A real options approach to renewable electricity generation in the Philippines

Abstract

Background: The Philippines is making a significant stride to become energy independent by developing more sustainable sources of energy. However, investment in renewable energy is challenged by competitive oil prices, very high investment cost for renewable energy, and high local electricity prices. This paper evaluates the attractiveness of investing in renewable energy sources over continue using oil for electricity generation. Methods: This paper uses the real options approach to analyze how the timing of investment in renewable energy depends on volatility of diesel price, electricity price, and externality for using oil. Results: The result presents a positive net present value for renewable energy investment. Under uncertainty in oil prices, dynamic optimization describes how waiting or delaying investment in renewables incurs loses. Decreasing the local electricity price and incorporating negative externality favor investment in renewable energy over continuing the use of oil for electricity generation. Conclusions: Real options approach highlights the flexibility in the timing of making investment decisions. At the current energy regime in the Philippines, substituting renewable energy is a better option than continue importing oil for electricity generation. Policies should aim at supporting investment in more sustainable sources of energy by imposing externality for using oil or decreasing the price of electricity.