Irreversible Investment and Uncertainty in Energy Conversion: a Clay-Clay Vintage Portfolio Selection Approach Adriaan van Zon * , Sabine Fuss † March 15, 2006 Abstract The methods by which fuels can be converted into electricity all be- long to different ”technology families”: the ”gas-fired-turbine-family”, the ”coal-fired-turbine-family”, etc. Each family consists of different genera- tions of technologies, as in a vintage model. Within a family, the latest generation embodies the most recent level of knowledge, becoming out- dated as new generations arrive. Producers face the problem of composing their portfolio of families to minimize risk-adjusted costs of investment and production under a given demand constraint. Risk emanates from several uncertainties, such as volatile fuel prices and uncertain techno- logical change. The paper presents a model capturing these features by integrating elements from financial optimum portfolio theory (OPT) in a clay-clay vintage model. We find that the cumulative nature of embodied technical change results in investment responses to changes in uncertainty being in between the ”standard” results of OPT and real options theory. * Corresponding author: University of Maastricht, PO Box 616, 6200 MD Maastricht, the Netherlands. Email: Adriaan.vanZon@MERIT.unimaas.nl † University of Maastricht, PO Box 616, 6200 MD Maastricht, the Netherlands. Email: S.Fuss@ALGEC.unimaas.nl 1