Sensitivity Analysis – Quantifying Risk for Your Investment

Any time you’re considering making an investment, it’s important to consider the risks and benefits involved.

“How much do I stand to gain?”
“How much could I lose?”
“What is likely to happen?”
“What is the best or worst case scenario that might impact the success of this investment?”
“What happens if I’m wrong?”

These are the sorts of questions anybody should be asking themselves before a big purchase or risk, so why wouldn’t you do the same with energy assets? Any time you are making a decision there will be factors that you cannot predict for certain, so it is a good idea to try to understand how much benefit or damage you may incur if those variables turn out to be a little different from you expectations. This is where sensitivity analysis is very important. Sensitivity analysis is a method of assessing how much the outcome of a particular thing may change as a function of differences in your estimates of something else.

For example- A lighting installation company solicits you and claims that they can save you 60% on your lighting costs each year by replacing your existing lights with newer, more efficient options. While this could very well be true and is in fact quite likely, it’s important to understand that this claim is made on the basis of a few assumptions that could very well be inaccurate to some degree. In this case, the difference that a lighting swap would make would be based on what sort of lighting you already have. If you already have very efficient lights, then the difference it would make to switch to the newest, most efficient model would not be as significant. An analysis of just how much difference having varying types of lights would make on the benefit to you is the purpose of a sensitivity analysis.

Sensitivity Analysis - Lighting Investment Graph

Sometimes an investment may sound good or bad, but the projected results are based upon some variable that is much more difficult to predict than something like how many lights you have, or what wattage they are. The estimates then would be said to have a lot of uncertainty. In cases like this, it’s especially important to assess how much that variable might affect the performance of your investment. For instance, many investments can be in some way affected by the weather, or the behavior of other human beings.

Nobody can predict the future! Estimates will often be wrong by some margin, no matter how smart you are, or how much data is available. For this reason, it’s essential to be aware of how much difference it will make if you’re a little bit off, and use that information to determine if a particular investment is right for you.

Facebook
LinkedIn
Twitter
Reddit
Share on facebook
Share on twitter
Share on linkedin
Share on reddit

Get the latest energy news

Fill out the form below and and we’ll send you the energy news updates every two weeks.