Power Systems Investments : A Real Options Analysis

Energy projects with extended life cycles and initial investments can be non-profitable under discount cash flow methods. Therefore, real options analysis has become relevant as a pricing technique for these types of projects, with private risks and high investment levels. Following this question, this study analyses different real options approaches to select the most acceptable for investing decisions in the energy sector. Combined cycle natural gas-fired plants constitute relevant generation assets that building decisions can mostly be studied by real options tools. Because traditional pricing approaches fail to consider the worth of flexibility, conditions for creating a significantly large options-based value can be found. Being unable to capture the value associated with the decision maker’s ability to react dynamically to changing market conditions, these assets constitute a fine example of flexibility, which contributes to increasing its intrinsic value. The study employs a real options approach that doesn’t need to capture all the uncertainty and proposes a process that directly determines the uncertainty associated with the first period. The results support that its use can be considered fair. However, it shows that long periods of operation and poor adhesion to the geometric Brownian motion by the project returns might call into question its use in the energy market. The values for option pricing have remained inside acceptable ranges, but some shortfalls could be found. First, the study employs Monte Carlo simulations, which can be viewed as forward-looking processes, and option pricing problems need backward recursive solutions. Second, the study shows that its simplicity produces results as accurate as those gathered from approaches with added complexity and computational needs. DOI: 10.4018/978-1-61350-138-2.ch008