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Business Cycles and Energy Real Options Valuation

In: Applied Operations Research and Financial Modelling in Energy

Author

Listed:
  • Turalay Kenc

    (TOBB ETU)

  • Mehmet Fatih Ekinci

    (Atilim University)

Abstract

This paper uses a real options approach to value energy projects whose cash flows follow a normal distribution and subject to macroeconomic risks. Large and irreversible energy investments are usually modelled in real options frameworks with lognormal distributions. This line of research omits two important factors for energy investments. They are the existence of negative cash flows and the impact of business cycles. We developed a unified framework to capture the implications of these omitted features. The framework is based on an arithmetic Brownian motion (ABM) process for the dynamics of cash flows with regime shifts. Our numerical analysis provide results on investment triggering cash flow critical values, probability of investing and optimal investment time. Comparing these results with those obtained under a conventional real option value framework with geometric Brownian motion (GBM) suggests that there are significant differences across these models. The results indicate that ABM investors are more likely to invest within a specified period. Numerical analysis also points that macroeconomic risks are important for investors.

Suggested Citation

  • Turalay Kenc & Mehmet Fatih Ekinci, 2021. "Business Cycles and Energy Real Options Valuation," Springer Books, in: AndrĂ© B. Dorsman & Kazim Baris Atici & Aydin Ulucan & Mehmet Baha Karan (ed.), Applied Operations Research and Financial Modelling in Energy, pages 173-200, Springer.
    • Handle: RePEc:spr:sprchp:978-3-030-84981-8_9
    DOI: 10.1007/978-3-030-84981-8_9
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