Options for real options Dealing with uncertainty in investment decisions for electricity networks (original) (raw)

Integrating Real Options Analysis with Long-Term Electricity Market Models

Energy Economics, 2019

In liberalized electricity markets, ongoing uncertainties play a major role to delay the decision-making of new power generation investments.  A valuation framework of power plant investments, based on Real Options Analysis, is integrated with a long-term electricity market model.  The decision-making model considers that the addition of new power capacity is guided by the economic value of the option to defer projects under uncertainty.  The main contribution is the integration of decision and option valuation theory in a long-term model for reproducing investment cycles observed in electricity markets.

Optimal Strategies for Investment in Generation of Electric Energy through Real Options

The Brazilian electric sector has two market-environments for the energy supply: a regulated pool (ACR), with 64 power distribution companies, and the free market (ACL), including free-consumers and energy wholesalers. In the regulated market, the power generation competition is enforced via energy auctions, where the winning generator has to sign long-term standard power purchase agreements (PPA) simultaneously with all distributors at the bidding-price. In this work we use the Real Options Theory to valuate new hydraulic generation assets, which will be traded in the new energy auction. This approach models the uncertainties in setting up the cash flow for the investments and incorporates some possible managerial flexibility associated with the decision taken along the investment forecast. A real example is presented, in which we incorporated the flexibilities regarding the waiting to invest in a new hydro power plant and an abandon option, representing the transfer of concession rights. Since the project involves a multistage investment consisting of design, construction and operation phases, it can be treated as a sequential compound option. A binomial approach was elaborated to model this investment opportunity analysis.

Real options and the value of generation capacity in the German electricity market

Review of Financial Economics, 2005

In this paper we implement a real options model for the unit commitment problem of an electricity producing 12 turbine in a liberalized market. The model accounts for various operating constraints of the turbine. Price 13 uncertainty is captured by a mean reverting process with jumps and time-varying means to account for seasonality.

Real options valuation applied to transmission expansion planning

Quantitative Finance, 2016

Transmission Expansion Planning (TEP) is a complex problem where building a new line involves a long permitting process of around 10 years. Therefore, transmission expansion must anticipate the evolution of uncertainties particularly those derived f by changes in the capacity and location of new generating facilities. As it is not possible to request permits for all possible lines, priorities must be established. We develop a formulation to use Real Options Valuation (ROV) to evaluate the potential benefit of candidate lines and thereby identify priority projects. We present a feasible representation of optionality in TEP projects and propose a tractable evaluation of option value. The proposed technique identifies the candidate transmission lines with the highest potential, as well as their main value drivers. This is implemented on a realistic case study based on the Spanish system.

Valuing Investments in Multi-Energy Generation Plants under Uncertainty: A Real Options Analysis

In this paper, a valuation method for multi-energy generation plants is presented. The operational flexibility of such plants is modeled using the Energy Hub concept -a modeling approach that has been developed in the "Vision of Future Energy Networks" project at ETH Zurich. The economic value of an Energy Hub including its flexibility is calculated by means of a Monte Carlo simulation method that generates a large amount of possible price paths for the input and output energy carriers of the respective hub configuration. The proposed Energy Hub real options model can be used to identify prospective hub configurations for future energy systems given the uncertainty concerning the future development of energy prices. In illustrative examples, the method is applied to two different Energy Hub configurations. Furthermore, sensitivity analyses with respect to different parameters such as the discount rate or price volatilities are carried out.

Brazilian power distribution investment under service price uncertainty: A Real Option analysis

Power distribution companies face great challenges in balancing profit maximization with the regulatory board requests. Modeling uncertainties has been essential to distribution investment risk assessment. For the Brazilian environment, the uncertainties in setting the price of wheeling services, coming from the Electricity Regulatory Agency, add more volatility to the investment return, as well as to other common uncertainties, like interest rates and equipment costs. The proposed investment analysis method encompasses the effects of price-cap regulation in association with the irreversibility, flexibility and uncertainty of a new investment. A Real Options framework is used to valuate investment opportunities under the regulated wheeling charge, providing the optimal investment frontier in terms of price. Examples coming from a real company are used for illustrating the concepts introduced in this paper.

A simple-to-implement real options method for the energy sector

Energy

Investment appraisal methods based on real options are gaining popularity in academia, while the adoption by practitioners is still infrequent. Having in mind practitioners, the method is designed to be: conceptually easy to understand, based on realistic hypotheses and data available, able to provide quantitative indications and strategic guidelines. The method is based on a systematic simulation of several scenarios generated according to exercise thresholds of relevant investment parameters. An exercise threshold gives to the investors the exercise right of taking some decision, for instance building a power plant. An exercise threshold is therefore a rule to decide whether to exercise or not a certain option on the basis of the values of one or more state variables. Consequently, the probability distribution of the Net Present Value (or analogous indicator) of the investment is a function of the state variables and the exercise threshold. Systematically changing the exercise thresholds allow to (A) establishing the "real option value" and (B) calculate relevant indications about when and on which type of plant to invest. The method is presented in detail and applied to a case study assessing the investment appraisal of: coal plant, gas plant, large nuclear reactor and small modular reactor.

Valuation of Wind Energy Projects: A Real Options Approach

Energies, 2014

We address the valuation of an operating wind farm and the finite-lived option to invest in it under different reward/support schemes: a constant feed-in tariff, a premium on top of the electricity market price (either a fixed premium or a variable subsidy such as a renewable obligation certificate or ROC), and a transitory subsidy, among others. Futures contracts on electricity with ever longer maturities enable market-based valuations to be undertaken. The model considers up to three sources of uncertainty: the electricity price, the level of wind generation, and the certificate (ROC) price where appropriate. When analytical solutions are lacking, we resort to a trinomial lattice combined with Monte Carlo simulation; we also use a two-dimensional binomial lattice when uncertainty in the ROC price is considered. Our data set refers to the UK. The numerical results show the impact of several factors involved in the decision to invest: the subsidy per MWh generated, the initial lump-sum subsidy, the maturity of the investment option, and electricity price volatility. Different combinations of variables can help bring forward investments in wind generation. One-off policies, e.g., a transitory initial subsidy, seem to have a stronger effect than a fixed premium per MWh produced.

Article Valuation of Wind Energy Projects: A Real Options Approach

2014

We address the valuation of an operating wind farm and the finite-lived option to invest in it under different reward/support schemes: a constant feed-in tariff, a premium on top of the electricity market price (either a fixed premium or a variable subsidy such as a renewable obligation certificate or ROC), and a transitory subsidy, among others. Futures contracts on electricity with ever longer maturities enable market-based valuations to be undertaken. The model considers up to three sources of uncertainty: the electricity price, the level of wind generation, and the certificate (ROC) price where appropriate. When analytical solutions are lacking, we resort to a trinomial lattice combined with Monte Carlo simulation; we also use a two-dimensional binomial lattice when uncertainty in the ROC price is considered. Our data set refers to the UK. The numerical results show the impact of several factors involved in the decision to invest: the subsidy per MWh generated, the initial lump-sum subsidy, the maturity of the investment option, and electricity price volatility. Different combinations of variables can help bring forward investments in wind generation. One-off policies, e.g., a transitory initial subsidy, seem to have a stronger effect than a fixed premium per MWh produced.