Investment Uncertainty Analysis for Smart Grid Adoption: A Real Option Approach

Abstract

The growth of smart grid technologies is already defining energy in the 21st century: smart cities depend on the smart grid for resilient energy delivery and improved energy efficiency. Adopting the smart grid under conditions of uncertainty demands focused attention and innovative approaches. This paper employs the Real Options Approach (ROA) to study how utilities make investment decisions regarding smart grid information technology innovation, under conditions of investment uncertainty. We argue that investing in the smart grid is analogous to having the option rights in a call option in the US financial market. We propose a model in which the smart grid cost is taken as the primary decision variable to identify the optimal first time for utility suppliers to adopt the smart grid. This study demonstrates that ROA can be an important tool for simulating the impact of public policy on the adoption of the smart grid technology of electric utilities.

Keywords: smart grid, information technology, real options theory, investment under uncertainty, public policy