Real Option Valuation of an Emerging Renewable Technology Design in Wave Energy Conversion

DiLellio, James A and Butler, John C and Rizaev, Igor G and Sheng, Wanan and Aggidis, George (2025) Real Option Valuation of an Emerging Renewable Technology Design in Wave Energy Conversion. ECONOMETRICS, 13 (1): 11. pp. 1-18. ISSN 1301-0011

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Abstract

The untapped potential of wave energy offers another alternative to diversifying renewable energy sources and addressing climate change by reducing CO2 emissions. However, development costs to mature the technology remain significant hurdles to adoption at scale and the technology often must compete against other marine energy renewables such as offshore wind. Here, we conduct a real option valuation that includes the uncertain market price of wholesale electricity and managerial flexibility expressed in determining future optimal decisions. We demonstrate the probability that the project’s embedded compound real option value can turn a negative net present value wave energy project to a positive expected value. This change in investment decision uses decision tree analysis, where real options are developed as decision nodes, and models the uncertainty as a risk-neutral stochastic process using chance nodes. We also show how our results are analogous to a financial out-of-the-money call option. Our results highlight the distribution of outcomes and the benefit of a staged long-term investment in wave energy systems to better understand and manage project risk, recognizing that these probabilistic results are subject to the ongoing evolution of wholesale electricity prices and the stochastic process models used here to capture their future dynamics. Lastly, we show that the near-term optimal decision is to continue to fund ongoing development of a reference architecture to a higher technology readiness level to maintain the long-term option to deploy such a renewable energy system through private investment or private–public partnerships.