Operational versus Capital Expenditure Risk in a Clean Energy Transition

This report analyzes the differences between risk profiles posed by fossil assets, such as natural gas power generation and gas-powered vehicles, and those of “green” alternatives, such as wind power and electric vehicles. Fossil assets tend to be exposed primarily to uncertainty in operational expenditures (OPEX) such as fuel prices, whereas green assets tend to be exposed primarily to uncertainty in capital expenditures (CAPEX). This report builds a quantitative dynamic economic model of investment under uncertainty that accounts for these different kinds of risk. The results show the relative value of such CAPEX-exposed green assets over OPEX-exposed fossil assets for reducing exposure to future cost uncertainty. The model’s key conclusions are that (1) correlated OPEX risk across assets implies that an all-green portfolio has lower uncertainty than an all-fossil one even when the assets themselves have similar total cost uncertainty, (2) adding a green asset option to an otherwise all-fossil investment strategy typically reduces cost uncertainty by more than adding a fossil option to an all-green strategy does, and (3) actually owning such a green asset almost uniformly reduces cost uncertainty by shielding society (investors and consumers) from OPEX risk. The primary mechanisms driving these results are threefold: first, an investment in CAPEX-exposed assets immediately resolves substantial cost uncertainty, second, spikes in fuel prices increase OPEX for all existing fossil assets whereas spikes in green CAPEX costs only affect new investments, and third, the availability of multiple options for future asset replacement decisions avoids locking in exposure to CAPEX risk.