A Real Options Model for the Disinvestment in Conventional Power Plants

Abstract

The liberalization of the energy markets and the merit order effect lead to difficulties in the operation even of modern, highly energy-effcient conventional power plants ('missing money problem'). Their operation often becomes unprofitable, so that sometimes the only remaining option is to liquidate the plant altogether. Decisions about further operation or shut-down can be supported by applying real options analysis. This approach has been used successfully for assessing investment projects in different sectors of the economy including the energy supply industry. In this paper, we develop a real options model for the disinvestment in conventional, fossil-fuelled power plants. Applying the proposed real options approach, we aim to determine the optimal timing for the shut-down of unprofitable gas-fired power plants as well as the probability level for all possible decisions. The results show that the decision and its probability value regarding continued operation, or the optimal timing for shutdown of the power plant, depend strongly on the volatility level of the capacity factor.