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Valuing Flexibility: The case of an Integrated Gasification Combined Cycle Power Plant

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  • Abadie, Luis María
  • Chamorro Gómez, José Manuel

Abstract

In this paper we analyze the valuation of options stemming from the flexibility in an Integrated Gasification Combined Cycle (IGCC) Power Plant. First we use as a base case the opportunity to invest in a Natural Gas Combined Cycle (NGCC) Power Plant, deriving the optimal investment rule as a function of fuel price and the remaining life of the right to invest. Additionally, the analytical solution for a perpetual option is obtained. Second, the valuation of an operating IGCC Power Plant is studied, with switching costs between states and a choice of the best operation mode. The valuation of this plant serves as a base to obtain the value of the option to delay an investment of this type. Finally, we derive the value of an opportunity to invest either in a NGCC or IGCC Power Plant, that is, to choose between an inflexible and a flexible technology, respectively. Numerical computations involve the use of one- and two-dimensional binomial lattices that support a mean-reverting process for the fuel prices. Basic parameter values refer to an actual IGCC power plant currently in operation.

Suggested Citation

  • Abadie, Luis María & Chamorro Gómez, José Manuel, 2005. "Valuing Flexibility: The case of an Integrated Gasification Combined Cycle Power Plant," IKERLANAK 6483, Universidad del País Vasco - Departamento de Fundamentos del Análisis Económico I.
    • Handle: RePEc:ehu:ikerla:6483
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    References listed on IDEAS

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    3. Schwartz, Eduardo S, 1997. "The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
    4. Sarkar, Sudipto, 2003. "The effect of mean reversion on investment under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 377-396, November.
    5. Bhattacharya, Sudipto, 1978. "Project Valuation with Mean-Reverting Cash Flow Streams," Journal of Finance, American Finance Association, vol. 33(5), pages 1317-1331, December.
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