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| Title: | Water Resources and Technology Investment Under Uncertainty |
| Authors: | Rice, John |
| Keywords: | real options
power plants
technology investments |
| Issue Date: | Aug-2009 |
| Abstract: | Supporting thermoelectric power generation requires a significant quantity of water, primarily
for cooling operations. Lack of available water due to physical scarcity or thermal permit limits
associated with the Clean Water Act 316 (a) can result in a forced curtailment of plant operation,
known as a “derating event.” Depending on the duration and severity of this derating event, a
utility can realize millions of dollars in economic loss. To prevent such events, a power plant can
invest in alternative cooling technology that reduces the plant’s dependence on large quantities
of water for cooling operations. Such investments however, may be difficult to justify due to
large capital costs for water conservation technologies and highly uncertain future cost of
derating events - future derating costs are a function of climate and energy market prices. Thus,
the capital decision to invest is complex. Traditional valuation approaches, like Net Present
Value (NPV) analysis, are unable to properly value irreversible investments in environments of
high uncertainty because they fail to account for managerial discretion and flexibility in
investment. Real options analysis (ROA) has been proposed as a promising solution to the
deficiencies of traditional valuation methods when facing risky technology investments or
ventures. The valuation technique, rooted in financial option theory, incorporates “Real option
thinking” - the managerial flexibility to capitalize on opportunities as they arise and minimize the
impact of threats - is precisely what is needed when faced with the uncertain future of
irreversible technology investments. This paper applies ROA to an evaluation of the investment
in water saving cooling technology at the Allen Steam Station in the Catawba River Basin of
North and South Carolina. The results indicate that the use of an NPV analysis leads to an
undervaluation of the project because the option value - the value of managerial flexibility - is
not included in the valuation. The flexibility of managers is an important criterion for making
decisions regarding sunk cost investments and firms should evaluate investments with techniques
that incorporate this option value. |
| Appears in Collections: | Natural Resources and Environment, School of (SNRE)
Dissertations and Theses (Ph.D. and Master's)
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| john rice practicum 0809.pdf | rice_practicum | 1743Kb | Adobe PDF | View/Open |
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