Real options and asset valuation in competitive energy markets by adekunle richard oduntan a thesis presented to the university of waterloo in fulfillment of the thesis requirement for the degree of doctor of philosophy in management sciences waterloo, ontario, canada, 2007 adekunle richard oduntan, 2007. Early exercise is the rule rather than the exception with real options. The energy sector, since 1970, has suffered market, regulatory and. Heres where marketbeating money manager david herro sees. Electricity was long considered a textbook example of natural monopoly. The real options method has been used in the valuation of energy assets and the decisionmakings in operation and investment in power plants. In this thesis we use well developed theory taken from quantitative finance, more specifically real options theory, as well as various mathematical and statistical techniques and models used in option pricing to determine the economic value of these resources. Analysis and valuation, risk management, and the future of energy. The market can be divided into two, that for exchangetraded derivatives and that for overthecounter derivatives. Since energy prices are highly volatile with unexpected spikes, cap. Technologybased startup valuation using real options with. Real options and investment decision making 6 assumes that the investment decision is a takeitorleaveit decision at that moment in time. Fan and zhu developed a real options model to help in the decisionmaking process on overseas oil investment decisions.
Analyzing stochastic interest rates in the context of real options valuation is of particular relevance. Real options are much more complex than financial options. Rov strategy tree is an easytouse module for creating visually appealing representations of strategic real options. Real options and simulation in energy markets nasba registry. Real options and asset valuation in competitive energy.
Real options valuation of us federal renewable energy research. He is also adjunct assistant professor of real estate at new york university, where he teaches in the master of science in real estate program. A real option is a choice made available with business investment opportunities, referred to as real because it typically references a tangible asset instead of. With the presence of markets other than energy, the valuation problem becomes a complicated optimisation problem where one must consider allocation of resources to different markets simultaneously. Using timeseries analysis and the real options approach, we focus on modelling energy prices and optimal decisionmaking in energy projects. Real options in energy and commodity markets econpapers. The latest overall data update was on january 5, 2018. The study provides a detailed analysis and overview of valuation and accounting trends in these subsectors of the energy. Real options analysis is the clearest book on real options that we have read to date. My country risk premiums get updated midyear as well. Most practitioners who use option pricing models to value real options argue for the binomial model over the blackscholes and justify this choice by noting that. The deregulation of energy markets around the world, including power markets has.
Guidelines for valuation of real options in energy markets energy markets contain a multitude of assets and contracts that offer the owner flexibility. A real options valuation of renewable energy projects by. If you have decided to remove your assets from your utility rate base, it will be to your advantage to know the fair market value of these assets in order to minimize any stranded costs. Every topic gives a chance to analyze many aspects of the business in depth with the aim of providing support to energy trading analysts as well as trying to bridge worlds of practitioners and academic research. This has enabled the valuation and risk management of a wide range of assets and derivatives in the energy and shipping markets.
The importance of spread options european call on the difference between two indexes. This application also builds on previous real options valuation work for. Real options and simulation in energy markets is a twoday energy trading course presented by the energy training experts at mennta energy solutions. This webpage presents the list of papers and short comments of the new real options book published by risk books. Ucal and kahraman proposed a new fuzzy real options valuation model to evaluate oil investments. Chapter 2 presents an overview of the real options theory.
It provides a systematic analysis and compares real options valuation using constant interest rates and the implied forward rates with methods that simulate interest rates stochastically. This source of uncertainty which has yet to be addressed in the literature, in the context of real options valuation, arises because of mismatch between natural gas and electricity wholesale markets. Section 3 presents a line of thought to real options valuing model. Watch leon cooperman break down energy stocks and the future of capitalism. The real options approach finance and capital markets series 9780230577374. Have you downloaded mercer capitals 2019 energy purchase price allocation study yet. Crude oil options are the most widely traded energy derivative on the new york mercantile exchange nymex, one of the largest derivative product markets in the world. Real options analysis seeks to value such flexibility both the flexibility embedded within the investment opportunity eg. Real options in the energy markets university of twente. The field of real options is concerned with the management and financial valuation of operational flexibility in. The promise and peril of real options aswath damodaran stern school of business 44 west fourth street. Joshua kahr is the president of kahr real estate services, llc, a consulting firm with specialization in real estate market analysis, financial software training, and financial modeling. Valuation of real options the tools developed to value financial options i. It provides a solid basis for conceiving, assessing and evaluating real option investments, which will make it useful to practitioners and students alike.
The use of real options approach in energy sector investments. A pricing method that did not consider these insurance and option like features would miss the real value of capacity reserves. A suitable valuation model should then associate the price paid for reserved. Overall, the figure reveals a strong positive trend with more than ten papers per annum in recent years. Managing market risk in energy power systems, ieee. Technologybased startup valuation using real options with edgeworth expansion. Real options valuation, also often termed real options analysis, rov or roa applies option valuation techniques to capital budgeting decisions. They include storage for natural gas, floating storage of crude. In contrast, the real options approach to investment analysis characterizes decisionmaking flexibility in terms.
Real option valuation in renewable energy literature. A real option itself, is the rightbut not the obligationto undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets. In 2010, several works applying real options to the energy sector were presented. Classical types of real options and the mathematical approaches to pricing real options are discussed. This module is used to simplify the drawing and creation of strategy trees but is not used for the actual real options valuation modeling use the real options sls software modules for actual modeling purposes. Real options and energy management using options methodology to enhance capital budgeting decisions. The whole sample of 101 papers is distributed along a timescale based on the publication year. Valuations might be based entirely on real option value if the market prices these in but we have no way to know whether the market has correctly accounted for real options. This book is intended to cover in a detailed way all the various aspects of energy trading from the most macro to the most micro.
Abstract the market risks encountered by energy asset operators can be categorized as short termoperational, intermediate termtrading, and long term valuation in nature. The growing body of research devoted to real option valuation of renewable energy investment is illustrated in fig. Natural gas markets in north america operate on a dayahead basis while power plants are dispatched in real time. Energy markets are designed in such a way that investors must take into. Heres where market beating money manager david herro sees value amid the market turmoil. Guidelines for valuation of real options in energy markets. The promise and peril of real options new york university. From the very outset, energy and commodity markets which play fundamental roles in the worldwide economy. Dcf valuation an application to a north sea oilfield 5 figure 1 options present in offshore oil production the figure summarizes the many options available to an offshore leaseholder during the exploration and. Stochastic control and real options valuation of thermal. Our empirical simulation results show that power plant values can be decreased by volumetric risk factors from both the supply side and the demand side. It does an excellent job of demystifying a difficult and complex subject. This book analyzes real options valuation for nonconstant versus constant interest rates using simulations and historical backtesting.
Market design and policy are key considerations throughout the analysis. Analysis and valuation, risk management, and the future of energy simkins, betty, simkins, russell on. Real options analysis third edition real options valuation. Option value maximum of option value maximum of a direct payoff or 0 a direct payoff or 0.
This paper describes how the market risks in operations can be measured and managed using real option models and stochastic optimization techniques. In district energy systems powered by combined heat and power chp plants, thermal storage can significantly increase chp flexibility to respond to real time market signals and therefore improve the business case of such demand response schemes in a smart grid environment. The legal nature of these products is very different, as well. Real options and energy management using options methodology to enhance capital budgeting decisions, edited by the professor ehud i.
Real options in traditional valuation methods where are real options in dcf method. Real options and asset valuation in competitive energy markets. The book of weron 1 provides and excellent introduction to common statistical. The term real option valuation is used to describe a whole range of mathematical. The use of real options approach in energy sector investments core.
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