Seasonality and valuation of renewable energy projects in a two factor model

Project valuation plays a key role in designing policies that support the uptake of renewable energy. Evaluating renewable energy projects is, however, challenging due to the intermittent nature of renewable energy generation and the unique characteristics of electricity prices. We introduce a new modeling framework for evaluating these projects, allowing for important aspects of spot electricity prices and renewable energy sources, including mean reversion, time-of-day variation, and seasonal fluctuations. Electricity prices can also have negative values as well as spikes. We show that a renewable energy project can be decomposed into a number of operational options, and derive the closed-form formula for these options to facilitate efficient evaluation of the project. We then propose and examine various approaches for modeling intermittent generation from renewables and apply the developed models to case studies of solar and wind investment projects in four different regions of the Australian National Electricity Market (NEM). Our findings suggest that the way seasonality in spot electricity prices and the output from renewable generation is modelled can have substantial impact on the valuation of investment into renewable energy sources. We also find that taking into account the correlation between renewable energy generation and spot electricity prices will play an increasing role in valuation, since the output from renewables can be expected to increase substantially in the future.