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Multi-Commodity Real Options Analysis of Power Plant Investments: Discounting Endogenous Risk Structures

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Author Info

  • Rohlfs, Wilko

    ()
    (Chair of Heat and Mass Transfer, RWTH Aachen University)

  • Madlener, Reinhard

    ()
    (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN))

Abstract

The value of power generation technologies can be derived from the investment cost, the plant’s expected lifetime, and the discounted cash-flows, the latter of which typically are a combination of several underlyings, such as the price of fuel, electricity, and CO2. To determine this value, most studies assume predefined, uniform, and constant discount rates, irrespective of the fact that the specific risk strongly varies with the technology concerned and also over time. In order to endogenize the technology-specific risk, we develop a new model that explicitly accounts for the (likewise technology-specific) combination of the underlyings. More specifically, we use a multivariate binomial tree real options approach for analyzing the value of different power plants (gas-fired and coal-fired, with and without carbon capture and storage (CCS); hydro; wind; photovoltaics) and for taking into account technical change. We further investigate the influence of alternative CO2 policies on the plants’ values, modeling the CO2 price in three different ways and for three different carbon price levels (5, 25, 45€/tCO2 ): (1) as a stochastic process (Geometric Brownian Motion), reflecting the price development in the Emissions Trading Scheme of the European Union (EU ETS); (2) as a (constrained) stochastic process with a price floor, and (3) as a deterministic carbon tax. From the model application, using data from German exchangebased markets and a much-cited pilot study on future energy strategies and scenarios in Germany, we find a strong preference for hard-coal power plants in the low CO2 price scenario (P2015 = €5) and a low value of waiting, irrespective of the CO2 price policy assumed. In the case of the moderate CO2 price scenario (P2015 = €25), the value of waiting is much higher for the CO2 permits with a price floor and the CO2 tax policy, leading to a dominance of the CCS power plants. In contrast, for the simulated EU ETS market, the conventional fossil fuel-fired power plants dominate the other technologies. In the high CO2 price scenario (P2015 = €45), the value of waiting only delays the investment decision in the case of the floored CO2 permit prices. For the two other policies, the model predicts an immediate investment in CCS power plants once the CCS technology becomes commercially available in 2020.

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Bibliographic Info

Paper provided by E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN) in its series FCN Working Papers with number 22/2011.

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Length: 32 pages
Date of creation: Dec 2011
Date of revision:
Handle: RePEc:ris:fcnwpa:2011_022

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Web page: http://www.eonerc.rwth-aachen.de/fcn
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Keywords: Real options; CAPM; multivariate binomial tree; carbon tax; energy technology choice; endogenous discount rate;

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  35. Madlener, Reinhard & Sicking, Stephan, 2011. "Assessing the Economic Potential of Microdrilling in Geothermal Exploration," FCN Working Papers 7/2011, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  36. Harmsen - van Hout, Marjolein J.W. & Herings, P. Jean-Jacques & Dellaert, Benedict G.C., 2010. "Communication Network Formation with Link Specificity and Value Transferability," FCN Working Papers 15/2010, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN), revised Mar 2011.
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  38. Bernstein, Ronald & Madlener, Reinhard, 2010. "Short- and Long-Run Electricity Demand Elasticities at the Subsectoral Level: A Cointegration Analysis for German Manufacturing Industries," FCN Working Papers 19/2010, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  39. Harmsen-van Hout, Marjolein J.W. & Dellaert, Benedict G.C. & Herings, P. Jean-Jacques, 2008. "Behavorial Effects in Individual Decisions of Network Formation," Research Memorandum 019, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  40. Madlener, Reinhard & Glensk, Barbara, 2010. "Portfolio Impact of New Power Generation Investments of E.ON in the UK, Sweden and Germany," FCN Working Papers 17/2010, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
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  42. Omann, Ines & Kowalski, Katharina & Bohunovsky, Lisa & Madlener, Reinhard & Stagl, Sigrid, 2008. "The Influence of Social Preferences on Multi-Criteria Evaluation of Energy Scenarios," FCN Working Papers 3/2008, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
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  47. Holtermann, Timm & Madlener, Reinhard, 2009. "Assessment of the Technological Development and Economic Potential of Photobioreactos," FCN Working Papers 8/2009, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
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  62. Luis M. Abadie & José; M. Chamorro & Mikel González-Eguino, 2011. "Optimal Abandonment of EU Coal-fired Stations," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 175-208.
  63. Bernstein, Ronald & Madlener, Reinhard, 2008. "The Impact of Disaggregated ICT Capital on Electricity Intensity of Production: Econometric Analysis of Major European Industries," FCN Working Papers 4/2008, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
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Cited by:
  1. Achtnicht, Martin & Madlener, Reinhard, 2012. "Factors Influencing German House Owners' Preferences on Energy Retrofits," FCN Working Papers 4/2012, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  2. Rohlfs, Wilko & Madlener, Reinhard, 2012. "Assessment of Clean-Coal Strategies: The Questionable Merits of Carbon Capture-Readiness," FCN Working Papers 18/2012, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  3. Ghosh, Gaurav & Shortle, James, 2012. "Managing Pollution Risk through Emissions Trading," FCN Working Papers 1/2012, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  4. Rohlfs, Wilko & Madlener, Reinhard, 2013. "Optimal Power Generation Investment: Impact of Technology Choices and Existing Portfolios for Deploying Low-Carbon Coal Technologies," FCN Working Papers 12/2013, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).

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