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Investment timing and optimal capacity choice for small hydropower projects

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  • Bøckman, Thor
  • Fleten, Stein-Erik
  • Juliussen, Erik
  • Langhammer, Håvard
  • Revdal, Ingemar

Abstract

This paper presents a method for assessing small hydropower projects that are subject to uncertain electricity prices. We present a real options-based method with continuous scaling, and we find that there is a unique price limit for initiating the project. If the current electricity price is below this limit it is never optimal to invest, but above this limit investment is made according to the function for optimal size. The connection between the real option and the physical properties of a small hydropower plant is dealt with using a spreadsheet model that performs a technical simulation of the production in a plant, based on all the important choices for such a plant. The main results of the spreadsheet are simulated production size and the investment costs, which are in turn used for finding the value of the real option and the price limit. The method is illustrated on three different Norwegian small hydropower projects.

Suggested Citation

  • Bøckman, Thor & Fleten, Stein-Erik & Juliussen, Erik & Langhammer, Håvard & Revdal, Ingemar, 2006. "Investment timing and optimal capacity choice for small hydropower projects," MPRA Paper 2693, University Library of Munich, Germany, revised 31 Dec 2006.
  • Handle: RePEc:pra:mprapa:2693
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    References listed on IDEAS

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    1. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, vol. 46(7), pages 893-911, July.
    2. Jean-Paul Décamps & Thomas Mariotti & Stéphane Villeneuve, 2006. "Irreversible investment in alternative projects," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(2), pages 425-448, June.
    3. Schwartz, Eduardo, 1998. "Valuing long-term commodity assets," Journal of Energy Finance & Development, Elsevier, vol. 3(2), pages 85-99.
    4. Dangl, Thomas, 1999. "Investment and capacity choice under uncertain demand," European Journal of Operational Research, Elsevier, vol. 117(3), pages 415-428, September.
    5. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    6. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    7. Eduardo S. Schwartz, 1998. "Valuing Long-Term Commodity Assets," Financial Management, Financial Management Association, vol. 27(1), Spring.
    8. Robert S. Pindyck, 2001. "The Dynamics of Commodity Spot and Futures Markets: A Primer," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 1-30.
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    More about this item

    Keywords

    OR in Energy; Real Options; Continuous Scaling; Project Evaluation; Hydropower;

    JEL classification:

    • Q25 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Water
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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