Investment timing and optimal capacity choice for small hydropower projects

This paper presents a method for assessing small hydropower projects that are subject to uncertain electricity prices. We present a real options-based method with continuous scaling, and we find that there is a unique price limit for initiating the project. If the current electricity price is below this limit it is never optimal to invest, but above this limit investment is made according to the function for optimal size. The connection between the real option and the physical properties of a small hydropower plant is dealt with using a spreadsheet model that performs a technical simulation of the production in a plant, based on all the important choices for such a plant. The main results of the spreadsheet are simulated production size and the investment costs, which are in turn used for finding the value of the real option and the price limit. The method is illustrated on three different Norwegian small hydropower projects.OR in Energy; Real Options; Continuous Scaling; Project Evaluation; Hydropower

Investment timing and optimal capacity choice for small hydropower projects

This paper presents a method for assessing small hydropower projects that are subject to uncertain electricity prices. We present a real options-based method with continuous scaling, and we find that there is a unique price limit for initiating the project. If the current electricity price is below this limit it is never optimal to invest, but above this limit investment is made according to the function for optimal size. The connection between the real option and the physical properties of a small hydropower plant is dealt with using a spreadsheet model that performs a technical simulation of the production in a plant, based on all the important choices for such a plant. The main results of the spreadsheet are simulated production size and the investment costs, which are in turn used for finding the value of the real option and the price limit. The method is illustrated on three different Norwegian small hydropower projects

New renewable electricity capacity under uncertainty: The potential in Norway

Uncertainty affecting project values makes investors hesitate to build new capacity unless profitability is significant. When analysing the potential for new renewable power system capacity in a region, it is therefore necessary to properly capture both uncertainty effects and decision-making behaviour of investors. Important stochastic factors typically include wholesale electricity prices and certificate prices. We calculate trigger levels for the sum of these factors, and compare these with the current long-term contract prices to estimate the potential for new renewable electricity capacity. We take into account the cost and technical potential of small hydro and wind in Norway, the number of prenotifications, concession applications and grants, and the capacity targets of subsidising governmental bodies. With an electricity certificate policy target of 41 TWh per year of new renewables for Sweden and Norway combined until 2016, we estimate that 12 TWh wind power and 6.2 TWh hydropower will be built in Norway. Due to the option value of waiting, most of this capacity will come after 2010.Finance, Hydroelectric power generation, Power system planning, Stochastic processes, Uncertainty, Wind energy

Evaluation of hydropower upgrade projects - a real options approach

When evaluating whether to refurbish existing hydropower plants or invest in a new power plant, there are two important aspects to take into consideration. These are the capacity chosen for the production facilities and the timing of the investment. This paper presents an investment decision support framework for hydropower producers with production facilities due for restoration. The producer can choose between refurbishing existing power plants and investing in a new production facility. A real options framework is proposed to support the investment decision. Using a case from Norsk Hydro ASA, a Norwegian hydropower producer, we employ the framework to evaluate the investment opportunities. Our main contribution is an approach that combines hydropower scheduling and real options valuation, and the results from our analysis suggest feasible investment strategies for Norsk Hydro ASA.Electricity price uncertainty; reservoir management; hydroelectric scheduling; investment under uncertainty; electricity markets

Stepwise Green Investment under Policy Uncertainty

We analyse how market price and policy uncertainty, in the form of random provision or retraction of a subsidy, interact to affect the optimal time of investment and the size of a renewable energy (RE) project that can be completed in either a single (lumpy investment) or multiple stages (stepwise investment). The subsidy takes the form of a fixed premium on top of the electricity price, and, therefore, investment is subject to electricity price uncertainty. We show that the risk of a permanent retraction (provision) of a subsidy increases (decreases) the incentive to invest, yet lowers (raises) the amount of installed capacity, and that this result is more pronounced as the size of the subsidy increases. Additionally, we show that increasing the number of policy interventions lowers the expected value of a subsidy and the size of the project. Furthermore, we illustrate that, although an increase in the size of a subsidy lowers the relative value of the stepwise investment strategy, the expected value of a lumpy investment strategy is still lower than that of stepwise investment

Electricity derivative markets : investment valuation, production planning and hedging

This thesis studies electricity derivative markets from a view point of an electricity producer. The traditionally used asset pricing methods, based on the no arbitrage principle, are extended to take into account electricity specific features: the non storability of electricity and the variability in the load process. The sources of uncertainty include electricity forward curve, prices of resources used to generate electricity, and the size of the future production. Also the effects of competitors' actions are considered. The thesis illustrates how the information in the derivative prices can be used in investment and production planning. In addition, the use of derivatives as a tool to stabilize electricity dependent cash flows is considered. The results indicate that the information about future electricity prices and their uncertainty, obtained from derivative markets, is important in investment analysis and production planning.reviewe

Optimal Technology Choice and Investment Timing: A Stochastic Model of Industrial Cogeneration vs. Heat-Only Production

In this paper we develop an economic model that explains the decision-making problem under uncertainty of an industrial firm that wants to invest in a process technology. More specifically, the decision is between making an irreversible investment in a combined heat-and-power production (cogeneration) system, or to invest in a conventional heat-only generation system (steam boiler) and to purchase all electricity from the grid. In our model we include the main economic and technical variables of the investment decision process. We also account for the risk and uncertainty inherent in volatile energy prices that can greatly affect the valuation of the investment project. The dynamic stochastic model presented allows us to simultaneously determine the optimal technology choice and investment timing. We apply the theoretical model and illustrate our main findings with a numerical example that is based on realistic cost values for industrial oil- or gas-fired cogeneration and heat-only generation in Switzerland. We also briefly discuss expected effects of a CO2 tax on the investment decision.Cogeneration, Irreversible investment, Risk, Uncertainty, Real options

Building Real Options into Physical Systems with Stochastic Mixed-Integer Programming

The problem of building real options into physical systems has three features: real options are not as easily defined as financial options; path-dependency and interdependencies among projects mean that the standard tools of options analysis tools are insufficient; and the focus is on identifying the best way to build flexibility into the design – not to value individual options. This paper suggests a framework for exploring real options in physical systems that especially addresses these two difficulties. This framework has two stages: options identification and options analysis. The options identification stage consists of screening and simulation models that focus attention on a small subset of the possible combination of projects. The options analysis stage uses stochastic mixed-integer programming to manage the path-dependency and interdependency features. This stochastic formulation enables the analyst to include more technical details and develop explicit plans for the execution of projects according to the contingencies that arise. The paper illustrates the approach with a case study of a water resources planning problem, but the framework is generally applicable to a variety of large-scale physical systems

Real options theory applied to the evaluation of small hydropower investments in Brazil

There have been several challenges concerning the decisions and timing of new investments in the Brazilian power electricity generation due to irreversibility characteristics and uncertainty inherent in the sector, such as the volatility of electricity prices. Large hydropower plants are getting difficult to implement in the Brazilian generation sector, primarily due to environmental concerns and political pressure. Therefore, there has been an increasing focus on investments of small-scale hydropower plants (SHP). In this context, this paper analyses the use of Real Option (RO) theory for decision-making concerning the investment in SHP’s in Brazil. This paper investigates the possibility for the entrepreneur of postponing its participation in the auctions proposed by the government. The deferral option can bring relevant value to the evaluation of SHP since the investor has the option to wait until more favorable conditions appear, e.g., better electricity prices or authorization. Therefore, the application proposed in this paper may be considered as a novel approach regarding the application of the RO theory. For this purpose, a real SHP of 7 MW of installed capacity was used as an investment case and it was assumed that the entrepreneur has the option to participate in the auctions in the next three years (2018 - 2020). A comparison of the results considering the traditional economic analysis (based on the discounted cash flows) is undertaken to evaluate the proposed approach. It can be concluded that the deferral option in participating in the auction can be considered a real option for investors and this time flexibility might bring financial advantages since the uncertainties are reduced. Furthermore, the methodology proposed in this paper has great potential to assess future SHP project evaluation and can be adapted to evaluate other power options.- (undefined

The use of real options approach in energy sector investments

Energy shortage, global warming, and climate change led to an increase in the use of alternative sources of energy, with renewable energy sources (RES) playing a fundamental role in this new energetic paradigm. However, the investment costs often constitute a major barrier to their spread use. Moreover, the overall benefits of renewable energy technologies are often not well understood and consequently they are often evaluated to be not as cost effective as traditional technologies. From the moment that the energy sector started a deregulation process, with a high level of competitiveness and associated increased market uncertainty, traditional project evaluation techniques alone became insufficient to properly deal with these additional risk and uncertainty factors. The diffusion of the renewable energy technologies is also affected by this feature. The way investors evaluate their investments call now for the use of more sophisticated evaluation techniques. Real options approach can deal with these issues and, as so, began to be considered and applied for the energy sector decision aid. This approach it is now extensively widespread in evaluating investment projects in the energy sector. A large set of applications in almost all fields of energy decision making, from electricity generation technologies appraisal to policy evaluation is available in the literature. However the use of this technique in the field of RES is still limited and worth to be analysed. This paper addresses this issue. A review of the current state of the art in the application of real options approach to investments in non-renewable energy sources and RES is presented, giving perspectives for further research in this field.This work was financed by: the QREN – Operational Programme for Competitiveness Factors, the European Union – European Regional Development Fund and National Funds- Portuguese Foundation for Science and Technology, under Project FCOMP-01-0124-FEDER-011377 and Project Pest-OE/EME/UI0252/201