An Options Pricing Approach to Ramping Rate Restrictions at Hydro Power Plants
60 Pages Posted: 5 Dec 2014
Date Written: November 22, 2014
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
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