Producing energy in a stochastic environment: Switching from non-renewable to renewable resources

In this paper, we study the determinants of switching from non-renewable natural resource inputs to renewable resource inputs in energy production. We assume that the stocks of both natural resources are stochastic, and that the adoption of renewable resources is costly and irreversible. Our formulation gives raise to an optimal stopping/switching problem that cannot be solved analytically, then we turn to numerical simulations. Our results suggest that the optimal switching time depends not only on the uncertainty parameters, but also on energy demand, costs, and the relative productivity of the resources.

► Switching from non-renewables to renewables depend on uncertainty and energy demand.
► Costs parameters, and the relative productivity of resources are also important.
► Firms do not switch immediately in the case of switching cost being equal to zero.
► Due to our assumptions, the resulting value function before the switch is S-shaped.
► We use numerical methods to approximate the optimal switching time.