysis Monte-Carlo-Simulation Emission abatement Investment decision Environmental investment 

JEL Classifications

G11 G17 G38 M21 Q48 Q53 

References

  1. Adkins R, Paxson D (2016) Subsidies for renewable energy facilities under uncertainty. Manch School 84(2):222–250CrossRefGoogle Scholar
  2. Ampofo KD (2017) Reasons why Real Options Analysis (ROA) is not widely adopted in the mineral industry, PhD Thesis, Brisbane, The University of QueenslandGoogle Scholar
  3. Andalib MS, Tavakolan M, Gatmiri B (2018) Modeling managerial behavior in real options valuation for project-based environments. Int J Project Manage 36(4):600–611CrossRefGoogle Scholar
  4. Baecker P, Hommel U, Lehmann H (2003) Marktorientierte Investitionsrechnung bei Unsicherheit, Flexibilität und Irreversibilität: Eine Systematik der Bewertungsverfahren. In: Hommel U, Scholich M, Baecker P (eds) Reale Optionen: Konzepte, Praxis und Perspektiven strategischer Unternehmensfinanzierung. Springer, Berlin, pp 15–35CrossRefGoogle Scholar
  5. Baldwin R, Cave ME, Lodge M (2012) Understanding regulation: Theory, strategy, and practice, 2nd edn. Oxford University Press, OxfordGoogle Scholar
  6. Balikcioglu M, Fackler PL, Pindyck RS (2011) Solving optimal timing problems in environmental economics. Resour Energy Econ 33(3):761–768CrossRefGoogle Scholar
  7. Black F, Scholes M (1973) The pricing of options and corporate liabilities. J Polit Econ 81:637–654CrossRefGoogle Scholar
  8. Boomsma TK, Meade N, Fleten S-E (2012) Renewable energy investments under different support schemes: a real options approach. Eur J Oper Res 220(1):225–237CrossRefGoogle Scholar
  9. Brach MA (2003) Real options in practice. Wiley, HobokenGoogle Scholar
  10. Breun P, Comes T, Doll C, Fröhling M, Hiete M (2012) National Integrated Assessment Modelling zur Bewertung umweltpolitischer Instrumente: Entwicklung des otello-Modellsystems und dessen Anwendung auf die Bundesrepublik Deutschland. KIT Scientific Publishing, KarlsruheGoogle Scholar
  11. Buurman J, Babovic V (2017) Adaptation pathways and real options analysis: an approach to deep uncertainty in climate change adaptation policies. Policy Soc 35(2):137–150CrossRefGoogle Scholar
  12. Chronopoulos M, Hagspiel V, Fleten S-E (2016) Stepwise green investment under policy uncertainty. Energy J 37(4):87–108CrossRefGoogle Scholar
  13. Cox J, Ross S, Rubinstein M (1979) Option pricing: a simplified approach. J Financ Econ 7(3):229–263CrossRefGoogle Scholar
  14. Detert N, Kotani K (2013) Real options approach to renewable energy investments in Mongolia. Energy Policy 56:136–150CrossRefGoogle Scholar
  15. Dixit AK, Pindyck RS (1994) Investment under uncertainty. Princeton University Press, PrincetonGoogle Scholar
  16. Eryilmaz D, Homans FR (2016) How does uncertainty in renewable energy policy affect decisions to invest in wind energy? Electr J 29(3):64–71CrossRefGoogle Scholar
  17. Ewald C-O, Yang Z (2008) Utility based pricing and exercising of real options under geometric mean reversion and risk aversion toward idiosyncratic risk. Math Methods Oper Res 68(1):97–123CrossRefGoogle Scholar
  18. Fernandes B, Cunha J, Ferreira P (2011) The use of real options approach in energy sector investments. Renew Sustain Energy Rev 15(9):4491–4497CrossRefGoogle Scholar
  19. Flyvbjerg B, Sunstein CR (2015) The principle of the malevolent hiding hand; or, the planning fallacy writ large. Soc Res 83:979–1004Google Scholar
  20. Haahtela TJ (2011) Estimating changing volatility in cash flow simulation based real option valuation with regression sum of squares error method. J Real Option 1(1):33–52Google Scholar
  21. Hahn JT (2013) Option pricing using artificial neural networks: an Australian perspective, Dissertation, Robina, Bond University, AustraliaGoogle Scholar
  22. Hambrick DC, Fredrickson JW (2001) Are you sure you have a strategy? Acad Manag Exec 15(4):48–59Google Scholar
  23. Hirschman AO (1967) Development projects observed. Brookings Inst, Washington DCGoogle Scholar
  24. Hommel U, Lehmann H (2001) Die Bewertung von Investitionsprojekten mit dem Realoptionsansatz—Ein Methodenüberblick. In: Hommel U, Scholich M (eds) Realoptionen in der Unternehmenspraxis: Wert schaffen durch Flexibilität. Springer, Berlin, pp 113–129CrossRefGoogle Scholar
  25. Hommel U, Pritsch G (1999) Investitionsbewertung und Unternehmensführung mit dem Realoptionsansatz. In: Achleitner A-K, Thoma GF (eds) Handbuch corporate finance. Köln, Deutscher Wirtschaftsdienst, pp 1–67Google Scholar
  26. Hugonnier JN, Morellec E (2003) Risk aversion and real options. SSRN Electr J 5:52–65Google Scholar
  27. Hull J (2012) Options, futures, and other derivatives, 8th edn. Prentice Hall, BostonGoogle Scholar
  28. Hundt M (2015) Investitionsplanung unter unsicheren Einflussgrößen: Thermische Kraftwerke als Realoptionen. Springer Gabler, WiesbadenCrossRefGoogle Scholar
  29. Kelly B, Pástor L, Veronesi P (2016) The price of political uncertainty: theory and evidence from the option market. J Finance 71(5):2417–2480CrossRefGoogle Scholar
  30. Kodukula P, Papudesu C (2006) Project valuation using real options: A practitioner’s guide. Fla., J. Ross Pub, Ft. LauderdaleGoogle Scholar
  31. Lambrecht BM (2017) Real options in finance. J Bank Finance 81:166–171CrossRefGoogle Scholar
  32. Laurikka H, Koljonen T (2006) Emissions trading and investment decisions in the power sector—a case study in Finland. Energy Policy 34(9):1063–1074CrossRefGoogle Scholar
  33. Lee S-C (2011) Using real option analysis for highly uncertain technology investments: the case of wind energy technology. Renew Sustain Energy Rev 15(9):4443–4450CrossRefGoogle Scholar
  34. Lee S-C, Shih L-H (2010) Renewable energy policy evaluation using real option model—the case of Taiwan. Energy Econ 32:S67–S78CrossRefGoogle Scholar
  35. Linnerud K, Andersson AM, Fleten S-E (2014) Investment timing under uncertain renewable energy policy: an empirical study of small hydropower projects. Energy 78:154–164CrossRefGoogle Scholar
  36. Longstaff FA, Schwartz ES (2001) Valuing American options by simulation: a simple least-squares approach. Rev Financ Stud 14(1):113–147CrossRefGoogle Scholar
  37. Maxwell C, Davison M (2015) Real options with regulatory policy uncertainty. In: Aïd R, Ludkovski M, Sircar R (eds) Commodities, energy and environmental finance. Springer, New York, pp 239–273CrossRefGoogle Scholar
  38. Mayer C, Lanzrath N, Breun P, Schultmann F (2016) A comparison of international nitrogen oxide emission regulation for the energy sector. In: Proceedings of the 22nd annual international sustainable development research society conference: rethinking sustainability models and practices: challenges for the new and old world contexts. Lisbon, July. Lisbon, pp. 394–406Google Scholar
  39. Mayer C, Breun P, Schultmann F (2017) Considering risks in early stage investment planning for emission abatement technologies in large combustion plants. J Clean Produc 142:133–144CrossRefGoogle Scholar
  40. Mostafa F, Dillon T (2008) A neural network approach to option pricing. In: Computational finance and its applications III: [papers presented at the Conference Computational Finance 2008, held in Cádiz in Spain]. Cadiz, Spain, 27–29 May 2008. Southampton, WIT Press, pp. 71–85Google Scholar
  41. Mostafa F, Dillon T, Chang E (2017) Option Pricing. In: Mostafa F, Dillon T, Chang E (eds) Computational intelligence applications to option pricing, volatility forecasting and value at risk. Springer International Publishing, Cham, pp 113–135CrossRefGoogle Scholar
  42. Muche T (2007) Investitionsbewertung in der Elektrizitätswirtschaft mit dem Realoptionsansatz. Zeitschrift für Energiewirtschaft 31(2):137–153Google Scholar
  43. Myers SC (1977) Determinants of corporate borrowing. J Financ Econ 5(2):147–175CrossRefGoogle Scholar
  44. Park H (2012) Real option analysis for effects of emission permit banking on investment under abatement cost uncertainty. Econ Model 29(4):1314–1321CrossRefGoogle Scholar
  45. Peters L (2016) Real options illustrated. Springer, ChamCrossRefGoogle Scholar
  46. Pindyck RS (2002) Optimal timing problems in environmental economics. J Econ Dyn Control 26(9–10):1677–1697CrossRefGoogle Scholar
  47. Pratt JW, Zeckhauser RJ (1985) Principals and agents. The structure of business. Mass, BostonGoogle Scholar
  48. Reedman L, Graham P, Coombes P (2006) Using a real-options approach to model technology adoption under carbon price uncertainty: an application to the Australian electricity generation sector. Econ Record 82(1):S64–S73CrossRefGoogle Scholar
  49. Rieger MO (2016) Optionen, Derivate und strukturierte Produkte, 2nd edn. Schäffer-Poeschel, StuttgartGoogle Scholar
  50. Ritzenhofen I, Spinler S (2016) Optimal design of feed-in-tariffs to stimulate renewable energy investments under regulatory uncertainty—a real options analysis. Energy Econ 53:76–89CrossRefGoogle Scholar
  51. Sarkis J, Tamarkin M (2005) Real options analysis for “green trading”: the case of greenhouse gases. Eng Econ 50(3):273–294CrossRefGoogle Scholar
  52. Sekar RC (2005) Carbon dioxide capture from coal-fired power plants: a real options analysis, Massachusetts Institute of Technology, LFEE 2005-002 RP [Online]. http://sequestration.mit.edu/pdf/LFEE_2005-002_RP.pdf. Accessed 3 Aug 2018
  53. Stentoft L (2004) Assessing the least squares Monte-Carlo approach to American option valuation. Rev Deriv Res 7(2):129–168CrossRefGoogle Scholar
  54. Szolgayova J, Fuss S, Obersteiner M (2008) Assessing the effects of CO2 price caps on electricity investments—a real options analysis. Energy Policy 36(10):3974–3981CrossRefGoogle Scholar
  55. Taudes A, Natter M, Trcka M (1998) Real option valuation with neuronal networks. Int J Intell Syst Account Finance Manag 7(1):43–52CrossRefGoogle Scholar
  56. TFTEI (2015) Estimation of costs of reduction techniques for LCP: methodology, TFTEI Technical Secretariat [Online]. http://tftei.citepa.org/images/files/2015-02-16/TFTEI_cost_calculation_methodology.pdf. Accessed 3 Aug 2018
  57. Trigeorgis L (1996) Real options: managerial flexibility and strategy in resource allocation. MIT Press, CambridgeGoogle Scholar
  58. Trigeorgis L, Reuer JJ (2017) Real options theory in strategic management. Strat Manag J 38(1):42–63CrossRefGoogle Scholar
  59. Umweltbundesamt (2012) Methodenkonvention 2.0 zur Schätzung von Umweltkosten: Ökonomische Bewertung von UmweltschädenGoogle Scholar
  60. UNFCCC (2014) United Nations Climate Change website [Online]. http://unfccc.int/2860.php. Accessed 14 Feb 2018
  61. US EPA (2005) International experiences with economic incentives for protecting the environment, National Center for Environmental Economics. https://www.epa.gov/sites/production/files/2017-08/documents/ee-0487-01.pdf. Accessed 3 Aug 2018
  62. Uszczapowski I (2008) Optionen und Futures verstehen: Grundlagen und neue Entwicklungen, 6th edn, München, [München]. Dt. Taschenbuch-Verl, BeckGoogle Scholar
  63. van der Slot A, Frans D, Ammermann H, Goemans M, Achterberg F (2015) Keep your megaproject on track: implement decision-making support for successful megaproject management. https://www.rolandberger.com/publications/publication_pdf/roland_berger_tab_megaproject_management_20151208.pdf. Accessed 3 Aug 2018
  64. Vose D (2015) Do your projects meet their budgets? Vose Software BVBAGoogle Scholar
  65. Welling A, Lukas E, Kupfer S (2015) Investment timing under political ambiguity. J Bus Econ 85(9):977–1010CrossRefGoogle Scholar
  66. Xu L, Sepehrnoori K, Dyer J, van Rensburg WC (2013) Application of real options to valuation and decision-making in the petroleum E&P industry. In: SPE hydrocarbon economics and evaluation symposium. Calgary, Alberta, Canada, 2012-09-24, Society of Petroleum EngineersGoogle Scholar
  67. Yang Y, Zheng Y, Hospedales TM (2017) Gated neural networks for option pricing: rationality by design. In: Proceedings of the thirty-first AAAI conference on artificial intelligence (AAAI-17), pp. 52–58Google Scholar
  68. Zhou W, Zhu B, Fuss S, Szolgayová J, Obersteiner M, Fei W (2010) Uncertainty modeling of CCS investment strategy in China’s power sector. Appl Energy 87(7):2392–2400CrossRefGoogle Scholar
  69. Zhu L, Fan Y (2011) A real options–based CCS investment evaluation model: case study of China’s power generation sector. Appl Energy 88(12):4320–4333CrossRefGoogle Scholar

Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP), Chair of Business Administration, Production and Operations ManagementKarlsruheGermany
  2. 2.University of Adelaide, Entrepreneurship, Commercialisation and Innovation Centre (ECIC)AdelaideAustralia

Personalised recommendations