Electricity Investment Behavior in Response to Climate Policy Risk

Abstract: We analyze the effects of climate policy and regulatory risk on invest-ment behaviour in the electricity sector. Using a multistage stochastic optimiza-tion model with uncertainty in carbon price, we demonstrate that financial details with real options and uncertainties can make substantial difference compared to the basic economic net present value evaluation. We also show that this approach is necessary to capture important details for reliable economic policy decisions. Thus, the effects of various carbon policies and market instruments on investment will depend on the characteristics of the companies, but appear to promote a less competitive market structure as well as path-dependent technology change. Our experiments identify that risk averse investors may, surprisingly under certain circumstances, invest before risk neutral investors and that rapid carbon capture and storage technology adoption rates can encourage investments even in non fossil technologies