Flexibility and Technology Choice in Gas Fired Power Plant Investments
The value of a gas fired power depends on the spark spread, defined as the difference between the price of electricity and the cost of gas used for the generation of electricity. We model the spark spread using a two-factor model, allowing mean-reversion in short-term variations and uncertainty in the equilibrium price to which prices revert. We analyze two types of gas plants: peak and base load plants. A peak load plant generates electricity when spark spread exceeds emission costs, whereas a base load plant generates electricity at all levels of spark spread. A base load plant can be upgraded to a peak load plant. First, we find the upgrading threshold for a base load plant. The upgrading threshold gives the optimal type of gas plant as a function of spark spread. Second, we calculate building threshold for the investment costs. When the investment costs are below the threshold it is optimal to build the plant. In the numerical example, we illustrate how our model can be used when investments in gas fired power plants are considered.
|Date of creation:||21 May 2004|
|Date of revision:||06 Apr 2006|
|Note:||Type of Document - pdf; pages: 33. See also ewp-fin/0404010|
|Contact details of provider:|| Web page: http://econwpa.repec.org|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- David G. Laughton & Henry D. Jacoby, 1993. "Reversion, Timing Options, and Long-Term Decision-Making," Financial Management, Financial Management Association, vol. 22(3), Fall.
- 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.
- He, Hua & Pindyck, Robert S., 1992.
"Investments in flexible production capacity,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 16(3-4), pages 575-599.
- He, Hua. & Pindyck, Robert S., 1989. "Investments in flexible production capacity," Working papers 2102-89., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- 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).
- 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. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpot:0405004. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.