An Option-Based Approach for the Fair Pricing of Flexible Electricity Supply

FCN Working Paper No. 10/2015

29 Pages Posted: 29 Aug 2016 Last revised: 26 Sep 2016

See all articles by Christiane Rosen

Christiane Rosen

RWTH Aachen University, E.ON Energy Research Center, Institute for Future Energy Consumer Needs and Behavior (FCN)

Reinhard Madlener

RWTH Aachen University

Date Written: August 1, 2015

Abstract

In this electricity market design paper, we investigate the value of flexibility of conventional power plants in today's electricity markets, and whether the current market conditions suffice for recouping the power plant operator's investments and expenses for enhanced flexibility. We find that traditional option valuation methods are inadequate for sufficient compensation, and argue that a levelized cost of electricity (LCOE) approach for option valuation of flexible and non-flexible electrical energy is preferable. In a case study, we create three different flexibility cost scenarios (optimistic, realistic, pessimistic) in order to determine the LCOE and the option prices of the flexibility options studied. We find that flexibility offered in such a way is affordable and that prices are more reasonable than otherwise incurred balancing costs.

Keywords: flexibility markets, energy options, levelized cost of electricity, capacity markets

JEL Classification: C91, D03, D44, D83

Suggested Citation

Rosen, Christiane and Madlener, Reinhard, An Option-Based Approach for the Fair Pricing of Flexible Electricity Supply (August 1, 2015). FCN Working Paper No. 10/2015. Available at SSRN: https://ssrn.com/abstract=2831340 or http://dx.doi.org/10.2139/ssrn.2831340

Christiane Rosen (Contact Author)

RWTH Aachen University, E.ON Energy Research Center, Institute for Future Energy Consumer Needs and Behavior (FCN) ( email )

Mathieustrasse 10
Aachen, 52074
Germany

Reinhard Madlener

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustra├če 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

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