Real options and a large producer: the case of electricity markets

Abstract

In this paper we extend the real option theory to consider the situation of a large producer and we employ the model to electricity markets. This is important because many producers in these markets affect the market supply and, therefore, also the electricity price. This production price effect influences not only on the assets that the energy company owns but also on its investment opportunities. We show that this production's price effect has to be considered in the investment analysis if the company is not able to hedge the price effect in the financial markets and if there is no competition on the investment opportunity.