Investment Valuation Model for Renewable Energy Systems in Buildings
Publication: Journal of Construction Engineering and Management
Volume 141, Issue 2
Abstract
Transformative technologies for producing renewable energy have promising features for substantial reductions in carbon emissions and environmental footprints of the building sector. Investments in renewable energy systems require substantial implementation costs followed by a long period of recovering the invested capital through savings in utilities bills. Favorable timing of renewable energy system implementation can reduce capital expenses and enhance returns on investments. An appropriate investment valuation method is needed to identify the appropriate time to implement any given renewable energy system and to find the values of properly scheduled investments. Real options analysis provides the ability to cope with investment timing under uncertainty. However, current real options models are theoretically limited in the context of decision making about investments in building energy improvements. In this paper, the writers address the theoretical limitations of current real options models and create a new real options model to evaluate investment options for renewable energy systems under uncertainty. This theoretically well-founded and practically useful model is tailored to the context of investment decision making for building energy improvements. The primary contribution of this research to the body of knowledge is the creation of (1) a method to account for uncertainty about energy savings following the implementation of renewable energy systems in buildings; (2) a novel method to estimate the volatility of renewable energy projects subject to uncertainty; and (3) an investment valuation approach to identifying the best time to implement renewable energy systems in buildings and to determine the corresponding investment option value. It is expected that this work will contribute to the construction engineering and management global community by presenting a new class of investment assessment tools that help in making hard energy investment decisions and will therefore increase the likelihood of achieving ambitious goals for the adoption of renewable energy systems.
Get full access to this article
View all available purchase options and get full access to this article.
Acknowledgments
This paper is based on work supported by the National Science Foundation under Grant No. NSF-CMMI 1300918.
References
Albrecht, J. (2007). “The future role of photovoltaics: A learning curve versus portfolio perspective.” Energy Policy, 35(4), 2296–2304.
Arboleda, C. A., and Abraham, D. M. (2006). “Evaluation of flexibility in capital investments of infrastructure systems.” Eng. Constr. Archit. Manage., 13(3), 254–274.
Ashuri, B., Rouse, W. B., and Bodner, D. (2008). “A real options approach to investment decisions in competitive, dynamic retail markets.” Proc., 2008 Hawaii Int. Conf. on System Sciences (HICSS-41), IEEE Computer Society Press, Los Alamitos, CA.
Bechberger, M., and Reiche, D. (2004). “The spread of renewable energy feed-in tariffs (REFITs) in the EU-25.” Proc., Berlin Conf. on the Human Dimensions of Global Environmental Change“Green Policies-Interlinkages and Policy Integration, Berlin.
Benaroch, M., Lichtenstein, O., and Robinson, K. (2006). “Real options in IT risk management: An empirical validation of risk-option relationships.” MIS Q., 30(4), 827–864.
Black, F., and Scholes, M. (1973). “The pricing of options and corporate liabilities.” J. Political Econ., 81(3), 637–654.
Borison, A. (2005). “Real options analysis: Where are the emperor’s clothes?” J. Appl. Corporate Finance, 17(2), 17–31.
Brandão, L. E. T., and Saraiva, E. (2008). “The option value of government guarantees in infrastructure projects.” Constr. Manage. Econ., 26(11), 1171–1180.
Bräutigam, J., Esche, C., and Mehler-Bicher, A. (2003). “Uncertainty as a key value driver of real option.” 7th Annual Real Option Conf.: Theory Meets Practice, Real Options Group, Nicosia, Cyprus.
Brigham, E. F., and Ehrhardt, M. C. (2011). Financial management: Theory and practice, Cengage Learning, Mason, OH.
Brown, M. A. (2010). “Low hanging fruit: Energy efficiency in the South.” Clean Energy Seminar Series, Georgia Institute of Technology, Atlanta.
Carling, K., Håkansson, J., and Rudholm, N. (2012). “Optimal retail location and CO2 emissions.” 〈http://urn.kb.se/resolve?urn=urn:nbn:se:du-11270〉 (Oct. 26, 2013).
Carr, A. J., and Pryor, T. L. (2004). “A comparison of the performance of different PV module types in temperate climates.” Solar Energy, 76(1–3), 285–294.
Cassimon, D., Engelen, P. J., Thomassen, L., and Van Wouwe, M. (2004). “The valuation of a NDA using a 6-fold compound option.” Res. Policy, 33(1), 41–51.
Chiara, N., and Garvin, J. M. (2007). “Utilizing real options for revenue risk mitigation in transportation project financing.” J. Transp. Res. Board, 1993(1), 1–8.
Chow, J. Y. J., and Regan, A. C. (2011). “Real option pricing of network design investments.” Transp. Sci., 45(1), 50–63.
Clarke, B. (2010). “Briefing: Carbon critical design.” Proc. ICE Eng. Sustain., 163(2), 57–59.
Cobb, B. R., and Charnes, J. M. (2004). “Real options volatility estimation with correlated inputs.” Eng. Econ., 49(2), 119–137.
Committee on Climate Change Science and Technology Integration (CCCSTI). (2009). “Strategies for the commercialization and deployment of greenhouse gas intensity-reducing technologies and practices.”, USDOE Office of Policy and International Affairs, Washington, DC.
Copeland, T., and Antikarov, V. (2003). Real options: A practitioners guide, Texere, New York.
Cui, Q., Bayraktar, M. E., Hastak, M., and Minkarah, I. (2004). “Use of warranties on highway projects: A real option perspective.” J. Manage. Eng., 118–125.
Cui, Q., Johnson, P., Quick, A., and Hastak, M. (2008). “Valuing the warranty ceiling clause on New Mexico Highway 44 using a binomial lattice model.” J. Constr. Eng. Manage., 10–17.
Damnjanovic, I., Duthie, J., and Waller, S. T. (2008). “Valuation of strategic network flexibility in development of toll road projects.” Constr. Manage. Econ., 26(9), 979–990.
de Neufville, R., Lee, Y. S., and Scholtes, S. (2008). “Flexibility in hospital infrastructure design.” IEEE Conf. on Infrastructure Systems Rotterdam, IEEE Systems, Man, and Cybernetics Society, New York.
Dixit, A., and Pindyck, R. (1994). Investment under uncertainty, Princeton University Press, NJ.
Doris, E., McLaren, J., Healey, V., and Hockett, S. (2009). “State of the states 2009: Renewable energy development and the role of policy.”, National Renewable Energy Laboratory, Golden, CO.
Dunlop, E. D., and Halton, D. (2006). “The performance of crystalline silicon photovoltaic solar modules after 22 years of continuous outdoor exposure.” Prog. Photovoltaics Res. Appl., 14(1), 53–64.
Elder, J., and Serletis, A. (2011). “Volatility in oil prices and manufacturing activity: An investigation of real options.” Macroecon. Dyn., 15(S3), 379–395.
Ellingham, I., and Fawcett, W. (2006). New generation whole-life costing: Property and construction decision-making under uncertainty, Taylor & Francis, New York.
Evatt, G. W., Soltan, M. O., and Johnson, P. V. (2012). “Mineral reserves under price uncertainty.” Resour. Policy, 37(3), 340–345.
Fan, Y., and Zhu, L. (2010). “A real options based model and its application to China’s overseas oil investment decisions.” Energy Econ., 32(3), 627–637.
Favato, G., Baio, G., Capone, A., Marcellusi, A., and Saverio Mennini, F. (2013). “A novel method to value real options in health care: The case of a multicohort human papillomavirus vaccination strategy.” Clin. Ther., 35(7), 904–914.
Fleten, S. E., Maribu, K. M., and Wangensteen, I. (2007). “Optimal investment strategies in decentralized renewable power generation under uncertainty.” Energy, 32(5), 803–815.
Ford, D. N., and Garvin, M. (2010). “Barriers to real options adoption and use in AEC project management practice.” Real options in engineering design, operations, and management, H. B. Nembhard, ed., CRC Press, London, U.K.
Ford, D. N., Lander, D. M., and Voyer, J. J. (2002). “A real options approach to valuing strategic flexibility in uncertain construction projects.” Constr. Manage. Econ., 20(4), 343–351.
Galera, A., and Soliòo, A. (2010). “A real options approach for the valuation of highway concessions.” J. Transp. Sci., 44(3), 416–427.
Garvin, M. J., and Ford, D. N. (2012). “Real options in infrastructure projects: Theory, practice and prospects.” Eng. Project Organiz. J., 2(1–2), 97–108.
Godinho, P. (2006). “Monte Carlo estimation of project volatility for real options analysis.” J. Appl. Finance, 16(1), 15–30.
Gorovaia, N., and Windsperger, J. (2013). “Real options, intangible resources and performance of franchise networks.” Managerial Decis. Econ., 34(3–5), 183–194.
Greden, L., and Glicksman, L. (2005). “A real options model for valuing flexible space.” J. Corporate Real Estate, 7(1), 34–48.
Greden, L. V., Glicksman, L. R., and Lopez-Betanzos, G. (2006). “A real options methodology for evaluating risk and opportunity of natural ventilation.” J. Solar Energy Eng., 128(2), 204–212.
Groeneveld, B., and Topal, E. (2011). “Flexible open-pit mine design under uncertainty.” J. Min. Sci., 47(2), 212–226.
Hartley, P., Medlock, K. B., Temzelides, T., and Zhang, X. (2010). Innovation, renewable energy, and macroeconomic growth, The James A. Baker III Institute for Public Policy and The Institute of Energy Economics, Tokyo.
Heiman, M. K. (2006). “Expectations for renewable energy under market restructuring: the US experience.” Energy, 31(6), 1052–1066.
Ho, S. P., and Liu, L. Y. (2002). “An option pricing-based model for evaluating the financial viability of privatized infrastructure projects.” Constr. Manage. Econ., 20(2), 143–156.
Hui, E., Ng, I., and Lo, K. (2011). “Analysis of the viability of an urban renewal project under a risk-based option pricing framework.” J. Urban Plann. Dev., 101–111.
Hull, J. C. (2008). Options, futures, and other derivatives, Prentice Hall, Upper Saddle River, NJ.
Johnson, P. V., Evatt, G. W., Duck, P. W., and Howell, S. D. (2011). “The determination of a dynamic cut-off grade for the mining industry.” Electrical engineering and applied computing, Vol. 90, S. I. Ao and L. Gelman, eds., Springer, Berlin, 391–403.
Jordan, D. C., and Kurtz, S. R. (2012). “Photovoltaic degradation risk: Preprint.”, National Renewable Energy Laboratory, Golden, CO.
Jordan, D. C., and Kurtz, S. R. (2013). “Photovoltaic degradation rates—An analytical review.”, National Renewable Energy Laboratory, Golden, CO.
Jordan, D. C., Smith, R. M., Osterwald, C. R., Gelak, E., and Kurtz, S. R. (2011). “Outdoor PV degradation comparison.” 〈http://digitalscholarship.unlv.edu/renew_pubs/46〉 (Oct. 25, 2013).
Jörnsten, K., Lise Nonås, S., Sandal, L., and Ubøe, J. (2012). “Mixed contracts for the newsvendor problem with real options and discrete demand.” Omega, 41(5), 809–819.
Kelly, S. (1998). “A binomial lattice approach for valuing a mining property IPO.” Q. Rev. Econ. Finance, 38(3), 693–709.
Kim, B., Lim, H., Kim, H., and Hong, T. (2012). “Determining the value of governmental subsidies for the installation of clean energy systems using real options.” J. Constr. Eng. Manage., 422–430.
Kumbaroğlu, G., and Madlener, R. (2012). “Evaluation of economically optimal retrofit investment options for energy savings in buildings.” Energy Build., 49(1), 327–334.
Kumbaroğlu, G., Madlener, R., and Demirel, M. (2008). “A real options evaluation model for the diffusion prospects of new renewable power generation technologies.” Energy Econ., 30(4), 1882–1908.
Lowitt, E. (2011). The future of value: How sustainability creates value through competitive differentiation, Wiley, San Francisco.
Luenberger, D. G. (1998). Investment science, Oxford University Press, New York.
Marion, B., and Adelstein, J. (2003). “Long-term performance of the SERF PV systems.” Proc., NCPV and Solar Program Review Meeting, National Renewable Energy Laboratory, Golden, CO, 199–201.
Martinez-Cesena, E. A., Azzopardi, B., and Mutale, J. (2013). “Assessment of domestic photovoltaic systems based on real options theory.” Prog. Photovoltaics, 21(2), 250–262.
McKinsey and Company. (2009). “Unlocking energy efficiency in the U.S. Economy.” McKinsey global energy and materials, 〈http://www.mckinsey.com/client_service/electric_power_and_natural_gas/latest_thinking/unlocking_energy_efficiency_in_the_us_economy〉 (Oct. 25, 2013).
Menassa, C. C. (2011). “Evaluating sustainable retrofits in existing buildings under uncertainty.” Energy Build., 43(12), 3576–3583.
Miller, L. T., and Park, C. S. (2005). “A learning real options framework with application to process design and capacity planning.” Prod. Oper. Manage., 14(1), 5–20.
Moel, A., and Tufano, P. (2002). “When are real options exercised? An empirical study of mine closings.” Rev. Financial Stud., 15(1), 35–64.
Mourelatou, A. (2001). “Renewable energies: Success stories.”, European Environment Agency (EEA) and ECOTEC Research and Consulting, Copenhagen, Denmark.
Muñoz, J. I., Contreras, J., Caamaño, J., and Correia, P. F. (2011). “A decision-making tool for project investments based on real options: The case of wind power generation.” Ann. Oper. Res., 186(1), 465–490.
National Academy of Engineering. (2009). “The potential of energy efficiency: An overview.” Bridge issue: Energy efficiency, 〈http://www.nae.edu/File.aspx?id=14867〉 (Sep. 4, 2014).
Nembhard, H. B., and Aktan, M. (2009). Real options in engineering design, operations, and management, CRC Press, London, U.K.
Nemet, G. F. (2006). “Beyond the learning curve: Factors influencing cost reductions in photovoltaics.” Energy Policy, 34(17), 3218–3232.
Nijman, L. (2012). “The impact of the new wave of financial regulation for European energy markets.” Energy Policy, 47(1), 468–477.
Osterwald, C. R., Anderberg, A., Rummel, S., and Ottoson, L. (2002). “Degradation analysis of weathered crystalline-silicon PV modules.” Proc., 29th IEEE Photovoltaic Specialists Conf., IEEE Foundation, Piscataway, NJ.
Pervaz, M., and Rahman, M. L. (2012). “Review and evaluation of successful and unsuccessful renewable energy projects in south Asia.” Proc., Int. Conf. on Life Science and Engineering, IPCBEE, Vol. 45, IACSIT Press, Singapore.
Pinho, C., and Madaleno, M. (2011). “CO2 emission allowances and other fuel markets interaction.” Environ. Econ. Policy Stud., 13(3), 259–281.
Shan, L., Garvin, M. J., and Kumar, R. (2010). “Collar options to manage revenue risks in real toll public-private partnership transportation projects.” Constr. Manage. Econ., 28(10), 1057–1069.
Sharpe, W. F. (1994). “The Sharpe ratio.” J. Portfolio Manage., 21(1), 49–58.
Sovacool, B. K. (2013). “A qualitative factor analysis of renewable energy and sustainable energy for all (SE4ALL) in the Asia-Pacific.” Energy Policy, 59(1), 393–403.
Stavins, R. N. (2003). “Experience with market-based environmental policy instruments.” Handbook of environmental economics, Vol. 1, K. Mäler and J. Vincent, eds., Elsevier B.V., Amsterdam, Netherlands, 355–435.
Suttinon, P., and Nasu, S. (2010). “Real options for increasing value in industrial water infrastructure.” Water Resour. Manage., 24(12), 2881–2892.
Tran, V., and Tookey, J. E. (2012). “Directions for future construction supply chain management research in New Zealand: A real options perspective.” Int. J. Constr. Supply Chain Manage., 2(1), 34–45.
U.S. Department of Energy. (2008). “Energy efficiency trends in residential and commercial buildings.” 〈http://apps1.eere.energy.gov/buildings/publications/pdfs/corporate/bt_stateindustry.pdf〉 (Sep. 4, 2014).
U.S. Department of Energy. (2011). “Building energy data book.” 〈http://buildingsdatabook.eren.doe.gov/〉 (Oct. 25, 2013).
U.S. Energy Information Administration (EIA). (2010). “Energy price volatility and forecast uncertainty.” 〈http://www.eia.doe.gov/steo/uncertainty.html〉 (Oct. 25, 2013).
U.S. Energy Information Administration (EIA). (2013a). “Annual energy outlook 2013.” 〈http://www.eia.gov/forecasts/aeo/pdf/0383(2013).pdf〉 (Oct. 25, 2013).
U.S. Energy Information Administration (EIA). (2013b). “Annual energy outlook retrospective review: Evaluation of 2012 and prior reference case projections.” 〈http://www.eia.gov/forecasts/aeo/retrospective/pdf/retrospective.pdf〉 (Oct. 25, 2013).
van Reedt Dortland, M., Voordijk, H., and Dewulf, G. (2012). “Towards a decision support tool for real estate management in the health sector using real options and scenario planning.” J. Corporate Real Estate, 14(3), 140–156.
van Reedt Dortland, M., Voordijk, H., and Dewulf, G. (2013). “Real options in project coalitions in Dutch health care: Two case studies of construction projects.” Constr. Manage. Econ., 31(3), 266–286.
Vázquez, M., and Rey-Stolle, I. (2008). “Photovoltaic module reliability model based on field degradation studies.” Prog. Photovoltaics Res. Appl., 16(5), 419–433.
Weiss, M., Junginger, H. M., Patel, M. K., and Blok, K. (2010). “Analyzing price and efficiency dynamics of large appliances with the experience curve approach.” Energy Policy, 38(2), 770–783.
Winston, W. L. (2001). Financial models using simulation and optimization II: Investment valuation, options pricing, real options and product pricing models, Palisade Corporation, Newfield, NY.
Wüstenhagen, R., and Bilharz, M. (2006). “Green energy market development in Germany: Effective public policy and emerging customer demand.” Energy policy, 34(13), 1681–1696.
WWF International (WWF). (2013). Meeting renewable energy targets: Global lessons from the road to implementation, Gland, Switzerland.
Xu, S. X., Lu, Q., and Li, Z. (2012). “Optimal modular production strategies under market uncertainty: A real options perspective.” Int. J. Prod. Econ., 139(1), 266–274.
Yu, C. F., van Sark, W. G., and Alsema, E. A. (2010). “Unraveling the photovoltaic technology learning curve by incorporation of input price changes and scale effects.” Renew. Sustain. Energy Rev., 15(1), 324–337.
Zhang, X., and Kumar, A. (2011). “Evaluating renewable energy-based rural electrification program in western China: Emerging problems and possible scenarios.” Renew. Sustain. Energy Rev., 15(1), 773–779.
Information & Authors
Information
Published In
Copyright
© 2014 American Society of Civil Engineers.
History
Received: Nov 17, 2013
Accepted: Aug 15, 2014
Published online: Sep 23, 2014
Published in print: Feb 1, 2015
Discussion open until: Feb 23, 2015
Authors
Metrics & Citations
Metrics
Citations
Download citation
If you have the appropriate software installed, you can download article citation data to the citation manager of your choice. Simply select your manager software from the list below and click Download.