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Optimal investment timing and capacity choice for pumped hydropower storage


Pumped hydropower storage can smooth output from intermittent renewable electricity generators and facilitate their large-scale use in energy systems. Germany has aggressive plans for wind power expansion, and pumped storage ramps quickly enough to smooth wind power and could profit from arbitrage on the short-term price fluctuations wind power strengthens. We consider five capacity alternatives for a pumped storage facility in Norway that practices arbitrage in the German spot market. Price forecasts given increased wind capacity are used to calculate profit-maximizing production schedules and annual revenue streams. Real options theory is used to value the investment opportunity, since unlike net present value, it accounts for uncertainty and intertemporal choice. Results show that the optimal investment strategy under the base scenario is to invest in the largest available plant approximately eight years into the option lifetime.

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  1. Additional revenue streams would be available to the facility through participation in ancillary service markets. Here we consider only arbitrage revenue in the spot market.

  2. The mean prices \(\mu _{y,j}\) are calculated monthly, since increasing price volatility around a daily mean would ignore that periods of high and low wind can last longer than a day, and adjusting prices around a yearly mean could mask finer-scale fluctuations and artificially suppress or elevate prices that are low or high for longer periods of time due to seasonal or macroeconomic effects.

  3. Phelix refers to the physical electricity index in the EEX power spot market for Germany and Austria.

  4. A Bermudan call option allows the owner to purchase an asset for a given exercise price at given points in time during the option lifetime. Here, the asset value is the present value of revenue to the pumped hydropower storage system, the exercise price is the investment cost, and the option can be exercised yearly. The option valuation method used in this study requires discrete exercise times, although an investment decision could be made more frequently than once per year, this frequency is adequate to yield insight into our problem.

  5. Although the success of obtaining a permit has a small degree of uncertainty, incorporating this uncertainty would require a two-stage option valuation framework that is outside the scope of this analysis. Dixit and Pindyck [9] have proposed a method for valuing such two-stage options; however, due to the low cost and large likelihood of success in obtaining a permit, the value of the two-stage option would be very close to that of the single-stage option we consider. We therefore choose to ignore uncertainty in the permitting stage.

  6. Continuation values appear to increase with time because they are discounted to the time of investment; if values were discounted to a uniform time they would of course decrease, reflecting the reduced flexibility as the option nears expiration.


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The authors thank Bjørn Bakken, Michael Belsnes, and Atle Harby of SINTEF Energy Research; Stein-Erik Fleten from the Norwegian University of Science and Technology (NTNU); Arne Sæterdal and Rolv Guddal from Sira Kvina Kraftselskap; and anonymous reviewers for helpful input. This work was supported by FINERGY Project 178374, the Center for Sustainable Energy Studies (CenSES) at NTNU, the National Science Foundation (NSF) Graduate Research Fellowship Program, and the Research Council of Norway and NSF through the Nordic Research Opportunity. This work was also supported in part by grants from the Alfred P. Sloan Foundation and EPRI to the Carnegie Mellon Electricity Industry Center; from the Doris Duke Charitable Foundation, the Department of Energy National Energy Technology Laboratory, and the Heinz Endowments to the RenewElec program at Carnegie Mellon University; and from the U.S. National Science Foundation under Award no. SES-0345798.

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Correspondence to Emily Fertig.

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Fertig, E., Heggedal, A.M., Doorman, G. et al. Optimal investment timing and capacity choice for pumped hydropower storage. Energy Syst 5, 285–306 (2014).

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  • Pumped hydropower storage
  • Real options
  • Wind power integration
  • European Energy Exchange
  • Mutually exclusive options