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
Date Written: August 1, 2015
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: Suggested Citation