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Risk Hedging Strategies Under Energy System and Climate Policy Uncertainties

In: Handbook of Risk Management in Energy Production and Trading

Author

Listed:
  • Volker Krey

    (IIASA)

  • Keywan Riahi

    (IIASA)

Abstract

The future development of the energy sector is rife with uncertainties. They concern virtually the entire energy chain, from resource extraction to conversion technologies, energy demand, and the stringency of future environmental policies. Investment decisions today need thus not only to be cost-effective from the present perspective, but have to take into account also the imputed future risks of above uncertainties. This chapter introduces a newly developed modeling decision framework with endogenous representation of above uncertainties. We employ modeling techniques from finance and in particular modern portfolio theory to a systems engineering model of the global energy system and implement several alternative representations of risk. We aim to identify salient characteristics of least-cost risk hedging strategies that are adapted to considerably reduce future risks and are hence robust against a wide range of future uncertainties. These lead to significant changes in response to energy system and carbon price uncertainties, in particular (i) higher short- to medium-term investments into advanced technologies, (ii) pronounced emissions reductions, and (iii) diversification of the technology portfolio. From a methodological perspective, we find that there are strong interactions and synergies between different types of uncertainties. Cost-effective risk hedging strategies thus need to take a holistic view and comprehensively account for all uncertainties jointly. With respect to costs, relatively modest risk premiums (or hedging investments) can significantly reduce the vulnerability of the energy system against the associated uncertainties. The extent of early investments, diversification, and emissions reductions, however, depends on the risk premium that decision makers are willing to pay to respond to prevailing uncertainties and remains thus one of the key policy variables.

Suggested Citation

  • Volker Krey & Keywan Riahi, 2013. "Risk Hedging Strategies Under Energy System and Climate Policy Uncertainties," International Series in Operations Research & Management Science, in: Raimund M. Kovacevic & Georg Ch. Pflug & Maria Teresa Vespucci (ed.), Handbook of Risk Management in Energy Production and Trading, edition 127, chapter 0, pages 435-474, Springer.
    • Handle: RePEc:spr:isochp:978-1-4614-9035-7_17
    DOI: 10.1007/978-1-4614-9035-7_17
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    Citations

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    Cited by:

    1. Parkinson, Simon C. & Djilali, Ned, 2015. "Long-term energy planning with uncertain environmental performance metrics," Applied Energy, Elsevier, vol. 147(C), pages 402-412.
    2. Way, Rupert & Lafond, François & Lillo, Fabrizio & Panchenko, Valentyn & Farmer, J. Doyne, 2019. "Wright meets Markowitz: How standard portfolio theory changes when assets are technologies following experience curves," Journal of Economic Dynamics and Control, Elsevier, vol. 101(C), pages 211-238.
    3. Karani Anthony Muriithi & Odari Sammy & Noor Shalle, 2021. "Moderating Effect of Environmental Uncertainties on the Relationship between Risk Hedging Supply Chain Strategy and Performance of Manufacturing Firms in Kenya," International Journal of Management Science and Business Administration, Inovatus Services Ltd., vol. 8(1), pages 45-49, November.
    4. Leibowicz, Benjamin D. & Krey, Volker & Grubler, Arnulf, 2016. "Representing spatial technology diffusion in an energy system optimization model," Technological Forecasting and Social Change, Elsevier, vol. 103(C), pages 350-363.
    5. Leibowicz, Benjamin D., 2015. "Growth and competition in renewable energy industries: Insights from an integrated assessment model with strategic firms," Energy Economics, Elsevier, vol. 52(PA), pages 13-25.
    6. Hossain, Ashrafee T. & Masum, Abdullah-Al, 2022. "Does corporate social responsibility help mitigate firm-level climate change risk?," Finance Research Letters, Elsevier, vol. 47(PB).
    7. Yulei Xie & Zhenghui Fu & Dehong Xia & Wentao Lu & Guohe Huang & Han Wang, 2019. "Integrated Planning for Regional Electric Power System Management with Risk Measure and Carbon Emission Constraints: A Case Study of the Xinjiang Uygur Autonomous Region, China," Energies, MDPI, vol. 12(4), pages 1-14, February.
    8. Zhou, Mo, 2015. "Adapting sustainable forest management to climate policy uncertainty: A conceptual framework," Forest Policy and Economics, Elsevier, vol. 59(C), pages 66-74.

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