Estimating the influence of U.S. ethanol policy on plant investment decisions: A real options analysis with two stochastic variables

U.S. ethanol policies have contributed to changes in the levels and the volatilities of revenues and costs facing ethanol firms. The implications of these policies for optimal investment behavior are investigated through an extension of the real options framework that allows for the consideration of...

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Bibliographic Details
Published in:Energy economics 2011-11, Vol.33 (6), p.1194-1205
Main Authors: Schmit, T.M., J., Luo, Conrad, J.M.
Format: Article
Language:English
Subjects:
Applied sciences
Biofuels
Correlation
Cost
Cost analysis
Costs
Economic data
Economics
Electric power
Energy
Energy economics
Energy policy
Ethanol
Ethyl alcohol
Exact sciences and technology
Financing
General, economic and professional studies
Government policy
Industry
Investment
Investments
Markets
Natural energy
Optimization
Policies
Policy
Power generation
Production
Profitability
Real options
Real options analysis
Renewable energy sources
Revenue
Revenues
Stochastic models
Studies
U.S.A
Volatility
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Summary:U.S. ethanol policies have contributed to changes in the levels and the volatilities of revenues and costs facing ethanol firms. The implications of these policies for optimal investment behavior are investigated through an extension of the real options framework that allows for the consideration of volatility in both revenue and cost components, as well as the correlation between them. The effects of policy affecting plant revenues dominate the effects of those policies affecting production costs. In the absence of these policies, much of the recent expansionary periods would have not existed and market conditions in the late-1990s would have led to some plant closures. We also show that, regardless of plant size, U.S. ethanol policy has narrowed the distance between the optimal entry and exit curves, implying a more narrow range of inactivity and indicative of a more volatile evolution for the industry than would have existed otherwise. ► An extended real options framework with two stochastic variables is developed. ► Ethanol expansion largely induced by the revenue-enhancing effects of policy. ► Removing effects of policy changes optimal entry/exit environment considerably. ► To expand US ethanol industry, size of policy contributions needs to grow. ► US ethanol policy has fostered more volatile industry development.
ISSN:0140-9883
1873-6181
DOI:10.1016/j.eneco.2011.07.013