Real Options Analysis of Electricity Portfolios

Abstract

The characteristics of large, sometimes giga-sized investments of complex engineering systems often require a multidisciplinary decision-making process. The investment parameters on which the decision-making is based, the optimality criteria underlying this process and the identification of the parameters of evaluation models also require mutual cooperation between engineering and economic professionals. Using methodological analysis and empirical testing of capacity planning in the power generation sector, I tried to knock holes in the preconceptions almost cast in stone which argue that traditional technologies decisively dominate renewable technologies under any circumstances, or that the stars in the paradigm shift that is taking place in the industry can be nothing else but renewable technologies. In order to prove this hypothesis, I choose real options and portfolio theory as a verification tool, as I consider these theories as methods that are capable of capturing all the factors behind the optimal power generation mix. The empirical results and qualitative arguments of this study demonstrate that real options theory along with portfolio theory can provide capacity planners with the most advanced optimisation tool for power generation mixes through taking advantage of the benefits of diversification and flexibility.