An Options Pricing Approach to Ramping Rate Restrictions at Hydro Power Plants

60 Pages Posted: 5 Dec 2014

See all articles by Shilei Niu

Shilei Niu

University of Waterloo - Department of Economics

Margaret C. Insley

University of Waterloo - Department of Economics

Date Written: November 22, 2014

Abstract

This paper uses a real options approach to examine the impact of ramping rate restrictions imposed on hydro operations to protect aquatic ecosystems. We consider the effect on profits from electricity generation in order to inform policy decisions about ramping rate restrictions. A novelty of the paper is in examining the optimal operation of a prototype hydro power plant with electricity prices modelled as a regime switching process. We show that profits are negatively affected by ramping restrictions, but the extent of the impact depends on key parameters which determine the desirability of frequent changes in water release rates. Interestingly for the case considered, profit is not sensitive to ramping restrictions over a large range of restrictions. The results point to the importance of accurately modelling electricity prices in gauging the trade offs involved in imposing restrictions on hydro operators which may hinder their ability to respond to volatile electricity prices and meet peak demands.

Keywords: ramping rate, regime switching, hydro-peaking, real options, stochastic control, Hamilton Jacobi Bellman-Partial Differential Equation

JEL Classification: C61, G12, Q25, Q49, Q51, Q58

Suggested Citation

Niu, Shilei and Insley, Margaret C., An Options Pricing Approach to Ramping Rate Restrictions at Hydro Power Plants (November 22, 2014). Available at SSRN: https://ssrn.com/abstract=2533547 or http://dx.doi.org/10.2139/ssrn.2533547

Shilei Niu (Contact Author)

University of Waterloo - Department of Economics ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada

HOME PAGE: http://sites.google.com/site/shileiniuston

Margaret C. Insley

University of Waterloo - Department of Economics ( email )

200 University Avenue, West
Waterloo, Ontario N2L 3G1
Canada
+1 519-888-4567, ext. 38918 (Phone)

HOME PAGE: http://economics.uwaterloo.ca/margaret-insley

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