In one sense, energy projects are no different than playing the roulette wheel in Las Vegas. Both are inherently risky, and you may well not have the shirt left on your back at the end. Actually, in one important sense, you should feel more confident about the roulette wheel than with energy projects – with roulette at least you know how terrible your odds are, and nothing is going to change those terrible odds. Because the financial fate of energy projects winds up so often in the hands of market and political factors, both of which can turn on a dime (just ask the coal industry following the publication of the Clean Power Plan, or electricity demand response companies like EnerNOC when a major aspect of its business model was overturned by the DC Circuit Court in 2014 - even though that ruling was eventually overturned by the Supreme Court), it can be difficult to know whether your project has a good or bad chance of succeeding. Given the nature of energy project investing – large up-front capital costs that must be recovered over a long duration – it’s sometimes a wonder that anything gets built at all!
The basic problem here is that the future is uncertain. In this lesson, we will look at a few different ways of considering uncertainty in project evaluation. Uncertainty has lots of different sources – markets may shift during a project cycle, making commodities more or less valuable; regulations may change; or public opposition to a project may be stronger than initially anticipated, making project permitting and siting all but impossible. Our focus here will be primarily on quantitative methods for incorporating uncertainty into project analyses, rather than on the sources of uncertainty themselves.
By the end of this lesson, you should be able to:
- calculate the expected monetary value of an energy project in the face of one uncertain variable;
- implement sensitivity analysis to examine the robustness of energy project performance to changes in key parameters;
- perform a threshold or breakpoint analysis on a single uncertain variable;
- illustrate the concept of Value at Risk for an energy project;
- explain the role of regulatory uncertainty in delaying market deployment of low-carbon energy technologies.
We will draw on sections from the following readings. The readings on coal-fired power plants and wind plants are a bit out of date but are useful illustrations of the types of uncertainty that energy projects face in the real world.
- M.G. Morgan, et al., “The U.S. Electric Power Sector and Climate Change Mitigation,” Section II (pp. 20-26)
- D. Berry, “Investment Risk of New Coal-Fired Power Plants”
- U.S. Energy Information Administration (EIA), “Wind Production Tax Credit Set to Expire in 2012”
- A. Damadoran, “Value at Risk”
Registered students can access copies of the readings in the Lesson 10 - External Readings page in Canvas.
What is due for Lesson 10?
This lesson will take us one week to complete. Please refer to the Course Calendar in Canvas for specific due dates. Specific directions for the assignment below can be found within this lesson.
- Submit a word-processed document with the answer to the Lesson 10 question to the Lesson 10 Drop Box.
- Don't forget that there is a final project deliverable coming up!
If you have any questions, please post them to our Questions about EME 801? discussion forum (not email), located in the Lesson 00 module in Canvas. I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.