Valuing fuel diversification in optimal investment policies for electricity generation portfolios
AbstractOptimal capacity allocation for investments in electricity generation assets can be deterministically derived by comparing technology specific long-term and short-term marginal costs. In an uncertain market environment, Mean-Variance Portfolio (MVP) theory provides a consistent framework to valuate financial risks in power generation portfolios that allows to derive the efficient fuel mix of a system portfolio with different generation technologies from a welfare maximization perspective. Because existing literature on MVP applications in electricity generation markets uses predominantly numerical methods to characterize portfolio risks, this article presents a novel analytical approach combining conceptual elements of peak-load pricing and MVP theory to derive optimal portfolios consisting of an arbitrary number of plant technologies given uncertain fuel prices. For this purpose, we provide a static optimization model which allows to fully capture fuel price risks in a mean variance portfolio framework. The analytically derived optimality conditions contribute to a much better understanding of the optimal investment policy and its risk characteristics compared to existing numerical methods. Furthermore, we demonstrate an application of the proposed framework and results to the German electricity market which has not yet been treated in MVP literature on electricity markets.
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Bibliographic InfoPaper provided by University of Duisburg-Essen, Chair for Management Science and Energy Economics in its series EWL Working Papers with number 0904.
Length: 40 pages
Date of creation: Nov 2009
Date of revision: Nov 2009
power plant investments; peak load pricing; mean-variance portfolio theory; fuel mix diversification;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
- Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy
- C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
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