Gas fired power plants: Investment timing, operating flexibility and abandonment

Fleten, Stein-Erik and Näsäkkälä, Erkka (2003): Gas fired power plants: Investment timing, operating flexibility and abandonment.

Abstract

We analyze investments in gas-fired power plants under stochastic electricity and natural gas prices. A simple but realistic two-factor model is used for price processes, enabling analysis of the value of operating flexibility, the opportunity to abandon the capital equipment, as well as finding thresholds for energy prices for which it is optimal to enter into the investment. Our case study uses representative power plant investment and operations data, and historical forward prices from well-functioning energy markets. We find that when the decision to build is considered, the abandonment option does not have significant value, whereas the operating flexibility and time-to-build option have significant effect on the building threshold. Furthermore, the joint value of the operating flexibility and the abandonment option is much smaller than the sum of their separate values, because both are options to shut down. The effects of emission costs on the value of installing CO2 capture technology are also analyzed.

• Item Type: MPRA Paper
• Language: English
• Keywords: Real options; spark spread; gas-fired power plant; forward prices
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy

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