Abstract
Flexibilities and optionalities in electricity systems are getting increasingly relevant in electricity systems for two reasons: first, the financial trading of electricity products which leads to consider flexibilities in physical assets, like power plants, analogously to financial contracts with flexibilities, namely as “real options”. Second, with the increasing shares of fluctuating renewables, there is a substantial threat of lacking flexibility. More flexibility may be needed when forecast errors increase while the shares of controllable conventional power plants decline in parallel. The chapter starts with the financial perspective on flexibilities. This includes modelling prices as stochastic processes, e.g. as Ornstein-Uhlenbeck process. The concept of the hourly price forward curve to link future and spot prices in electricity markets is then introduced. These elements form the basis for a first simple option valuation approach. A digression to financial options and the seminal Black-Scholes model follows. Assumptions as well as merits and limits of this approach for electricity markets are thereby scrutinised. The modelling of thermal and hydropower plants as options is subsequently developed. An application example shows how the method enables to identify the intrinsic value and the time value of power plants. Finally, the challenge to combine this asset valuation with the system perspective is addressed.
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Notes
- 1.
There was an exemption during the beginning of the Corona crisis in April 2020, as oil demand suddenly sharply decreased resulting in negative prices for the US standard oil variety WTI (West Texas Intermediate). In fact, the strong demand shock coincided with a lack of spare physical storage at the delivery point – and this combination drove prices below zero given that WTI futures are settled physically, contrarily to the common practice mentioned in Sect. 8.6.
- 2.
Yet all statistical and econometric methods rely in one way or another on the assumption of the absence of structural breaks.
- 3.
A broad variety of options is traded on financial markets. The most standard options are labelled European and American options. European options may only be exercised at the exercise date, whereas American options may be exercised any time up to the exercise date. So for American options “early exercise”, i.e. a use before the agreed exercise date is possible whereas it is not for European options. Real options involve a physical activity and hence obviously may not exercised in advance—they correspond to European options, or often rather to a sequence of European options (cf. Sect. 11.6).
- 4.
The term underlying is used in finance to designate the asset, which a derivative is based on, e.g. the shares of a particular company, cf. also Sect. 8.2.
- 5.
These products are frequently subsumed under the term “derivatives” (cf. Chap. 8). Yet we avoid this nomenclature in the following to avoid confusion with the mathematical concept of derivatives of a function.
- 6.
Note that there are no indices \(T|t\) or likewise to the value function \(V\) as in the previous subsection. In fact, we consider here always the value at time \(t\) evaluated with information at the same time \(t\). Therefore, we drop these unnecessary, identical indices.
- 7.
Mathematically, it is a consequence of Ito’s lemma, which is a fundamental theorem in stochastic calculus.
- 8.
Pushing even further, a CHP plant with heat as second output besides electricity is dependent on four underlyings.
- 9.
Swing options have been introduced in the finance literature mostly to describe the characteristics of common gas contracts, which include minimum and maximum delivery quantities, cf. e.g. Jaillet et al. (2004).
- 10.
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Weber, C., Möst, D., Fichtner, W. (2022). Valuing Flexibilities in Power Systems as Optionalities. In: Economics of Power Systems. Springer Texts in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-030-97770-2_11
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