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Microgrid investment under uncertainty: a real option approach using closed form contingent analysis

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  • Farnaz Farzan
  • Khashayar Mahani
  • Kaveh Gharieh
  • Mohsen Jafari

Abstract

The traditional net present value approach to investment in microgrid assets does not take into account the inherent uncertainties in fuel prices, cost of technology, and microgrid load profile. We propose a real option approach to microgrid investment, which includes solar photovoltaic (PV) and gas-fired generation assets. Likewise the (n, m) exchange literature in real option analysis, we examine cases with interdependency and independency of fuel price and the cost of PV technology. This work, however, makes a major contribution by the way of introducing a new parameter, which is defined as the elasticity of the option value to prices and is used in the formulation of closed form solutions. We further extend the (1, 1) exchange problem here to include operational flexibility of microgrid, such that optimal switching between investment, suspension and re-activation can be examined. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Farnaz Farzan & Khashayar Mahani & Kaveh Gharieh & Mohsen Jafari, 2015. "Microgrid investment under uncertainty: a real option approach using closed form contingent analysis," Annals of Operations Research, Springer, vol. 235(1), pages 259-276, December.
    • Handle: RePEc:spr:annopr:v:235:y:2015:i:1:p:259-276:10.1007/s10479-015-1929-y
    DOI: 10.1007/s10479-015-1929-y
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    Cited by:

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    2. Cheng, Cheng & Dong, Kangyin & Wang, Zhen & Liu, Shulin & Jurasz, Jakub & Zhang, Haoran, 2023. "Rethinking the evaluation of solar photovoltaic projects under YieldCo mode: A real option perspective," Applied Energy, Elsevier, vol. 336(C).
    3. Sendstad, Lars Hegnes & Chronopoulos, Michail, 2020. "Sequential investment in renewable energy technologies under policy uncertainty," Energy Policy, Elsevier, vol. 137(C).
    4. Alibeiki, Hedayat & Lotfaliei, Babak, 2022. "To expand and to abandon: Real options under asset variance risk premium," European Journal of Operational Research, Elsevier, vol. 300(2), pages 771-787.
    5. Carol Alexander & Xi Chen, 2021. "Model risk in real option valuation," Annals of Operations Research, Springer, vol. 299(1), pages 1025-1056, April.
    6. Qüinny Soares Rocha & Rafaele Almeida Munis & Richardson Barbosa Gomes da Silva & Elí Wilfredo Zavaleta Aguilar & Danilo Simões, 2023. "Photovoltaic Solar Energy in Forest Nurseries: A Strategic Decision Based on Real Options Analysis," Sustainability, MDPI, vol. 15(5), pages 1-11, February.
    7. Trigeorgis, Lenos & Tsekrekos, Andrianos E., 2018. "Real Options in Operations Research: A Review," European Journal of Operational Research, Elsevier, vol. 270(1), pages 1-24.
    8. Nadarajah, Selvaprabu & Secomandi, Nicola, 2023. "A review of the operations literature on real options in energy," European Journal of Operational Research, Elsevier, vol. 309(2), pages 469-487.

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