The value of operational flexibility by adding thermal to hydropower: A real option approach

This paper presents a valuation study of operational flexibility for a hydropower operator restricted by contracts to deliver a steady flow of electricity to the contract counterpart. The hydropower operator has the flexibility to deliver from own production of hydro-electric generation, or deliver by buying option contracts of electricity from thermal electricity producers. The option may be in the form of a call option, or may be an implicit option created by having a separate thermal electricity plant that can be switched on and off. Long term industry contracts can make some operators obligated to always generate at a certain minimum level. Such operators cannot save the water in the reservoirs for peak price periods if this action compromises their ability to deliver the contracted minimum. If thermal generation is added and controlled, flexibility is enhanced and hence more generation can be allowed in peak price periods.

[1]  L. Trigeorgis,et al.  The General Flexibility to Switch: Real Options Revisited , 2000 .

[2]  H. He,et al.  Investments in flexible production capacity , 1992 .

[3]  Roar Adland,et al.  Are Spot Freight Rates Stationary , 2006 .

[4]  E. Näsäkkälä.  Hydropower production planning and hedging under inflow and forward uncertainty , 2004 .

[5]  Eduardo S. Schwartz,et al.  The Valuation of Commodity Contingent Claims , 1994 .

[6]  Nalin Kulatilaka,et al.  Valuing the flexibility of flexible manufacturing systems , 1988 .

[7]  R. Pindyck.  Inventories and the Short-Run Dynamics of Commodity Prices , 1990 .

[8]  Erkka Näsäkkälä,et al.  Hydropower with Financial Information , 2008 .

[9]  J. Hull.  Options, Futures, and Other Derivatives , 1989 .

[10]  Valuation of Asian options and commodity contingent claims , 2002 .

[11]  Luc Gagnon,et al.  Adding wind energy to hydropower , 2002 .

[12]  R. Neufville.  Real Options: Dealing With Uncertainty in Systems Planning and Design , 2003 .

[13]  Frode Kjærland,et al.  A real option analysis of investments in hydropower--The case of Norway , 2007 .

[14]  M. Ilić,et al.  Futures and spot prices - an analysis of the Scandinavian electricity market : Proceedings of the 34th Annual North American power Symposium (NAPS 2002); Tempa AZ- USA, October 2002. , 2003 .

[15]  Avinash Dixit,et al.  Investment and Hysteresis , 1992 .

[16]  Stein-Erik Fleten,et al.  Flexibility and Technology Choice in Gas Fired Power Plant Investments , 2004 .

[17]  R. Voeks.  Real Options: Managerial Flexibility and Strategy in Resource Allocation , 1997 .

[18]  Juliana de Moraes Marreco,et al.  Flexibility valuation in the Brazilian power system: A real options approach , 2006 .

[19]  T. Copeland.  Real Options: A Practitioner's Guide , 2001 .

[20]  Steen Koekebakker,et al.  Forward curve dynamics in the Nordic electricity market , 2005 .

[21]  Nalin Kulatilaka,et al.  The value of flexibility: The case of a dual-fuel industrial steam boiler , 1993 .

[22]  A. Gjelsvik,et al.  Generation scheduling in a deregulated system. The Norwegian case , 1999 .

[23]  Eduardo S. Schwartz,et al.  Electricity Prices and Power Derivatives: Evidence from the Nordic Power Exchange , 2000 .