Valuing Plug-In Hybrid Electric Vehicles' Battery Capacity Using a Real Options Framework

Abstract:     
Plug-in hybrid electric vehicles (PHEVs) allow their drivers to choose whether to use electricity or gasoline, but this fuel flexibility benefit requires the purchase of additional battery capacity relative to most other vehicles. We value this fuel exibility by representing the purchase of the battery as the purchase of a strip of call options on the price of transportation. We find that using a real options approach instead of a discounted cash flow analysis can substantially raise the retail battery price at which the battery pays for itself. Unless battery prices fall or expected long-term average U.S. gasoline prices rise to $5 per gallon or greater, the PHEV's battery may still not pay for itself, and greenhouse gas abatement via PHEVs may cost over $100/tCO2-eq. However, the value of subsidizing PHEVs as an abatement strategy is greater than represented by their direct reductions in emissions because the vehicles reduce the cost of adopting more stringent climate policies in the future.

Working Paper Series