Investment under Uncertainty in Power Generation: Integrated Electricity Prices Modeling and Real Options Approach

A proposal is made to analyze the problem of investments under uncertainty in electric power generation through the development of a methodology that uses real options and electric prices modeling. A trinomial tree numerical procedure is implemented using parameters estimated from a stochastic one-factor mean reversion model, integrating a system's operation model to find the electric market long-term expectations. Through dynamic programming, the American real option is assessed, determining the value of the investment opportunity and finding the long-term critical price where the investments become optimal. As a study case, the methodology is applied in the Chilean energy market, evaluating various electric generation technologies and studying the impact of the main parameters of the price model, hence demonstrating that flexibility in decisions adds value to the investments.