Operating profit of pumped hydroelectric plants operating under uncertainty

This paper develops a measure of performance for pumped hydroelectric plants that accounts for uncertainties in the production environment. This uncertainty is characterised in terms of different possible states of Nature (e.g., amounts of rainfall). The decision-making process of plant managers is then broken into two stages. In the first stage, plant managers must choose variable inputs (e.g., labour and materials) to maximise expected operating profit in the face of uncertainty about the state of Nature. In the second stage, after variable inputs have been chosen and the state of Nature has been revealed, the plant manager must choose the amounts of energy to sell and store to maximise revenue. The associated measure of performance compares observed operating profit with the operating profit that would have been obtained if the manager had made the optimising choices in both stages. The empirical feasibility of the methodology is demonstrated using a data envelopment analysis (DEA) estimator and data from pumped hydroelectric plants in Italy. In this application, the decisions that plant managers make in the first stage are found to have a larger impact on profits than the decisions they make in the second stage.