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Short-Term Generation Asset Valuation: A Real Options Approach

Author

Listed:
  • Chung-Li Tseng

    () (Department of Civil & Environmental Engineering, University of Maryland, College Park, Maryland 20742)

  • Graydon Barz

    () (Electricity & Natural Gas Practice, McKinsey & Co., Two Houston Center, 909 Fannin, Suite 3500, Houston, Texas 77010)

Abstract

This paper discusses using real options to value power plants with unit commitment constraints over a short-term period. We formulate the problem as a multistage stochastic problem and propose a solution procedure that integrates forward-moving Monte Carlo simulation with backward-moving dynamic programming. We assume that the power plant operator maximizes expected profit by deciding in each hour whether or not to run the unit, that a certain lead time for commitment and decommitment decisions is necessary to start up and shut down a unit, and that these commitment decisions, once made, are subject to physical constraints such as minimum uptime and downtime. We also account for the costs associated with starting up and shutting down a unit. Last, we assume that there are hourly markets for both electricity and the fuel used by the generator and that their prices follow Ito processes. Using numerical simulation, we show that failure to consider physical constraints may significantly overvalue a power plant.

Suggested Citation

  • Chung-Li Tseng & Graydon Barz, 2002. "Short-Term Generation Asset Valuation: A Real Options Approach," Operations Research, INFORMS, vol. 50(2), pages 297-310, April.
  • Handle: RePEc:inm:oropre:v:50:y:2002:i:2:p:297-310
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    File URL: http://dx.doi.org/10.1287/opre.50.2.297.429
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    Cited by:

    1. repec:wsi:ijtafx:v:20:y:2017:i:01:n:s0219024917500042 is not listed on IDEAS
    2. Matt Thompson, 2013. "Optimal Economic Dispatch and Risk Management of Thermal Power Plants in Deregulated Markets," Operations Research, INFORMS, vol. 61(4), pages 791-809, August.
    3. Rubin, Ofir D. & Babcock, Bruce A., 2011. "A novel approach for modeling deregulated electricity markets," Energy Policy, Elsevier, vol. 39(5), pages 2711-2721, May.
    4. repec:eee:ejores:v:266:y:2018:i:3:p:1153-1174 is not listed on IDEAS
    5. Angelica Gianfreda & Derek Bunn, 2018. "A Stochastic Latent Moment Model for Electricity Price Formation," BEMPS - Bozen Economics & Management Paper Series BEMPS46, Faculty of Economics and Management at the Free University of Bozen.
    6. Zdenìk Zmeškal, 2008. "Application of the American Real Flexible Switch Options Methodology A Generalized Approach," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 58(05-06), pages 261-275, August.
    7. Guthrie, Graeme & Videbeck, Steen, 2004. "Electricity Spot Price Dynamics: Beyond Financial Models," Working Paper Series 3866, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    8. Matt Thompson & Matt Davison & Henning Rasmussen, 2004. "Valuation and Optimal Operation of Electric Power Plants in Competitive Markets," Operations Research, INFORMS, vol. 52(4), pages 546-562, August.
    9. Nemat Safarov & Colin Atkinson, 2016. "Natural gas-fired power plants valuation and optimisation under Levy copulas and regime-switching," Papers 1607.01207, arXiv.org, revised Jul 2016.
    10. repec:eee:eneeco:v:63:y:2017:i:c:p:1-12 is not listed on IDEAS
    11. Drago Papler & Štefan Bojnec, 2015. "Competitiveness and Factors of Delivery of Electricity," Faculty of Management Koper Monograph Series, University of Primorska, Faculty of Management Koper, number 978-961-266-188-5, January.
    12. Rubin, Ofir David, 2010. "Equilibrium pricing in electricity markets with wind power," ISU General Staff Papers 201001010800002361, Iowa State University, Department of Economics.
    13. Kallio, Markku & Kuula, Markku & Oinonen, Sami, 2012. "Real options valuation of forest plantation investments in Brazil," European Journal of Operational Research, Elsevier, vol. 217(2), pages 428-438.

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