Managerial flexibility in levelized cost measures: A framework for incorporating uncertainty in energy investment decisions

John Bistline, Stephen D. Comello and Anshuman Sahoo

Energy, 2018, vol. 151, issue C, 211-225

Abstract: Many irreversible long-run capital investments entail opportunities for managers to respond flexibly to changes in the economic environment. However, common levelized cost measures used to guide decision-making, such as the levelized cost of electricity, implicitly assume that the values of random economic variables are known with certainty when investment decisions are made. This assumption implies, often incorrectly, that managerial flexibility carries zero value. This paper improves levelized cost measures by deriving an expansion that accounts for both uncertainties in relevant variables and the value of managerial flexibility in responding to them. This method is applied to quantify the value of flexibility in two example decision problems. In one, an operator of a natural gas electricity generation facility evaluates whether to invest in carbon capture capabilities. Another considers retirement decisions for U.S. nuclear plants. These examples illustrate that simplified cost metrics can inaccurately guide decision-making by inflating cost estimates relative to the proposed levelized cost measure that accounts for uncertainty and flexibility.

Keywords: Levelized cost; Managerial flexibility; Uncertainty; Investment decision-making; Operational decision-making (search for similar items in EconPapers)
Date: 2018
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Working Paper: Managerial Flexibility in Levelized Cost Measures: A Framework for Incorporating Uncertainty in Energy Investment Decisions (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:energy:v:151:y:2018:i:c:p:211-225

DOI: 10.1016/j.energy.2018.03.036

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