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Uncertainty and Energy Saving Investments

Matti Liski and Pauli Murto

March 2010

Matti Liski and Pauli Murto, March 2010

Energy costs are notoriously uncertain but what is the effect of this on energysaving investments? We find that real-option frictions imply a novel equilibrium response to increasing but uncertain energy costs: early investments are cautious but ultimately real-option frictions endogenously vanish, and the activity affected by higher energy costs fully recovers. We use electricity market data for counterfactual analysis of the real-option mark-ups and policy experiments. Uncertainty alone implies that the early compensation to new technologies exceeds entry costs by multiple factors, and that uncertainty-reducing subsidies to green energy can benefit the consumer side at the expense of the old capital rents, even in the absence of externalities from energy use.

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