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Optimal Energy R&D Portfolio Investments in Response to a Carbon Tax

In this paper, we deal with a very timely issue-R&D strategies needed for compliance with a climate policy in an economically optimal way. We provide interesting insights into the composition of R&D portfolios across the main mitigation options for decision makers and policy makers. We address the optimal R&D investment response of a decision maker or an engineering manager-at the firm level with a portfolio of alternative technologies-to a rising carbon tax. Understanding the optimal allocation of investments in these technologies is crucial because like most economic resources, there is a limitation on the investment capabilities of a firm to undertake these innovative efforts. In addition, environmental R&D spending is irreversible and investment decisions made today have multiperiod consequences on the energy technologies landscape. Thus, we explore the reaction of a firm's optimal investment in an energy R&D portfolio comprising four different technologies to increases in a future carbon tax. We find that investment allocation depends on the elasticity of substitution between fossil and nonfossil energy inputs, and the relative costs and efficacy of the R&D programs; and that overall investment tends to decrease in risk depending on firm flexibility and specifications.