On the valuation of legacy power production in liberalized markets via option-pricing

Ibrahim Abada, Mustapha Belkhouja and Andreas Ehrenmann

European Journal of Operational Research, 2025, vol. 322, issue 3, 1005-1024

Abstract: Legacy assets can constitute entry barriers in liberalized power markets. Regulations pertaining to such assets have many objectives, the most important of which are to transfer the benefits of an economical production technology to consumers and foster competition. To that end, countries have adopted various regulations but there is no consensus today on identifying the first best solution. Inspired by the French regulation of historical nuclear production and considering the market risk that now prevails in the sector, we propose an option-based approach to regulating legacy assets that reflects production costs and encompasses optionality at the same time. To achieve that aim, we study a competitive, but financially incomplete market where the incumbent and several competitors exchange legacy production via a regulated call option. Agents do not face the same risk exposure and their attitudes toward risk, which we model by coherent risk measures, might differ. The result is a stochastic equilibrium model of regulated option-pricing in incomplete markets that we calibrate numerically and solve for the French market. We quantify the option value and assess its impact on the system for various regimes of the spot market, including the one of very high and volatile prices of the recent energy crisis. We also analyze the impacts of risk aversion and the option’s maturity. Based on our analysis, we provide recommendations for enhancing the current French regulation of historical nuclear production.

Keywords: Power markets; Nuclear regulations; Option-pricing; Stochastic equilibrium; Risk aversion; Incomplete markets (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:322:y:2025:i:3:p:1005-1024

DOI: 10.1016/j.ejor.2024.10.033

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