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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
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    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.
    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

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    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.

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    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

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