PrintOverview
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), or even the renewable energy industry during 2022 when Build Back Better was defeated, but the inflation Reduction Act passed Building A Clean Energy Economy, 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 primarily will be on quantitative methods for incorporating uncertainty into project analyses, rather than on the sources of uncertainty themselves.
Learning Outcomes
By the end of this lesson, you should be able to:
- Discuss topics related to cost-benefit analysis and decision making
- Calculate the expected monetary value of an energy project in the face of one uncertain variable
- Illustrate the concept of Value at Risk for an energy project
- Explain commodity price risk and how it could affect your project
- Explain what sensitivity analysis is and how you will use it in your project
- Explain two types of uncertainty and how you might mitigate these risks in your project
Reading Materials
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)
- 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 6 module.
What is due for Lesson 6?
This lesson will take us one week to complete. Please refer to the Course Calendar in Canvas for specific due dates. Specific directions and grading rubrics for assignment submissions can be found in the Lesson 6 module in Canvas.
- Participate in the Zoom call
- Complete Quiz 4
Questions?
If you have any questions, please post them to our Questions? discussion forum (not email). I will not be reviewing these. I encourage you to work as a cohort in that space. If you do require assistance, please reach out to me directly after you have worked with your cohort --- I am always happy to get on a one-on-one call, or even better, with a group of you.