Influence of regulatory uncertainty on capacity investments – Are investments in new technologies a risk mitigation measure?

Understanding the investment decisions of power companies is vital for a regulator as particularly deficient investments in generation capacity could jeopardize the market in the long run. Considering potential risks that could hamper investments, the paper focuses on regulatory uncertainty and firms’ behavior to mitigate risk. The question of how uncertainty influences investment decisions has been explained by a number of researchers. In the specific case of regulatory uncertainty it is agreed that organizational strategies and decision processes are influenced. However, it is not agreed whether this form of environmental uncertainty triggers or hampers investment decisions. One stream in literature supports the argumentation that regulatory uncertainty results in reducing, postponing or cancelling of decisions. An opposing stream questions the direct consequence of regulatory uncertainty and the link to postponements of investment decisions. The argumentation can be based on either a real-option perspective that states that an organization exposed to regulatory uncertainty can have a benefit from small initial investments. Or the resource-based view can be predominant that argues that environmental uncertainty increases the probability that a company invests proactively. The paper provides a literature review to give a better understanding of the impact of regulatory uncertainty on firms and their corporate responses to mitigate the risk associated to generation investments. We further discuss potential investments in new technologies in the current environment (especially CCS) as risk mitigation measure in the light of regulatory uncertainty. Finally, we propose a new framework to give an answer to the question of generation investment under uncertainty. By matching the factor of irreversibility with the degree of perceived regulatory uncertainty, firms will follow different investment strategies, depending of the combination of the factors and value of the option to postpone based on the real option approach. Therefore, at highly regulatory uncertainty firms may prefer to invest in new technologies because of their high flexibility and high option value and rather postpone large irreversible projects.