Valuation of an Option to Build a Power Plant in a Transmission Network under Demand Uncertainty

Abstract

<p>In this paper, we investigate how to value an option to build a power plant when electricity demand fluctuates over time. Towards this aim, we first construct a transmission network, and obtain locational marginal prices for the network buses utilizing optimal power flow. Next, we construct a lattice model under the assumption that the demand fluctuation over time is represented by a geometric Brownian motion. Based on this demand lattice, we derive the economic consequences of costs to a bus with and without a power plant in a risk neutral world. These in turn will lead to the computation of the value of an option to build a power plant. This value of the option will be useful for the electric power planning as the bus with a higher value of this option indicates that the community in this bus is demonstrating a higher degree of potential need for such a power plant.</p>