Real option valuation of power transmission investments by stochastic simulation

Rolando Pringles, Fernando Olsina and Francisco Garcés

Energy Economics, 2015, vol. 47, issue C, 215-226

Abstract: Network expansions in power markets usually lead to investment decisions subject to substantial irreversibility and uncertainty. Hence, investors need valuing the flexibility to change decisions as uncertainty unfolds progressively. Real option analysis is an advanced valuation technique that enables planners to take advantage of market opportunities while preventing or mitigating losses if future conditions evolve unfavorably. In the past, many approaches for valuing real options have been developed. However, applying these methods to value transmission projects is often inappropriate as revenue cash flows are path-dependent and affected by a myriad of uncertain variables. In this work, a valuation technique based on stochastic simulation and recursive dynamic programming, called Least-Square Monte Carlo, is applied to properly value the deferral option in a transmission investment. The effect of option's maturity, the initial outlay and the capital cost upon the value of the postponement option is investigated. Finally, sensitivity analysis determines optimal decision regions to execute, postpone or reject the investment projects.

Keywords: Power network; Investments; Real options; Uncertainty; Flexibility; Monte Carlo (search for similar items in EconPapers)
JEL-codes: C52 C53 C63 D81 E22 O22 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:47:y:2015:i:c:p:215-226

DOI: 10.1016/j.eneco.2014.11.011

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