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Decision making under uncertainty - an option valuation approach to power planning (English)

This paper addresses the problem of irreversibility of investments, a topic related to the recently evolving "real options" literature. In the presence of alternatives, the opportunity to invest in a large "irreversible" project with uncertain benefits and costs is similar to a financial "call" option. In exercising this option one forgoes the potential gains from postponing the investment decision. Conventional economic appraisal techniques ignore this opportunity cost, thus usually tending to accept large inflexible projects. This problem is particularly important in power investment decisions, where the presence of uncertain demand, fuel prices, construction cost, etc. makes the opportunity cost too high to ignore. The present paper includes an exposition of the options approach, a discussion on the main model and its parameters, and experience in applying this innovative approach in four power planning case studies.

Details

  • Author

    Crousillat, Enrique Martzoukos, Spiros Industry and Energy Department

  • Document Date

    1991/08/31

  • Document Type

    Departmental Working Paper

  • Report Number

    11330

  • Volume No

    1

  • Total Volume(s)

    1

  • Disclosure Date

    2010/07/01

  • Doc Name

    Decision making under uncertainty - an option valuation approach to power planning

  • Keywords

    discount rate;option model;construction cost;expansion plan;Present Value of Benefits;power system;standard deviation;data collection and analysis;fuel saving;sensitivity analysis;Gas Turbine;power planning;fuel price;opportunity cost;power system planning;measure of uncertainty;rate of change;choice of technology;demand for power;energy demand growth;Oil and Gas;power investment program;long term agreement;effect of uncertainty;net present value;power system expansion;random walk hypothesis;crude oil price;irreversibility of investments;reduction of uncertainty;coal generating plant;demand for electricity;Oil & Gas;international crude oil;transmission line;hydro plant;thermal plant;fuel cost;total saving;nuclear plant;option valuation;avoided costs;hydropower plant;investment cost;coal plant;increasing function;risk analysis;installed capacity;energy price;transmission investment;forecast error;irreversible investment;exercise price;investment opportunities;economic appraisal;base case;quantitative measure;capacity factor;fixed investment;real cost;systems approach;mathematical formulation;weighted average;diesel plant;equal share;financial literature;Small Hydro;Power Market;variable cost;sunk cost;alternative investment;Exchange Rates;power supply;plant capacity;investment expansion;effective capacity;total fuel;cost uncertainty;thermal generation;future investment;construction period;base year;simulation result;hydropower development;river flow;dam site;water regulation;option price;construction time;electrical system;short period;total life;project costing;power grids;investment option;future value;initial value;extreme values;confidence interval;negative value;hydro scheme;alternative development;monetary term;constant rate;exponential growth;stochastic process;thermal technology;standard model;industrialized country;Industrialized countries;literature review;conventional investment;financial investment;production decision;previous work;stock price;finance terminology;financial resource;correlation coefficient;cost escalation;peak demand;regional market;cycle plant;reserve capacity;reliability standards;technological innovation;hydro development;investment problems;analytical tool;macro level;benefit stream;simulation approach;black box;cost analysis;energy department;net saving;conventional analysis;rural area;diesel oil;geothermal plant;dry period;hydro energy;simulation model;economic efficiency;standard practice;

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Citation

Crousillat, Enrique Martzoukos, Spiros Industry and Energy Department

Decision making under uncertainty - an option valuation approach to power planning (English). Industry and Energy Department working paper. Energy Series paper ; no. 39 Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/284621468764740876/Decision-making-under-uncertainty-an-option-valuation-approach-to-power-planning