A Review of the Operations Literature on Real Options in Energy

Abstract

Real option models maximize the estimated market value of operational assets, exploiting the flexibility that decision makers have in managing these assets. Inspired by the valuation of financial options, their natural domains of application feature high levels of market or operational risk. The existence of financial markets that trade instruments associated with the inputs or outputs of the underlying processes facilitates the use of these models. The energy industry has thus received a substantial amount of attention within the real option and operations (management/research) communities. The extant work lacks a review of the operations literature on energy real options. We present a synthesis of this literature considering review categories that pertain to the phenomena it studies and the tools it uses to conduct its analysis. Further, we outline potential research directions.

Keywords: Finance, Energy, Real Options, Operations

JEL Classification: C44, C61, C63, G12, L9, Q2, Q3, Q4, Q5