A Real Options Approach to Determining Power Prices

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A Real Options Approach to Determining Power Prices

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Titel: A Real Options Approach to Determining Power Prices
Forfatter: Misir, Nihat
Resume: This dissertation is at the crossroads of electricity markets, industrial organization and real options literature. The main contribution of the dissertation is to investigate the effects of market power when the strategic producers own a portfolio of generation technologies and have ability to affect prices while facing demand or production uncertainties. The dissertation presents three chapters that deal with the short and long term impacts of market power in the electricity markets. Specifically, the first chapter provides a thorough look at the start up and shut down decisions of the peakload generators and paves way to a better assessment of the extent of the market power of a strategic firm. The second chapter shows the significance of wind power generator ownership on the peakload firms production decisions and market outcomes. Finally, the third chapter investigates how the investment decisions and technology choice differ between fixed and flexible production generators. Overall, this dissertation mainly adopts a real options methodology where the optimal decisions of the producers have a direct impact on the electricity prices contrary to the vast majority of the real options literature. The first chapter studies the effects of operational characteristics of power plants on optimal dispatch decisions and estimation of market power. Specifically, I give a real options model to show how operational characteristics of power plants and market uncertainty affect start up and shut down decisions. I show that in the case of ownership of multiple generation technologies, optimal dispatch decisions cause capacity withholding for the peakload generator in both the monopoly and the social planner cases. Moreover, the difference between the start up trigger prices for the social planner and the marginal cost reveals significant levels of real options premium. Overall, the existence of significant real options premium levels shows that ignoring market uncertainties and operational characteristics of individual generators, results in overestimating the extent of market power of the firms in the industry. Therefore, I conclude that real options analysis can be an asset for more accurate investigations and decisions on the exercise of market power. The second chapter shifts the focus to the ownership of wind generators as the fixed baseload generation in the first chapter is assumed to be replaced by the stochastic wind generation. Specifically, this chapter investigates the short term effects of wind generator ownership by the owners of fossil-fueled peakload generators. I show that aggregate wind generator ownership reduces the positive impact of the wind generation on the market outcomes and as a result the total peakload production decreases and the market price increases. Furthermore, when all wind generators are owned by the peakload firms, the impact of wind generation on the market outcomes vanishes. Additionally, start up and shut down (suspension) price thresholds are significantly higher when the owner of peakload capacity also owns a share of wind power generators. I also find that a feed-in premium support scheme does not affect the peakload firms production levels and hence the market outcomes. However, under a feed-in tariff type of support scheme, there is an increase in the total production and a decrease in the market price. The third chapter, coauthored with Rune Ramsdal Ernstsen, compares the investment timing and the optimal level of investment for a hypothetical monopolist and a social planner that have a one-time opportunity to invest in a generator with either fixed or flexible production. It specifically investigates how the investment triggers, optimal capacities and technology choices change with the changes to the investment cost function, demand uncertainty and the level of installed capacity in the market. The main contribution of this paper is to document that the choice to invest between generators with fixed or flexible production does not only depend on the differences in costs for different technologies but also on the differences in operation of those technologies. We find that the strategic firm tends to invest at a higher demand trigger level and lower capacity compared to the social planner for both the baseload and the peakload investment cases. Hence, the strategic firm is expected to invest at a later date while incurring lower investment costs. Furthermore, for both the strategic firm and the social planner, fixed baseload generation is preferable during low uncertainty cases whereas high uncertainty tends to result in the choice of flexible peakload generation. We additionally find that highly convex investment costs greatly diminishes the impact of market power on the investment decisions.
URI: http://hdl.handle.net/10398/9135
Dato: 2015-05-19

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