How to Proceed with Competing Alternative Energy Technologies: a Real Options Analysis

Concerns with CO2 emissions are creating incentives for the development and deployment of energy technologies that do not use fossil fuels. Indeed, such technologies would provide tangible benefits in terms of avoided fossil-fuel costs, which are likely to increase as restrictions on CO2 emissions are imposed. However, there are a number of challenges that need to be overcome, and the current costs of developing new alternative energy technologies would be too high to be handled privately. We analyse how a government may proceed with a staged development of meeting electricity demand as fossil-fuel sources are being phased out. A large-scale, new alternative technology is one possibility, where one would start a major research and development programme as an intermediate step. Alternatively, the government could choose to deploy an existing renewable energy technology, and using the real options framework, we compare the two projects to provide policy implications on how one might proceed.