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A real options model for renewable energy investment with application to
solar photovoltaic power generation in China
M.M. Zhang, P. Zhou, D.Q. Zhou
PII:
DOI:
Reference:
S0140-9883(16)30200-6
doi: 10.1016/j.eneco.2016.07.028
ENEECO 3405
To appear in:
Energy Economics
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Revised date:
Accepted date:
10 January 2015
23 July 2016
30 July 2016
Please cite this article as: Zhang, M.M., Zhou, P., Zhou, D.Q., A real options model for
renewable energy investment with application to solar photovoltaic power generation in
China, Energy Economics (2016), doi: 10.1016/j.eneco.2016.07.028
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A real options model for renewable energy investment with
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Abstract
This paper proposes a real options model for evaluating renewable energy investment by
considering uncertain factors such as CO2 price, non-renewable energy cost, investment cost
and market price of electricity. A phase-out mechanism is built into the model to reflect the
long-term changes of subsidy policy. We apply the proposed model to empirically evaluate
the investment value and optimal timing for solar photovoltaic power generation in China.
Our empirical results show that the current investment environment in China may not be able
to attract immediate investment, while the development of carbon market helps advance the
optimal investment time. A sensitivity analysis is conducted to investigate the dynamics of
investment value and optimal timing under the changes of unit generating capacity, subsidy
level, market price of electricity, CO2 price and investment cost. It is found that the high
investment cost and the volatility of electricity and CO2 prices, are not conducive to attract
immediate investment. Instead, increasing the level of subsidy, promoting technological
progress and maintaining the stability of market are useful to stimulate investment.
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1. Introduction
Many countries have realized the importance of renewable energy development
and utilization in reducing the dependence on fossil energy and mitigating climate
change. As the world largest carbon dioxide (CO2) emitter, China has made
substantial efforts in promoting the development and utilization of renewable energy.
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Although renewable energy only accounted for about 10% of total primary energy
consumption in 2014, in its Middle and Long Term Plan for Renewable Energy
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Development, China government has set the target of increasing the share of
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utilization of renewable energy, has four key features. First, the investment is partially
or completely irreversible. Second, the investment costs of renewable electricity
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generation projects are often higher than fossil fuel fired electricity generation
projects because of technological immaturity. Third, renewable energy investment is
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progress and supporting policies. Forth, the investment timing for renewable energy
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projects is discretionary (Yang et al., 2008, Fan et al., 2013). If the return of a
renewable energy project is comparable to the risk it takes or the investment can be
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postponed to acquire more knowledge about the risk, profit-seeking investors may do
the investment. Because of these features, the traditional net present value (NPV)
method, which cannot well model the uncertain factors, becomes inappropriate for
evaluating renewable energy investment (Dixit and Pindyck, 1995).
In China, the investment on renewable energy projects is even more complicated
due to its extremely complex and uncertain investment environment. Its electricity
sector is moving slowly towards a more competitive and market-based system. Seven
provinces and cities in China have launched their pilot carbon trading emission
schemes in 2013, and a national emission trading system will be established in 2017.
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While carbon emission trading provides investors a new source of revenues, it is also
an uncertain factor affecting investment due to the volatility of CO2 prices. In addition,
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the timing and strength of supporting policies for promoting renewable energy
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investment is not clear in the long run. Due to the uncertain factors, evaluating
renewable energy investment in China becomes more challengeable.
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This paper aims to develop a real options model for evaluating renewable energy
investment in China by considering four uncertain factors including CO2 price,
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non-renewable energy (NRE) cost, market price of electricity and investment cost of
renewable energy project. Compared to earlier similar studies which will be reviewed
in the next section, this study considers more uncertain factors in model development
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so that the modeling results might be more consistent with the actual situations of
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on renewable energy investment. In view of the fact that the incentive policies for
renewable energy should gradually be adjusted with the change of investment
environment in the long run, we built a phase-out mechanism of subsidy for
renewable electricity, which can better reflect the long-term change of timing and
strength of policy support.
The proposed real options model can be used to estimate the investment value
and optimal timing for renewable energy investment. The effects of unit generating
capacity, subsidy, market price of electricity, CO2 price and investment cost on
renewable energy investment can also be assessed by sensitivity analysis. In this study,
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we apply the proposed model to empirically evaluate solar photovoltaic (PV) power
generation in China to address the following questions: Is the current investment
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environment positive enough to attract immediate investment? What are the effects of
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2. Literature review
Real options method has been used to evaluate renewable energy investment
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Country/
Resource
Solution
Region
type
method
Greece
Wind
PDE
al. (2002)
Uncertain factors
Purpose of study
Deregulated
Assessing the
energy market
profitability of wind
power plants
Davis and
Owens
USA
Renewable
PDE
energy (RE)
Quantifying the
benefits of research
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(2003)
and development
(R&D) expenditures
on renewable
electricity
France
Nuclear
PDE
Competitive
Comparing large
Gollier et al.
(2005)
electricity price
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with sequential
Kjaerland
Norway
Hydropower
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investments on small
PDE
Electricity price
Fleten et al.
Norway
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(2007)
Wind
PDE
Siddiqui et
USA
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(2007)
Electricity price
RE
DP (tree)
Norway
Kumbaroglu
Yang et al.
(2008)
Turkey
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et al. (2008)
Hydropower
CE
P
al. (2008)
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Bockman et
RE
Exploring the
investment decisions
of hydropower
projects
Estimating the
investment timing and
scale of wind power
Cost-benefit analysis
of research,
development,
demonstration and
al. (2007)
NRE cost
deployment programs
PDE
Electricity price
Assessing the
investment and
capacity choice for
small hydropower
plants
DP
Evaluating investment
electricity price
alternatives in a
recursive manner
Nuclear
Simulation
Energy and
and DP
carbon price
of climate policy on
different power
stations
Fuss and
Wind
Simulation
Technical
Investigating uncertain
Szolgayova
change and
factors impact on
(2008)
replacement
investment decisions
Siddiqui and
RE
PDE
Fleten (2010)
Electricity price
Analyzing the
and operating
deployment of
cost
competing alternative
renewable energy
technologies
Taiwan
Wind
DP (tree)
(2010)
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Fossil fuel
prices and
value of renewable
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Lee (2011)
Taiwan
Wind
PDE
technical change
energy development
Electricity price
Germany
Wind
DP
(2012)
Electricity price
Analyzing the
for renewable
Boomsma et
Nordic
Wind
PDE
Jose (2013)
Finland
Wind
and
Mongolia
Kotani
(2013)
China
Wesseh Jr
(2013)
Zhang et al.
China
RE
Wesseh Jr
Liberia
support
schemes, e.g.
energy projects
Simulation
Production cost,
and DP
investment cost
(tree)
and consumer
option on renewable
price index
energy project
investment
Simulation
Coal price
DP (tree)
DP (tree)
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(2014)
Solar
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Lin and
RE
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Detert and
Portugal
Analyzing investment
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Denmark,
Different
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al. (2012)
Manuel and
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energy
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Reuter et al.
investment
Quantifying the
and technical
change
generation
NRE cost,
Evaluating the
technical change
existence of balance
point of interest for
renewable energy
RE
DP (tree)
Quantifying the
and Lin
Learning effects
benefits of R&D in
(2015)
in technologies
renewable power
generation
Wesseh Jr
China
Wind
DP (tree)
NRE cost
and Lin
of wind energy
(2016)
projects
Note: PDE-partial differential equation; DP-dynamic programming; FIT- feed-in tariff; RPS- renewable
portfolio standard.
As shown in Table 1, earlier studies were mainly carried out for developed
countries such as the US, Greece, Germany, France and Norway. Recently, several
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researchers began to examine renewable energy investment in Asian countries such as
China (Lin and Wesseh Jr, 2013; Zhang et al., 2014; Wesseh Jr and Lin, 2016). In
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terms of energy type, while some researchers treated renewable energy as a whole,
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others analyzed the investment for different types of renewable energy such as wind
and hydropower. It should be pointed out that there are not many studies focusing on
solar power. While China government has paid more attention on solar photovoltaic
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power generation, there are many uncertain factors affecting its development, which
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Real options model can be solved by three methods, including partial differential
equation (PDE), dynamic programming (DP) approach and simulation method. It can
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be found that previous studies mainly applied PDE and DP to solve their models.
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Nevertheless, both PDE and DP are unable to deal with more than two factors. With
the introduction of multiple uncertain market and policy factors, some researchers
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have begun to use simulation method to solve their real options models (Yang et al.,
2008; Manuel and Jose, 2013; Detert and Kotani, 2013).
In terms of the uncertain factors considered, previous studies mainly considered
electricity price, fossil fuel price and technological change. There are not many
studies considering carbon emission trading scheme and the varying incentive policies.
While carbon emission trading scheme is designed to reduce greenhouse gas
emissions, it indirectly affects the revenue of renewable energy investors. Nowadays
renewable energy is still heavily dependent on policy support. The way for treating
policy factors is likely to influence the evaluation results of renewable energy
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investment. It is thus essential to take all these factors into account to ensure the
feasibility and accuracy of evaluation results. In addition, previous studies mainly
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analyzed the potential of renewable energy, the ability of renewable energy to replace
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traditional energy and the benefits of renewable energy power generation. The
interactive relationship between renewable energy investment and relevant influential
factors has not received enough attention, which are worth exploring in order to
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3. Methodology
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operating state of power generation project is assumed to be one (i.e. full load
operation), which implies that the shift between temporary suspension and full load
operation is negligible (Kumbaroglu et al., 2008). Since the value of a renewable
energy project is dependent on many uncertain factors in its lifetime, it is reasonable
to express the project value by its expectation E[] . If the investment on a renewable
energy project starts in year t, the total net present value of the project can be
represented by
tL
Vt E e r (i t ) i I t
i t
(1)
where r is the discount rate and i denotes the cash flow in year i.
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The yearly cash flow i of a renewable energy project usually comprises the
returns from selling electricity, gains through selling CO2 emission allowances,
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operation and maintenance cost, and tax expenditure. Suppose that p e and p c are
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respectively the price of renewable energy electricity and CO2 emissions, q e and
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(3)
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qte qte1 (1 - dr )
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generation system gradually decreases with the natural aging of equipment and other
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investors to evaluate uncertainty and accurately determine managerial flexibility. i.e.,
the investment can be deferred in response to the arrival of new information or until
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the uncertainty is fully resolved. Thus the investors can grasp the optimal investment
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opportunity and obtain the maximal investment value (Shahnazari et al., 2014;
Pringles et al., 2015). The investment value calculated with real options method is the
summation of the NPV and the economic value of the flexibility under uncertainty,
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(4)
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F V OV
where F is the investment value calculated with real options method and OV is the
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In other words, a profit-seeking investor just needs to make decision within the
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valid investment period t v . Based on the real options method, the investor has the
right to delay the investment and select the optimal timing for investment to
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maximize the project value (Hach and Spinler, 2014; Pringles et al., 2015), i.e.
(5)
0t S t v
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market price of electricity. The comparison between NRE cost and renewable energy
cost determines the deadline of price subsidy and tax incentives for renewable energy
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a new source of revenue for investors. Therefore, NRE cost and CO2 price actually
represent two uncertain market factors. Investment cost may be considered as an
uncertain technological factor, which is mainly dependent on the level of
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technological development and accounts for a large portion of the total cost of a
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factors. Previous studies have used the geometric Brownian motion (GBM) to
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describe the motion process for the NRE cost (Davis and Owens, 2003; Siddiqui,
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2007; Kumbaroglu et al., 2008; Yang et al., 2008; Siddiqui and Fleten, 2010; Fan and
Zhu, 2010 ). CO2 prices in both European and China markets were also assumed to
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follow the GBM, e.g. Fuss et al., (2008), Abadie and Chamorro (2008) and Heydari et
al. (2012). With the improvement of technological level, investment cost tends to
decline whereas it is also affected by the market volatility of PV component material.
The evolution of technological level may also be modeled by the GBM (Kumbaroglu
et al., 2008; Manuel and Jose, 2013; Welling, 2016). In this paper, we employ the
GBM to characterize the uncertainties in market and technological development as
follows:
dSt St dt St dz
(6)
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where S t denotes an uncertain variable, and represent the drift and volatility
parameters of the variable, dz represents independent increment of Wiener process
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unit standard deviation. It can be shown that the expected value of S is E St S0e t .
When the NRE cost is considered, let ptf denotes the NRE cost per unit of electricity
output (in RMB/kWh), f and f respectively represent the drift rate and
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volatility parameters of the NRE cost, and dz tf t f dt . When the CO2 price is
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considered, let ptc denote CO2 price (in RMB/kWh), c and c represent the drift
rate and volatility parameters of CO2 price, and dz tc tc dt . When the investment
cost is concerned, let I t denotes the unit investment cost (in RMB/kW), I and I
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represent the drift rate and volatility parameters of investment cost, and dz tI tI dt .1
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The costs and benefits of renewable energy and fossil energy may mutually influence each other by exerting
impacts on investors' willingness and preference (Reuter et al. 2012; Detert and Kotani, 2013). Therefore, the new
renewable energy investment and installed capacity may reduce renewable energy cost by following learning
effects, which may have influences on the NRE cost (Zhu, 2012; Welling, 2016; Siddiqui et al., 2016). To reflect
this relationship, this study considers the correlation between the investment cost of renewable energy project,
which accounts for about 80% of the total cost of solar PV system, and the NRE cost. Let
If
denote the
correlation coefficient, we then have dz dzt dt that can quantify the extent to which both stochastic
variables influence each other (Abadie and Chamorro, 2008, Fan et al. 2013; Zhu and Fan, 2013).
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t
If
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tct vtct itct
(7)
(8)
(9)
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Where rt v and rti respectively denote the rates of value-added tax and corporate
income tax.
(2) Price policy
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With regard to the price for renewable energy electricity, China government
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implements feed-in tariff (FIT) policy that is a fixed payout for unit electricity
generated from renewable energy. An adequate FIT, fixed for a longer period of time,
could promote the wide deployment of renewable energy (Schmidt et al., 2013). The
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FIT in China is composed by market price of electricity ptd and price subsidy Pbt
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(10)
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In this paper, we assume that once the investment is implemented, the level of
subsidy will be determined and kept constant for the entire lifetime of the project.
Chinas electricity pricing policy is transiting from a government-regulated
mechanism to a market-based one. Currently, power generation sector takes
sub-regional electricity pricing mechanism, and most of the provinces adopt the
baseline electricity price. Since the change of market price of electricity is related to
the change of NRE cost, we may model the change of market price of electricity by
(Fan and Zhu, 2010):
dptd d ptd dt d ptd dztd
(11)
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where ptd is the market price of electricity (RMB/kWh), dz td is the independent
increment of Wiener process dz td td dt , td is a normally distributed random
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variable with zero mean and unit standard deviation. d and d represent the drift
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rate and volatility parameters of market price of electricity, which are respectively
equal to the drift rate and volatility parameters of the NRE cost. The expected value of
p d is E[ Pt d ] P0d e d t .2
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There must be a phase-out mechanism of subsidy in the long run because the
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subsidy would be reduced with technical progress and the perfection of market system.
National Development and Reform Commission (NDRC), which is the main
decision-making institution of subsidy, ever declared that the price subsidy should be
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adjusted based on such factors as the change of investment cost and technological
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progress from time to time. Therefore, in this paper we assume that the price subsidy
is adjusted based on the change of the investment cost that often accounts for about
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80% of the total cost. Rigter and Vidican (2010) also derived the expected annual
declining rate of FIT based on solar PV system cost. By assuming that price
subsidy has a constant reduction rate before the deadline of subsidy, we derive the
following formula:
Pbt Pbt 1 e S , t t z
t tz
Pbt 0,
(12)
where s represents the constant reduction ratio equal to the drift rate of investment
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There may be an interaction between CO2 price and market price of electricity in the long run. Thus this study
considers the correlation between CO2 price and market price of electricity.
cd denotes
the correlation
coefficient between them with dz dz dt , which can reflect what extent both stochastic variables
influence each other beyond their development trends (Abadie and Chamorro, 2008; Fan et al., 2013; Zhu and Fan,
2013).
c
t
d
t
cd
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cost, and t z stands for the deadline of subsidy.
There indeed exists a deadline after which the subsidy would be ceased. The
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deadline for price subsidy are determined by the comparison between the NRE cost
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and the renewable energy cost. When the unit NRE cost is greater than or equal to the
unit renewable energy cost, price subsidy will be ceased. The unit renewable energy
electricity generated.
1
(1 dr ) e r 1
It
e
q
[(1 dr ) e r ]L 1
(13)
(14)
UI t
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cost can be obtained by dividing all the expenditures in the lifetime by the amount of
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where UI t denotes the unit investment cost (RMB/kWh) for the renewable energy
project invested in year t which can obtained by dividing the investment cost by the
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In view of the complexity of project value function and the introduction of many
uncertain factors, a method, which consists of the backward dynamical programming
algorithm and the Least Squares Monte Carlo (LSMC) methods, is used to solve the
real options model. The backward dynamic programming algorithm begins from the
last decision point, working back to the starting decision point and comparing
exercising investment versus the continuation value (Dixit and Pindyck, 1994). The
Least Squares Monte Carlo method, which is based on the Monte Carlo simulation
and least squares regression method, is used to calculate the continuation value and
optimal investment rules (Longstaff and Schwartz, 2001; Zhu and Fan, 2011; Zhu,
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2012). Must point out is that the result of least-square regression is an efficient
unbiased estimator of the conditional expectation function and allows accurately
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estimating the optimal stopping-rule for the options. The Least Squares Monte Carlo
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method, which has advantages over other solving techniques for real options, is not
only efficient to value American financial options, but also can be extended to valuing
complex real investments with several embedded real options and multiple uncertain
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variables. The solution procedures in our study resemble some earlier studies such as
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Yang et al., (2008), Zhou et al., (2014), Shahnazari et al., (2014) and Pringles et al.,
(2015). The detailed solution procedure is given below.
Step 1. Let W and N respectively denote the numbers of simulation path and
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tv
and t is the step size. Simulate the change
t
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each discrete decision point during the validity period of investment ( tv ) according to
Eq. (1).
Step 3. For any path j , the problem can be solved by dynamic programming
backward recursion. At the final observation date of the validity period ( t tv ),
conditional on not having invested in the previous periods, we can obtain
Ft , j max Vt , j , 0
(15)
1,V 0
t , j t , j
0, Otherwise
(16)
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Step 4. For every period 1 t tv , evaluate whether it is better to invest
immediately or delay the investment by comparing the expected net present value
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from immediate investment with the expected investment opportunity value from
delaying investment.3
(17)
(18)
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1,V e r Et Ft 1, j
t , j t , j
0, Otherwise
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Ft , j max Vt , j , e r Et [ Ft 1, j ]
Step 5. The recursion proceeds by rolling back in time and repeating the
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procedure until the exercise decisions at each possible exercise time along each path
has been determined. t j is the optimal investment timing in path j . The optimal
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investment timing ( t S ) is the one with highest frequency. The investment value is
computed by taking the average value over all the paths.
1
W
(e
r t j
Ft j , j )
1 t tv
(19)
j 1, 2,3......W
(20)
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t j inf t t , j 1
It should be pointed out that the accuracy of the Monte Carlo method is heavily
dependent on the scale of simulation, i.e. the number of sampling points and
In Eq. (17), the conditional expected value of continuation ( e r Et [ Ft 1, j ] ) is estimated by least squares
regression method. The dependent variable is the investment value from year t 1 until the end of the project
lifetime under the assumption of optimal investment behavior. Since this study also consider the uncertainty in
investment cost, the independent variables used are the expected cumulative cash flow C t for the whole lifetime
and investment cost I t
are e Et Ft 1 a0 a1C t a2 (C t ) a3 It a I , which is same with that in Shahnazari et al., (2014) and Pringles
r
2
4 t
et al., (2015). Longstaff and Schwartz (2001) have argued that the results are remarkably robust to the choice of
basis functions and the value of regression is unaffected by the correlation among the independent variables. In
order to ensure the rationality of results, we test various polynomials in this study by following Shahnazari et al.,
(2014), which shows the results may not be affected significantly in this study.
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simulation paths. Renewable energy investment is featured by large time span and
multiple influencing factors. If simulation trajectory contains a large number of
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solve this problem, this paper applies the antithetic variable variance reduction
technique in the process of Monte Carlo simulation (Lavenberg and Welch, 1981).
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4. Empirical study
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low-carbon society. At the end of 2014, the newly installed capacity reached 1.06
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million kW and the total installed capacity reached 2.805 million kW (National
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Energy Administration, 2014). Nevertheless, there is still a big gap between China
and other developed countries in the installed capacity and technological level which
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might be an indication of the great potential for solar PV power generation in China.
On the other hand, the trade friction between China and Europe in PV module had
serious impact on Chinese PV equipment manufacturing industry. These imply that
the expansion and investment of the solar PV power generation in China is inevitable.
In this section, we shall apply the models described in section 3 to evaluate the
feasibility and economy of the investment on solar PV power generation. The base
year is 2015 and the validity period of investment is 15 years (2016-2030). And the
step size is one year. For simplicity, we use the unit value, i.e. the value that unit solar
PV system (kW) brings, in the followings.
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4.1. Parameters estimation
This section shows the parameters used in our empirical study which are mainly
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collected or compiled from governmental documents and previous studies. For clarity,
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we differentiate the parameters for stochastic variables from others which are
respectively displayed in Tables 2 and 3. In the followings, we provide additional
Table 2
Parameters for stochastic variables
Variable
Description
Initial value
CO2 price
0.12
RMB/kWh
Drift rate of
CO2 price
0.02
Volatility rate of
CO2 price
NRE cost
pd
d
d
It
D
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pc
pf
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Drift rate of
investment cost
0.03
0.29
RMB/kWh
0.02
0.02
0.43
RMB/kWh
0.02
0.02
12000
RMB/kW
-0.06
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cd
0.23
0.1
t In( Pt / Pt 1 ) and = / t ,
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If
0.04
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Volatility rate of
investment cost
The correlation
coefficient between
investment cost of
renewable energy
and NRE cost
The correlation
between CO2 price
and market price of
electricity
and t represents the length of time interval with year as the unit (Insley, 2002).
b. The volatility rate is calculated by S (1/ l 1) l ( )2 and
t
S / t , where
l 1 is the
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t 1
number of observations and Pt represents variable value at the end of one period (Insley, 2002).
Table 3
Variable
Descriptions
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0.54
RMB/kWh
0.2
RMB/kWh
1500 kWh
rv
0.085
ri
The rate of
0.25
OMC
qe
dr
qc
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Pbt
CE
P
0.02
1500kWh
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Lifetime of solar PV
system
The constant
reduction ratio of
subsidy
25
15
(2016-2030)
-0.06
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tv
0.08
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corporate income
tax
Discount rate
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China, this paper takes the average cost of coal-fired power generation to represent
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NRE cost. Lin and Wesseh Jr (2013) estimated that the proportion of coal cost is
about 68% of NRE cost in China. Then we estimate the NRE cost
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by p f Pcoal (3.33 104 ) / 68%, where P coal denotes coal price (RMB/ton). In this
study, we use the monthly average coal prices in 2013 obtained from Qinhuangdao
Coal Net (http://www.cqcoal.com/) to compute the average coal price of Bohai rim
steam coal. The values of the drift and volatility rates for the NRE cost are directly
taken from Zhou et al. (2014).
(2) Market price of electricity
To make thermal power plant (mainly the coal-fired power plant) install
desulphurization
facilities,
Chinese
government
determines
price
for
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installed desulphurization facilities. Thus this paper uses desulfurization electricity
price to represent market price of electricity. The data were collected from the Notice
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on reducing the price of coal-fired electricity and electricity prices for industrial and
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trading schemes which provide a new source of revenue for the investors. Shenzhen is
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the first city implementing carbon emission trading in China. In view of the
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estimation in Zhu and Fan (2011) and the the daily CO2 prices from June 2013 to
August 2014 in Shenzhen carbon trading market, we can calculate the average CO2
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price as well as the values of the drift and volatility rates of CO2 price.
(4) Investment cost
With the improvement of R&D capability as well as the growth of installed
capacity, the investment cost of solar PV power generation has been declining.
According to China photovoltaic development report (CREIA and CPIA, 2013) as
well as the estimations in Zeng et al., (2012) and Zhang et al., (2013), we obtain the
costs of PV modules over time (see Fig. 1). It has been estimated that PV modules
account for about 60% of the total investment cost. Using I I pm / 60% where
I pm refers to the cost of PV module, we then obtain the unit investment cost.
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The NDRC of China issued the Notice on promoting the healthy development of
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solar PV industry by the role of leverage which provided the level of FIT for solar
PV power (NDRC, 2013). Based on these figures and the average desulfurization
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electricity price in China, we can obtain the unit price subsidy ( Pbt ) by Eq. (10).
According to the reports of Energy Research Observer (http://www.chinaero.com.cn/),
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4.2. Main results
The investment value and optimal investment timing for solar PV power
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generation in China are examined in this section. Since most of the provinces in China
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dont implement carbon emission trading scheme, we have also investigated the
potential effects of carbon emission trading on the investment value and optimal
investment timing. At first, it is necessary to examine the robustness of the model to
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the number of simulation paths (Pringles et al., 2015). Fig. 2 illustrates the statistical
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Thus we perform 10000 simulations in our solution process. Figs. 3 to 6 show 100 out
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of the 10000 simulation paths of NRE cost, investment cost, desulfurization electricity
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Table 4 shows the results when carbon emission trading is considered or not
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calculated by the NPV method is negative. When the real options (RO) method is
used, the investment value becomes 1185.3 RMB. Since the delay option value is
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explain why the solar PV power generation industry in China has not rapidly
developed from an investment perspective. When carbon emission trading is
considered, the investment value increases no matter whether the NPV method or RO
method is used. The investment value based on the NPV method is 1159.8 RMB,
which means immediate investment decision can be made. Using the real options
method, however, the investment value is 2019.5 RMB and the optimal investment
time becomes the year 2026, which means that the investment should be delayed. If
immediate investment decision is made, the delay option value 859.7 RMB
(2019.5-1159.8=859.7) would be abandoned.
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Comparing the results with and without carbon emission trading, we may find
that carbon emission trading influences the investment value and optimal investment
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timing, and then changes the investment decision. The value that carbon emission
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trading brings to investors with the NPV method (1594.3 RMB) is higher than that
with the RO method (834.2 RMB). And whether or not to consider carbon emission
trading, the subsidy value with RO is always less than that with NPV. These indicate
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that the significance of subsidy and carbon emission trading in promoting renewable
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energy investment is decreasing in the long run. Additionally subsidy value is always
higher than carbon emission trading value, which indicates carbon emission trading
cannot replace the role of subsidy on promoting investment for solar PV power
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In addition, we can also find the impact of using real options method relative to
the NPV approach by comparing the results calculated with these two methods. On
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one hand, since the determination of investment strategy with real options method
synthetically considers the investors managerial flexibility and the uncertainties in
the long-term changes of CO2 price, investment cost, the NRE cost and the subsidy
policy, the derived investment strategy, which may grasp the future investment
opportunities and make the best of new information, can bring the maximal
investment value to investors. In this case, investors are more willing to delay
investment decision, which is obviously not conductive to the growth of solar PV
power generation. On the other hand, the government can deprive the underlying
reasons that limit the further growth of solar PV power generation from an investment
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perspective. Thus the government can introduce more useful and appropriate policies
to minimize the possibility of policy risk and promote the investment in solar PV
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Table 4
Methods
Investment
value
Delay
Option value
Without
carbon
trading
NPV
-434.5
RO
1185.3
With
carbon
trading
NPV
1159.8
RO
2019.5
Subsidy
value
Investment
decision
7409.5
Dont invest
1619.8
1042.3
Invest in 2028
1594.3
7409.5
Invest
immediately
834.2
1232.3
Invest in 2026
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859.7
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Carbon
trading
value
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Scenarios
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electricity, CO2 price and investment cost. It is meaningful to examine the sensitivity
of investment value and optimal investment timing with respect to these factors.
Based on this, we may acquire some useful findings on how to promote more
investments in solar PV power generation project.
(1) Unit generating capacity
Fig. 7 shows the changes of investment value and optimal investment timing
under different levels of unit generating capacity. The solar energy resource, i.e.
natural resource endowment, is mainly reflected in the unit generating capacity for
solar PV system. Currently, the unit generating capacity of solar system ranges from
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1000 kWh to 2100 kWh in China. As shown in Fig. 7, on one hand, the investors in
the regions with high unit generating capacity would get more benefit. The investment
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value increases from 663 RMB at the lowest capacity level to 5671.8 RMB at the
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highest capacity level with an average growth rate of 21.7%. On the other hand, the
optimal investment timing is shifted to an earlier year with the increase of unit
generating capacity. When unit generating capacity is increased to over 1900 kWh,
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the optimal investment time becomes the year 2016, which indicates that it may not
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be necessary to provide policy support to solar project investors in the regions with
such unit generating capacity. However, when unit generating capacity is under this
level, the policy support, which could play an important role in encouraging investors
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The results described have some policy implications. On one hand, although
China is abundant with solar energy resources, the distribution of solar energy
resources is extremely uneven. Thus government can adjust the nationwide unified
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incentive policies, e.g. FIT and tax incentive, and make them be to be sub-regional,
which helps perfect market system and promote the investment on solar PV power
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generation project with minimum extra financial support. On the other hand, unit
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Fig. 8 shows how investment value and optimal investment timing vary with the
change of subsidy level. The government may take different policies, e.g. subsidy and
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tax incentive, to influence investment value and optimal investment timing, and then
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affect the investors decisions. Compared with subsidy, the scope and strength of tax
incentive are relatively small, so we only consider subsidy here. It can be seen from
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Fig. 8 that the effect of subsidy is significant. On the one hand, the investment value
increases from 786 RMB to 6897 RMB with an average growth rate of 24.5%. On the
other hand, the optimal investment timing is shifted to an earlier year. When subsidy
increases to 0.7 RMB/kWh, the optimal investment timing will be advanced to the
year 2016. Currently, the average subsidy level for solar PV power generation in
China is about 0.54 RMB/kWh which is not high enough to attract immediate
investment of solar PV project obviously.
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The above analysis provides a way to assess subsidy level from the perspective
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On the other hand, the optimal investment timing is advanced to an earlier year with
the increase of market price of electricity. When electricity price is increased to 0.8
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RMB/kWh, the optimal investment timing becomes the year 2016, which indicates
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that immediate investment decisions could be made. Although we cannot increase the
market price of electricity freely, we can provide higher subsidy for investors to
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Fig. 10 shows the changes of investment value and optimal investment timing
under different volatility levels of electricity price. The electricity price volatility,
which mainly comes from the fluctuation of NRE cost, could lead to an increase in the
investment value with an average rate 18.2%. This is consistent with the main idea of
the real options theory. In addition, the optimal investment timing is delayed by the
increase of electricity price volatility. As long as the volatility rate is increased to 0.05,
the optimal investment timing could be postponed to the year 2030. Although the
volatility of electricity price helps increase investment value, it postpone the optimal
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investment timing. To solve negative effects caused by volatility of electricity price,
Governments can take two measures. First, since coal-fired power generation fully
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dominates thermal power generation in China, they can take measures, e.g. improving
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the legal system, regulating market management and guaranteeing supply, to maintain
the stability of coal price. Second, the reason that solar PV power generation
investment could be affected by volatility of market price of electricity is the
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pricing mechanism which is more suitable for solar power and could make solar
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of investment environment. It can be seen from Fig. 11 that when CO2 price increases
from 0 to 0.48 RMB/kWh, the investment value increases from 1185.3 RMB to
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5486.5 RMB. And the optimal investment timing is also advanced to an earlier year.
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When CO2 price is increased to 0.48 RMB/kWh, the immediate investment decision
could be made in 2016. Carbon emission trading scheme can be recognized as an
incentive measures for renewable energy. With the implementation of carbon emission
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national carbon emission policy, the deepening of civil understanding for low-carbon
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idea and the promotion of low-carbon technology. It can be imagined carbon emission
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trading scheme would provide more support for promoting investment of solar PV
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Fig. 12 displays the changes of investment value and the optimal investment
timing caused by the CO2 price volatility. The increase of CO2 price volatility could
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increase the investment value with an average growth rate 7.9%. The investment
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value increases from 1968.2 RMB when the volatility rate of CO2 price is 0 to 4145.4
RMB when the volatility rate of CO2 price is 0.1. However, the increase of CO2 price
volatility could postpone the optimal investment timing. Once the volatility rate of
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CO2 price is raised to 0.06, the optimal investment timing could be delayed to the year
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2030. Thus the volatility of CO2 price is positive related to investment value and
negative related to the optimal investment timing. Government should take measures,
e.g. perfecting market and policy system, regulating operation management and
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own rich experience in carbon emission trading, to maintain the stability of the
CO2 price. Only by these can we attract more immediate investment and minimize the
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(5) Investment cost
Fig. 13 shows how the investment value and optimal investment timing vary
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with the change of unit investment cost. Currently, solar PV power generation
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technology is still immature. High investment cost is still one of the most important
factors affecting solar PV project investment. As shown in Fig. 13, the investment
value decreases at an average rate 14.9% with the increase of investment cost, and the
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optimal investment timing is postponed to a later year. If unit investment cost could
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be reduced to 9000 RMB, the optimal investment timing could be advanced to the
year 2016. Clearly, the level of investment cost is not conductive to increase
investment value and advance optimal investment timing. Investment cost couldnt be
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fundamentally reduced by market control measures. The most basic way is to promote
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Fig. 14 shows the changes of investment value and optimal investment timing
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gradual reduction of investment cost in the long run. In this case, the long-term
reduction trend of investment cost is slowed down and the cost advantage in the future
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is reduced. Therefore, the investment value is reduced from 2105.9 RMB when the
volatility rate of investment cost is 0 to the 1996 RMB when the volatility rate of
investment cost is 0.1 with an average growth rate 0.5%. At the same time, the
optimal investment timing is gradually advanced from the year 2027 to the year 2023
with the increase of investment cost volatility. Although the increase of investment
cost volatility can advance optimal investment timing, it is not conductive the
development of solar PV power generation because of its adverse effects on the
reduction of investment cost and the growth of investment value.
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5. Conclusions
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CO2 price and investment cost on investment value and optimal investment timing
could also be examined by sensitivity analysis.
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several interesting findings. First, we find that the current investment environment in
China is not positive enough to attract immediate investment, which could explain
why the development of solar PV power generation industry in China is not as rapid
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investment value tends to increase substantially, and the optimal investment timing
could also be shifted to an earlier year. Third, the increase of unit generating capacity,
market price of electricity, CO2 price and subsidy could increase investment value and
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advance optimal investment timing, whereas the increase of investment cost plays an
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opposite role. The volatility in market price of electricity and CO2 price could delay
the optimal investment timing though it would increase investment value. The
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volatility of investment cost could slightly advance optimal investment timing and
reduce investment value.
These results have some important policy implications. First, China government
should increase subsidy so that the investment without delay becomes the optimal
strategy for the investors. Second, maintaining stability of market conditions,
including CO2 price and market price of electricity, are also important for attracting
immediate investment. It indicates that increasing subsidy should be implemented
together with maintaining the stability of market condition. Otherwise, the effects of
policies would be greatly reduced, and the financial burden of government would be
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increased seriously. Third, China government should take a variety of measures, e.g.
increasing the expenditure on R&D, establishing R&D investment guarantee
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While our proposed model considers the actual situations in China as much as
possible, it inevitably has some limitations in view of the complexity of renewable
energy investment. First, there could be other influencing factors that are not
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resulting from technological progress is not considered in this paper. Third, due to the
limitation of data, we only use GBM to describe uncertain factors which may be
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insufficient. And the accurate values of drift rate and volatility rate are also difficult to
be estimated. Further researches could be carried out to improve the evaluation model
by addressing these limitations. Given the importance of other types of renewable
energy in China, it is also worthwhile applying our model to evaluate other renewable
energy projects by considering their special characteristics.
Acknowledgements
The authors gratefully acknowledge the financial support provided by the
National Natural Science Foundation of China (nos. 71573121, 71573119, 71273005
& 71373122), the Jiangsu Natural Science Foundation for Distinguished Young
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Scholar (no. BK20140038), the Ph.D. Programs Foundation of Ministry of Education
of China (no. 20123218110028), the 333 programme research project in Jiangsu
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province (no. BRA2015332), and the NUAA fundamental research fund (nos.
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Research Highlights
Propose real option model for evaluating renewable energy investment under
uncertainty
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