IDEAS home Printed from https://ideas.repec.org/p/ris/fcnwpa/2015_010.html
   My bibliography  Save this paper

An Option-Based Approach for the Fair Pricing of Flexible Electricity Supply

Author

Listed:
  • Rosen, Christiane

    (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN))

  • Madlener, Reinhard

    (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN))

Abstract

In this electricity market design paper, we investigate the value of flexibility of conventional power plants in today's electricity markets, and whether the current market conditions suffice for recouping the power plant operator's investments and expenses for enhanced flexibility. We find that traditional option valuation methods are inadequate for sufficient compensation, and argue that a levelized cost of electricity (LCOE) approach for option valuation of flexible and non-flexible electrical energy is preferable. In a case study, we create three different flexibility cost scenarios (optimistic, realistic, pessimistic) in order to determine the LCOE and the option prices of the flexibility options studied. We find that flexibility offered in such a way is affordable and that prices are more reasonable than otherwise incurred balancing costs.

Suggested Citation

  • Rosen, Christiane & Madlener, Reinhard, 2015. "An Option-Based Approach for the Fair Pricing of Flexible Electricity Supply," FCN Working Papers 10/2015, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
    • Handle: RePEc:ris:fcnwpa:2015_010
    as

    Download full text from publisher

    File URL: http://www.fcn.eonerc.rwth-aachen.de/global/show_document.asp?id=aaaaaaaaaasrlht
    File Function: Full text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Cramton, Peter & Stoft, Steven, 2008. "Forward reliability markets: Less risk, less market power, more efficiency," Utilities Policy, Elsevier, vol. 16(3), pages 194-201, September.
    2. Wolfgang Buchholz & Jonas Frank & Hans-Dieter Karl & Johannes Pfeiffer & Karen Pittel & Ursula Triebswetter & Jochen Habermann & Wolfgang Mauch & Thomas Staudacher, 2012. "Die Zukunft der Energiemärkte: Ökonomische Analyse und Bewertung von Potenzialen und Handlungsmöglichkeiten," ifo Forschungsberichte, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, number 57, September.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Xiong, Bobby & Predel, Johannes & Crespo del Granado, Pedro & Egging-Bratseth, Ruud, 2021. "Spatial flexibility in redispatch: Supporting low carbon energy systems with Power-to-Gas," Applied Energy, Elsevier, vol. 283(C).
    2. Glensk, Barbara & Madlener, Reinhard, 2015. "Real Options Analysis of the Flexible Operation of an Enhanced Gas-Fired Power Plant," FCN Working Papers 11/2015, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
    3. Glensk, Barbara & Madlener, Reinhard, 2019. "The value of enhanced flexibility of gas-fired power plants: A real options analysis," Applied Energy, Elsevier, vol. 251(C), pages 1-1.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Cuervo, Felipe Isaza & Botero, Sergio Botero, 2016. "Wind power reliability valuation in a Hydro-Dominated power market: The Colombian case," Renewable and Sustainable Energy Reviews, Elsevier, vol. 57(C), pages 1359-1372.
    2. Weihan Li & Jin E. Zhang & Xinfeng Ruan & Pakorn Aschakulporn, 2024. "An empirical study on the early exercise premium of American options: Evidence from OEX and XEO options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(7), pages 1117-1153, July.
    3. Dybvig, Philip H. & Gong, Ning & Schwartz, Rachel, 2000. "Bias of Damage Awards and Free Options in Securities Litigation," Journal of Financial Intermediation, Elsevier, vol. 9(2), pages 149-168, April.
    4. Boyarchenko, Svetlana & Levendorskii[caron], Sergei, 2007. "Optimal stopping made easy," Journal of Mathematical Economics, Elsevier, vol. 43(2), pages 201-217, February.
    5. Robert C. Merton, 2006. "Paul Samuelson and Financial Economics," The American Economist, Sage Publications, vol. 50(2), pages 9-31, October.
    6. Ammann, Manuel & Kind, Axel & Wilde, Christian, 2003. "Are convertible bonds underpriced? An analysis of the French market," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 635-653, April.
    7. Pringles, Rolando & Olsina, Fernando & Penizzotto, Franco, 2020. "Valuation of defer and relocation options in photovoltaic generation investments by a stochastic simulation-based method," Renewable Energy, Elsevier, vol. 151(C), pages 846-864.
    8. Kim, Amy M. & Li, Huanan, 2020. "Incorporating the impacts of climate change in transportation infrastructure decision models," Transportation Research Part A: Policy and Practice, Elsevier, vol. 134(C), pages 271-287.
    9. Collan, Mikael, 2008. "New Method for Real Option Valuation Using Fuzzy Numbers," Working Papers 466, IAMSR, Åbo Akademi.
    10. Grosen, Anders & Lochte Jorgensen, Peter, 2000. "Fair valuation of life insurance liabilities: The impact of interest rate guarantees, surrender options, and bonus policies," Insurance: Mathematics and Economics, Elsevier, vol. 26(1), pages 37-57, February.
    11. Bjork, Tomas, 2009. "Arbitrage Theory in Continuous Time," OUP Catalogue, Oxford University Press, edition 3, number 9780199574742.
    12. Hoque, Ariful & Le, Thi & Hasan, Morshadul & Abedin, Mohammad Zoynul, 2024. "Does market efficiency matter for Shanghai 50 ETF index options?," Research in International Business and Finance, Elsevier, vol. 67(PB).
    13. Santos, Lúcia & Soares, Isabel & Mendes, Carla & Ferreira, Paula, 2014. "Real Options versus Traditional Methods to assess Renewable Energy Projects," Renewable Energy, Elsevier, vol. 68(C), pages 588-594.
    14. Jobst, Andreas A., 2014. "Measuring systemic risk-adjusted liquidity (SRL)—A model approach," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 270-287.
    15. Timothy Johnson, 2015. "Reciprocity as a Foundation of Financial Economics," Journal of Business Ethics, Springer, vol. 131(1), pages 43-67, September.
    16. Yongxin Yang & Yu Zheng & Timothy M. Hospedales, 2016. "Gated Neural Networks for Option Pricing: Rationality by Design," Papers 1609.07472, arXiv.org, revised Mar 2020.
    17. Sanghyo Lee & Kyunghwan Kim, 2015. "Collar Option Model for Managing the Cost Overrun Caused by Change Orders," Sustainability, MDPI, vol. 7(8), pages 1-15, August.
    18. Tabesh, Hamid, 1987. "Hedging price risk to soybean producers with futures and options: a case study," ISU General Staff Papers 1987010108000010306, Iowa State University, Department of Economics.
    19. Manley, Bruce & Niquidet, Kurt, 2010. "What is the relevance of option pricing for forest valuation in New Zealand?," Forest Policy and Economics, Elsevier, vol. 12(4), pages 299-307, April.
    20. Dapena, Jose Pablo, 2003. "On the Valuation of Companies with Growth Opportunities," Journal of Applied Economics, Universidad del CEMA, vol. 6(1), pages 1-24, May.

    More about this item

    Keywords

    flexibility markets; energy options; levelized cost of electricity; capacity markets;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ris:fcnwpa:2015_010. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Hendrik Schmitz (email available below). General contact details of provider: https://edirc.repec.org/data/fceonde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.