Shaping investments in renewable energies with real options: insights on hybrid systems and aging hydropower plants

Making strategic investment decisions in renewable energy sources (RES) is increasingly complex due to market volatility, regulatory reforms, and climate-related risks. The ability of the decision-maker to wait for more information to come and adapt to changing conditions, namely strategic flexibility, is crucial for value creation and maximization of investment value. Unlike traditional capital budgeting techniques, such as the Net Present Value (NPV), which give a measure of investment profitability according to a now-or-never proposition, the Real Options Approach (ROA) provides a rigorous framework to capture this value of flexibility, according to a wait-and-see perspective, which accounts for the investor’s opportunity to alter her/his initial operating strategy as uncertainty about future cash flows is gradually resolved. Hydropower production plants represent key assets in the energy transition and can effectively contribute to national grid stability and local energy security. However, many hydropower plants (HP) worldwide are obsolete and require modernization. Moreover, the rising energy demand in mountain communities can be met sustainably by combining the use of local water and solar resources. In this context, hybrid renewable energy systems (HRES) — that combine two or more RES, in some cases with fossil-fuel ones — enhance energy security, seasonal balance, and climate resilience, fostering sustainable development in mountain areas. Building on these premises, this thesis applies the ROA to assess investments in RES, with two main research focuses: first, on HRES that integrate small hydropower plants (SHP) with photovoltaic plants coupled with battery storage (PVB); second, on obsolete HP. In the first research line, an optimization model simulates the decision to invest in a hybrid SHP-PVB system that serves the energy demand of a mountain community. It integrates both economic variables (e.g., costs, energy prices) and technical factors (e.g., storage efficiency), and it aims at maximizing self-sufficiency rather than profit gained by selling energy. By applying a stochastic dynamic programming approach, the model derives the optimal HRES investment timing and size. Results show that it is optimal to defer the HRES investment and to include a high share of hydropower generation in the mix. SHP are the preferred technological choice compared to PVB and HRES. Moreover, comparative statics show that for increasing streamflow variability, the share of SHP in HRES reduces, whereas the share of PVB increases. In the second research line, a real option model investigates the decisions to either reinvest (e.g., replace turbines) or upgrade (capacity expansion) obsolete HP when the concession expiry for water use is approaching. The asymmetry in investment timing flexibility is explicitly captured by the model: the incumbent holds an American option with early exercise flexibility, while new entrants face a European option with fixed maturity. Calibration draws on Norwegian energy price and cost data. The comparison of option values for the two alternatives — to reinvest or upgrade — per unit of energy production indicates the most profitable strategy for the incumbents: upgrading overtakes reinvestment once costs exceed 150 NOK/MWh and production increases by at least 30%. In stylized bidding scenarios, normalized option values represent the maximum bid a firm would be willing to submit in a first-price auction for concession renewal: for new entrants this corresponds to a European call option, while for incumbents it reflects both European and American call options. Incumbents benefit from early upgrading, highlighting how timing and sizing flexibility can shape concession allocation. This thesis offers insights for investors and policymakers on HRES design, hydropower repowering, and concession renewal. Applying real options theory to hydropower planning aligns investments with long-term energy goals.