An Application of Real Options to Capital Budgeting for Power Grid Reliability

8 Pages Posted: 12 Mar 2018 Last revised: 15 Mar 2019

See all articles by Paul Borochin

Paul Borochin

University of Miami - Department of Finance

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics

Date Written: March 13, 2019

Abstract

How does a public electric utility company optimize its capital budget for grid reliability? We illustrate an economically optimal way to allocate funding these efforts using circuit-level data from Eversource Energy to quantify the benefits to tree trimming treatments over the period of 2013-2017. A real options framework allows us to quantify in dollar terms the uncertain benefits in terms of customer outages avoided relative to known costs of treatment. We find that the less costly Standard Maintenance Trimming (SMT) is economically effective for all circuit types observed in Eversource's CT grid, while the more extensive Enhanced Tree Trimming (ETT) is effective on dense circuits only. Compared to this model, a traditional discounted cash flow model leads to underinvestment in grid resilience and ignores both uncertainty in estimates and the ability to change policy based on its efficacy.

Keywords: Resilience, Power System Economics, Power System Stability

JEL Classification: H42, H54

Suggested Citation

Borochin, Paul and Zhao, Yanhui, An Application of Real Options to Capital Budgeting for Power Grid Reliability (March 13, 2019). Available at SSRN: https://ssrn.com/abstract=3138209 or http://dx.doi.org/10.2139/ssrn.3138209

Paul Borochin (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics ( email )

Whitewater, WI 53190
United States

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