Optimal Technology Choice and Investment Timing: A Stochastic Model of Industrial Cogeneration vs. Heat-Only Production

Reinhard Madlener and Marcel Wickart ()
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Marcel Wickart: Center for Energy Policy and Economics CEPE, Department of Management, Technology and Economics, ETH Zurich, Switzerland

No 04-37, CEPE Working paper series from CEPE Center for Energy Policy and Economics, ETH Zurich

Abstract: In this paper we develop an economic model that explains the decision-making problem under uncertainty of an industrial firm that wants to invest in a process technology. More specifically, the decision is between making an irreversible investment in a combined heat-and-power production (cogeneration) system, or to invest in a conventional heat-only generation system (steam boiler) and to purchase all electricity from the grid. In our model we include the main economic and technical variables of the investment decision process. We also account for the risk and uncertainty inherent in volatile energy prices that can greatly affect the valuation of the investment project. The dynamic stochastic model presented allows us to simultaneously determine the optimal technology choice and investment timing. We apply the theoretical model and illustrate our main findings with a numerical example that is based on realistic cost values for industrial oil- or gas-fired cogeneration and heat-only generation in Switzerland. We also briefly discuss expected effects of a CO2 tax on the investment decision.

Keywords: Cogeneration; Irreversible investment; Risk; Uncertainty; Real options (search for similar items in EconPapers)
JEL-codes: C61 D21 D81 D92 O33 Q41 Q48 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2004-12
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Journal Article: Optimal technology choice and investment timing: A stochastic model of industrial cogeneration vs. heat-only production (2007)
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