Network Pricing With Investment Waiting Cost Based on Real Options Under Uncertainties

Abstract

Existing capacity-based network pricing uses discounted cash flows to calculate network costs, unable to reflect the uncertainties and flexibilities of the network users. Such shortcoming could distort the cost-reflectivity of pricing signals, particularly those for renewables and flexible technologies, causing more constraints and curtailment issues in networks. Corresponding to these issues, this paper designs a new pricing method, Incremental Cost Network Pricing based on Real Options (ICOC), which can reflect network user uncertainties on network investment by using real options theory. Under this concept, network operators can delay investment for a certain period by paying waiting cost based on options’ value until more information is available, thus avoiding non-reversible investment due to uncertainties. The options’ cost will be levied on network users as i) rewards if they provide flexibilities to the system, or ii) waiting costs if they present uncertainties to the system. The reward or cost to the network users is determined by a binomial tree pricing under a risk-neutral condition, which is added onto asset present value as the total cost to be recovered. Such cost is allocated to network users based on their nodal incremental costs. The proposed method is demonstrated on a practical network with different users, i) uncertain, ii) flexible; iii) certain and nonflexible. The new ICOC pricing scheme can capture the impact of network user uncertainty on network investment and thus set cost-reflective price signals to influence their behaviours.