Real option approach to solar PV investment amid uncertainties and land opportunity costs

Abstract

The transition to renewable energy requires careful consideration of land-use trade-offs, particularly when repurposing agricultural land for solar photovoltaic (PV) projects. This study develops a real options (RO) framework to determine the optimal timing for investing in a solar PV plant under uncertainty, explicitly incorporating the opportunity cost of land conversion and the stochastic evolution of electricity prices and technology costs. Using the Bellman equation, we model the investment decision as an American-style option, where firms can defer installation until economic conditions become optimal. Both electricity prices and investment costs are assumed to follow geometric Brownian motion (GBM), allowing us to derive an analytical expression for the critical investment threshold and estimate the expected time to reach this optimal ratio. Our results show that uncertainty delays investment decisions, encouraging a more conservative and risk-aware adoption of PV technology. This delay is particularly relevant for policymakers, as it suggests that traditional subsidy schemes based on static NPV calculations may be insufficient to accelerate adoption. Instead, policies that explicitly account for market volatility and future technological cost reductions are needed to incentivize timely investments. Furthermore, for regions aiming to regulate PV expansion on agricultural land, our framework provides insights into how regulatory interventions—such as land-use restrictions or incentives for dual-use solar-agriculture projects—can strategically influence adoption timelines. By integrating financial uncertainty and land-use dynamics, this study offers a robust decision-making tool for investors and policymakers navigating the trade-offs between energy transition and sustainable land management.

The authors acknowledge the support and funding from ANID-Subdireccion ´ de Capital Humano/Doctorado Nacional/2021–21210320, Conicyt-Fondecyt 1221943, Conicyt-FONDAP 1522A0006 (SERC Chile), MCIU/AEI&ERDF-EU PID2022–140546OB-I00 and Departament de Recerca i Universitat de la Generalitat de Catalunya 2021SGR00355.