Abstract
This paper presents how to apply a decision-making tool based on real options to assess the investment in a wind energy plant.
The work shows six case studies where the main model’s parameters are analyzed. The uncertainty coming from wind regimes is simulated by using Weibull distributions and the volatility of market prices is obtained from the mean reverting process of the Ornstein-Uhlenbeck type, also known as Geometric Mean Reversion (GMR). From these and other values, such as investment and maintenance costs, the Net Present Value (NPV) curve, made up of different values of NPV in different periods of the investment is calculated, as well as its average volatility.
Having the key parameters of the model, a real options valuation method is applied. The volatility, strength of reversion and long-term trend of the NPV curve reflecting different periods are inserted into a trinomial investment option valuation tree. From this, it is possible to calculate the probabilities of investing right now (exercise), deferring the investment (wait), or not investing at all (abandon).
This powerful decision-making tool allows wind energy investors to decide whether to invest in many different scenarios.
Similar content being viewed by others
References
Ault, G. W., McDonald, J. R., & Burt, G. M. (2003). Strategic analysis framework for evaluating distributed generation and utility strategies. IEE Proceedings. Generation, Transmission and Distribution, 150, 475–481.
Correia, P. F., Carvalho, P. M. S., Ferreira, L. A. F. M., Guedes, J., & Sousa, J. (2008). Power plant multistage investment under market uncertainty. IEE Proceedings. Generation, Transmission and Distribution, 2, 149–157.
Cox, J. C., Ingersoll, J. E., & Ross, S. A. (1979). Duration and determination of basis risk. Journal of Business, 52, 51–61.
Cox, J. C., Ingersoll, J. E., & Ross, S. A. (1985). An intertemporal general equilibrium model of asset prices. Econometrica, 53, 363–384.
Deng, S.-J., & Oren, S. S. (2003). Incorporating operational characteristics and start-up costs in option-based valuation of power generation capacity. Probability in the Engineering and Informational Sciences, 17(2), 155–182.
Dixit, A., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton: Princeton University Press.
El-Khattam, W., Bhattacharya, K., Hegazy, Y., & Salama, M. M. A. (2004). Optimal investment planning for distributed generation in a competitive electricity market. IEEE Transactions on Power Systems, 19(3), 1674–1684.
Fleten, S.-E., & Näsäkkälä, E. (2003). Gas-fired power plants: Investment timing, operating flexibility and abandonment. In Proceedings of the 7th annual international conference on real options, 10–12 July 2003, Washington, DC.
Fleten, S.-E., Maribu, K. M., & Wangensteen, I. (2007). Optimal investment strategies in decentralized renewable power generation under uncertainty. Energy, 32, 803–815.
Hull, J. C. (2005). Prentice-Hall finance series. Options, futures, and other derivatives (6th ed.). New York: Prentice Hall. ISBN:0-1314-9908-4.
Khatib, H. (2003). IEE power series: Vol. 23. Financial and economic evaluation of projects in the electricity supply industry. Stevenage: The Institution of Engineering and Technology.
Lucía, J. J., & Schwartz, E. S. (2002). Electricity prices and power derivatives: evidence from the Nordic power exchange. Review of Derivatives Research, 5, 5–50.
Metcalf, G. E., & Hassett, K. A. (1995). Investment under alternative return assumptions: comparing random walks and mean reversion. Journal of Economic Dynamics & Control, 8, 1471–1488.
Muñoz, J. I., Contreras, J., Caamaño, J., & Correia, P. F. (2009). Risk assessment of wind power generation project investments based on real options. In Proceedings of IEEE PowerTech 2009, June 28–July 2, 2009, Bucharest (pp. 1–8). ISBN:978-1-4244-2234-0.
Näsäkkälä, E., & Fleten, S.-E. (2005). Flexibility and technology choice in gas fired power plant investments. Review of Financial Economics, 14(3–4), 371–393. Special Issue on Real Options.
Royal Decree 661/2007 (2007). Regulating the activity of energy production in a special regime, 25th of May 2007. http://www.boe.es/boe/dias/2007/05/26/pdfs/A22846-22886.pdf (in Spanish).
Schwartz, E. S. (1997). The stochastic behaviour of commodity prices: implications for valuation and hedging. Journal of Finance, 52(3), 923–973.
Trigeorgis, L. (1995). Real options in capital investment: models, strategies and applications. New York: Praeger. ISBN:978-0-2759-4616-6.
Trigeorgis, L. (1996). Real options: managerial flexibility and strategy in resource allocation. Cambridge: MIT Press.
Tseng, C.-L. (2000). Exercising real unit operational options under price uncertainty. In Proceedings of the 2000 IEEE PES winter meeting, 23–27 January, Singapore (pp. 436–440).
Tseng, C.-L., & Barz, G. (2002). Short-term generation asset valuation: a real options approach. Operations Research, 50(2), 297–310.
Tseng, C.-L., & Lin, K. Y. (2007). A framework using two-factor price lattices for generation asset valuation. Operations Research, 55(2), 234–251.
Wang, C.-H., & Min, K. J. (2006). Electric power generation planning for interrelated projects: a real options approach. IEEE Transactions on Engineering Management, 53(2), 312–322.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Muñoz, J.I., Contreras, J., Caamaño, J. et al. A decision-making tool for project investments based on real options: the case of wind power generation. Ann Oper Res 186, 465–490 (2011). https://doi.org/10.1007/s10479-011-0856-9
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10479-011-0856-9