Determining the Value of Governmental Subsidies for the Installation of Clean Energy Systems Using Real Options

Abstract

Limiting greenhouse gas emissions has continually gained importance since the Kyoto protocol became effective in 2005. A variety of efforts have been made to reduce energy consumption and introduce supposedly clean and renewable energy that can replace fossil fuelbased energy sources. However, many clean energy sources are not economically viable by themselves, and, therefore, government subsidies are necessary to provide sufficient economic motivation for the installation of new types of energy. For that reason, it is necessary to develop a method for reasonably and accurately determining an appropriate level of government subsidy for private entities. In this paper we propose a real option-based framework for rationally quantifying the amount of government subsidy required by private entities in order to implement a clean energy generation system. A case study that involved the installation of a photovoltaic system in an average household in Seoul, Korea was conducted in order to verify the proposed framework. The proposed framework is expected to help energy policymakers choose the proper level of government subsidy that will effectively encourage private entities to install clean energy systems without wasting taxpayers’ money.