An Analytical Method to the Economics of Pumped Storage Power Plants Based on the Real Options Method

This paper develops an economic evaluation framework for pumped storage hydropower (PSH) projects based on real options, addressing the limitations of traditional economic evaluation methods that neglect investment flexibility and path dependence. The framework integrates an annual net cash flow model with an improved mean-reverting electricity price model to generate thousands of electricity price trajectories, while backward dynamic programming dynamically values abandonment options. The core innovation of this study lies in the dynamic pricing mechanism of abandonment options, which explicitly captures the flexibility of terminating projects under adverse conditions. A comparative analysis between the traditional NPV approach and the real options method reveals significant differences: the average NPV under base scenario is −38.35 million CNY, whereas option scenario yields an average NPV of 143.15 million CNY. The average value of real options is 181.5 million yuan, and it increases the average internal rate of return by 0.34%. These results demonstrate that incorporating real options prevents the underestimation of project value and provides more robust decision-making support under uncertainty, thereby offering methodological and policy insights for the investment appraisal of large-scale energy storage projects.