ENE473 Real Options Analysis of Electricity Markets

• Topics

  Electricity generation assets are capital intensive, last for many years, and, due to the deregulation of electricity markets, their revenues are subject to uncertainty and strategic interactions. Hence, given the unprecedented investment level in response to pressing climate change concerns, inaccurate decisions may entail dire financial consequences. Therefore, investment and operational problems in electricity markets are amenable to analysis by the real options approach, which accounts for decision making under uncertainty while reflecting the value from embedded managerial discretion. Examples of the latter include discretion over investment timing, project scale, operations and technology choice. Thus, real options theory offers an enhancement of the traditional net present value (NPV) approach, as it allows for the assessment of strategies that would not have been able to be addressed otherwise. This course offers a balanced treatment of real options theory and its applications within electricity markets.

  The main topics to be covered are:

  1. Introduction to real options theory and its application to electricity markets.
  2. Timing, sizing and technological characteristics of investments in electricity generation facilities.
  3. Support schemes and their impact on electricity capacity expansion.
  4. Electricity market structures and strategic interactions.

• Learning outcome

  Knowledge

  Upon completing the course students will

  • Have developed an understanding of the real options theory and its relevance for decision making in electricity markets.
  • Know how to analyse investment and operational decisions under uncertainty.
  • Know how to model key aspects of the structural transformation of electricity markets and the transition to low-carbon energy.

  Skills

  Upon completing the course students will know how to

  • Evaluate investment opportunities within deregulated environments.
  • Formulate and implement real options models for deriving policy insights in electricity markets.
  • Derive policy and managerial insights for complex investment opportunities by analysing the behavioural impact of incentives upon market agents.

  General competence

  Upon completing the course students

  • Can use Excel for modelling critical aspects of electricity markets and analysing investment and operational decisions.
  • Can apply real options and dynamic programming models for deriving policy-making and managerial insights relevant for investment and operational decisions in electricity markets.

• Teaching

  One week long intensive course with lectures and solution to exercises. Pre-recorded sessions covering different topics will also be available as supporting/supplemental material.

• Recommended prerequisites

  Basic knowledge of calculus and Excel.

• Credit reduction due to overlap

  None.

• Compulsory Activity

  None.

• Assessment

  Written assignment that may be delivered either individually or in groups of maximum four.

  The students will be given three weeks to complete the assignment, following the completion of lectures.

• Grading Scale

  Pass - Fail

• Literature

  Lecture notes combined with:

  • Dixit, AK and RS Pindyck (1994), Investment under Uncertainty, Princeton University Press, Princeton, NJ, USA (ISBN: 0-691-03410-9)
  • Financial Aspects of Energy and Commodity Markets, taught at the level of Hull (2012), Options, Futures and other Derivatives, 7th Edition, Prentice-Hall