Power Plant Investments in the Turkish Electricity Sector: A Real Options Approach Taking into Account Market Liberalization

FCN Working Paper No. 21/2010 (revised July 2011)

31 Pages Posted: 16 Jul 2011 Last revised: 11 Nov 2013

Date Written: July 2011

Abstract

In this paper we study the economic feasibility of constructing a 560 MW coal-fired power plant in Turkey, using real options theory. We start from a short review of the Turkish electricity market as well as the literature on real options theory and power plant investment. We then investigate the peculiarities and uncertainties related to large-scale power generation. Our special research focus is on the determination of the real options value of the sequential nature of the power plant project considered. To this end, we develop a sequential investment model based on the binomial tree model of Cox, Ross and Rubinstein. The four stages considered are (1) initial project development; (2) detailed planning and permitting; (3) first major project payments; and (4) release of final order. We find that especially for the strategic planning of projects the application of the real options analysis (ROA) can be very useful. The relatively high option value compared to the net present value (NPV) of the project makes clear that the flexibilities of reacting during project realization, depending on the market developments, can be assigned an immense value. A further advantage of the ROA for a staged or sequential investment lies in the fact that it also delivers, besides the option value of the investment, the optimal strategy for exercising the option (i.e. if and when to invest). The revelation of action possibilities and their examination sheds new light on the conventional calculation of the NPV of such projects.

Keywords: Real options, Liberalized market, Sequential investment, Turkey

Suggested Citation

Madlener, Reinhard and Stoverink, Simon, Power Plant Investments in the Turkish Electricity Sector: A Real Options Approach Taking into Account Market Liberalization (July 2011). FCN Working Paper No. 21/2010 (revised July 2011) . Available at SSRN: https://ssrn.com/abstract=1887046 or http://dx.doi.org/10.2139/ssrn.1887046

Reinhard Madlener (Contact Author)

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustraße 10
Aachen, 52074
Germany
+49 241 80 49 820 (Phone)
+49 241 80 49 829 (Fax)

HOME PAGE: http://www.eonerc.rwth-aachen.de/fcn

Simon Stoverink

Evonik Steag GmbH ( email )

Rellinghauser Straße 1-11
Essen, 45128
Germany

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