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Energy intensive infrastructure investments with retrofits in continuous time: Effects of uncertainty on energy use and carbon emissions

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  • Framstad, Nils Chr.
  • Strand, Jon
Abstract
Energy-intensive infrastructure may tie up fossil energy use and carbon emissions for a long time after investment, and thus be crucial for the ability to control long-run emissions. Much or most of the resulting carbon emissions can often be eliminated later, through a retrofit that may however be costly. This paper studies the joint decision to invest in such infrastructure, and retrofit it later, given that future climate damages are uncertain and follow a geometric Brownian motion process with positive drift. We find that higher climate cost volatility (for given unconditional expected costs) then delays the retrofit decision by increasing the option value of waiting to invest. The initial infrastructure is also chosen with higher energy intensity, further increasing total emissions, when volatility is higher. We provide conditions under which higher climate cost volatility increases total expected discounted climate damage from the infrastructure, which happens in a wide set of circumstances.

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  • Framstad, Nils Chr. & Strand, Jon, 2015. "Energy intensive infrastructure investments with retrofits in continuous time: Effects of uncertainty on energy use and carbon emissions," Resource and Energy Economics, Elsevier, vol. 41(C), pages 1-18.
    • Handle: RePEc:eee:resene:v:41:y:2015:i:c:p:1-18
    DOI: 10.1016/j.reseneeco.2015.03.003
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    Cited by:

    1. Bernard Lapeyre & Emile Quinet, 2017. "A Simple GDP-based Model for Public Investments at Risk," Post-Print hal-01666574, HAL.
    2. Strand, Jon, 2014. "Implications of a lowered damage trajectory for mitigation in a continuous-time stochastic model," Energy Economics, Elsevier, vol. 42(C), pages 43-49.
    3. Nils Chr. Framstad, 2014. "When can the environmental profile and emissions reduction be optimised independently of the pollutant level?," Journal of Environmental Economics and Policy, Taylor & Francis Journals, vol. 3(1), pages 25-45, March.
    4. Chiu, Yi-Bin, 2017. "Carbon dioxide, income and energy: Evidence from a non-linear model," Energy Economics, Elsevier, vol. 61(C), pages 279-288.
    5. Strand, Jon & Miller, Sebastian & Siddiqui, Sauleh, 2014. "Long-run carbon emission implications of energy-intensive infrastructure investments with a retrofit option," Energy Economics, Elsevier, vol. 46(C), pages 308-317.
    6. Lingyun He & Fang Yin & Zhangqi Zhong & Zhihua Ding, 2017. "The impact of local government investment on the carbon emissions reduction effect: An empirical analysis of panel data from 30 provinces and municipalities in China," PLOS ONE, Public Library of Science, vol. 12(7), pages 1-20, July.

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    More about this item

    Keywords

    Greenhouse gas emissions; Long-term investments; Retrofits; Uncertainty; Option value of waiting;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • R42 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government and Private Investment Analysis; Road Maintenance; Transportation Planning

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