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Climate Policy Uncertainty and Investment Behavior: Evidence from Small Hydropower Plants

Using real options theory and a multivariate discrete choice model, we investigate how investments in renewable electricity production are affected by climate policy uncertainty. More specifically, based on panel data of 214 licenses to construct small hydropower plants, we examine whether uncertainty with respect to the introduction of a market for green certificates has affected the timing of investments in small hydropower plants Norway from 2001 to 2010. We find that real options models, which translate uncertainty into investment risk, give better explanation of investors' behavior compared to traditional net present value analysis.