Capacity expansion under regulatory uncertainty:Â A real options-based study in international container shipping

We present a real options model for capacity expansion that introduces uncertainty about potential future regulation (regulatory uncertainty) and key characteristics of capacity decisions: investment with time to build, divestment, the option to charter, and operating flexibility. Regulatory uncertainty is modelled as a possible jump in operating, investment, and charter costs during the simulation horizon. We find that regulatory uncertainty with grandfathering (the extant fleet is exempt from compliance) promotes high up-front investment leading to excess capacity and increased emissions. However, regulatory uncertainty without grandfathering reduces investment and emissions and the use of more flexible capacity options, such as chartering.