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Gas Fired Power Plants: Investment Timing, Operating Flexibility and Abandonment

  • Stein-Erik Fleten

    (Norwegian University of Science & Technology)

  • Erkka Näsäkkälä

    (Helsinki University of Technology)

We analyze investments in gas fired power plants under stochastic electricity and gas prices. We use a real options approach, taking into account the economic information in futures and forward prices. A simple but realistic two-factor model is used for price process, enabling analysis of the value of operating flexibility, the opportunity to sell and abandon the capital equipment, as well as finding thresholds for energy prices for which it is optimal to enter into the investment. Our case study, using real data, indicates that when the decision to build is considered, the plant’s flexibility and abandonment option do not have significant value.

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File URL: http://econwpa.repec.org/eps/fin/papers/0404/0404010.pdf
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Paper provided by EconWPA in its series Finance with number 0404010.

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Length: 29 pages
Date of creation: 21 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0404010
Note: Type of Document - pdf; pages: 29
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, vol. 60(1), pages 55-73, January.
  2. Nasakkala, Erkka & Fleten, Stein-Erik, 2005. "Flexibility and technology choice in gas fired power plant investments," Review of Financial Economics, Elsevier, vol. 14(3-4), pages 371-393.
  3. Abadie, Luis M. & Chamorro, José M., 2008. "Valuing flexibility: The case of an Integrated Gasification Combined Cycle power plant," Energy Economics, Elsevier, vol. 30(4), pages 1850-1881, July.
  4. 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.
  5. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
  6. Saman Majd & Robert S. Pindyck, 1985. "Time to Build, Option Value, and Investment Decisions," NBER Working Papers 1654, National Bureau of Economic Research, Inc.
  7. Siddiqui, Afzal S. & Maribu, Karl, 2009. "Investment and upgrade in distributed generation under uncertainty," Energy Economics, Elsevier, vol. 31(1), pages 25-37, January.
  8. 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 923-73, July.
  9. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  10. Denny Ellerman, 1998. "Note on The Seemingly Indefinite Extension of Power Plant Lives, A Panel Contribution," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
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