Real Options Approach as a Decision-Making Tool for Project Investments: The Case of Wind Power Generation

  • José I. Muñoz
  • Javier Contreras
  • Javier Caamaño
  • Pedro F. Correia
Part of the Energy Systems book series (ENERGY)


This chapter develops a decision-making tool to invest in renewable power plants using a real options approach. The model is validated for a wind energy plant. To build a base for the investment model, market prices and wind regimes are obtained from Geometric Brownian Motion (GBM) and Weibull models, respectively. Then, considering these and other values, such as investment, maintenance and operation costs, the Net Present Value (NPV) is obtained. As a result, an NPV curve is drawn by shifting the initial time of investment. From the NPV curve obtained, a trinomial lattice is built and applied to a real options valuation method. From this model, it is possible to estimate the probabilities of investing right now, deferring, or not investing at all. This decision tool allows wind energy investors to decide whether to invest or not in different scenarios. Several realistic case studies are presented to illustrate the decision-making method.


Investments assessment net present value curves real options risk management stochastic modelling trinomial trees 


  1. 1.
    El-Khattam W, Bhattacharya K, Hegazy Y, Salama MMA (2004) Optimal investment planning for distributed generation in a competitive electricity market. IEEE T Power Syst 19(3):1674–1684CrossRefGoogle Scholar
  2. 2.
    Khatib H (2003) Financial and economic evaluation of projects in the electricity supply industry, vol 23, IEE Power series. The Institution of Engineering and Technology, StevenageCrossRefGoogle Scholar
  3. 3.
    Dixit A, Pindyck RS (1994) Investment under uncertainty. Princeton University Press, New JerseyGoogle Scholar
  4. 4.
    Trigeorgis L (1996) Real options: managerial flexibility and strategy in resource allocation. MIT Press, BostonGoogle Scholar
  5. 5.
    Correia PF, Carvalho PMS, Ferreira LAFM, Guedes J, Sousa J (2008) Power plant multistage investment under market uncertainty. IET Gener Transm Dis 2:149–157CrossRefGoogle Scholar
  6. 6.
    Näsäkkälä E, Fleten S-E (2005) Flexibility and technology choice in gas fired power plant investments. Rev Financ Econ 14(3–4):371–393. Special issue on Real OptionsCrossRefGoogle Scholar
  7. 7.
    Tseng C-L, Barz G (2002) Short-term generation asset valuation: a real options approach. Oper Res 50(2):297–310MathSciNetCrossRefzbMATHGoogle Scholar
  8. 8.
    Tseng C-L (2000) Exercising real unit operational options under price uncertainty. In: Proceedings of the 2000 IEEE PES winter meeting, Singapore, 23–27 Jan 2000, pp 436–440Google Scholar
  9. 9.
    Lucía JJ, Schwartz ES (2002) Electricity prices and power derivatives: evidence from the Nordic Power Exchange. Rev Derivatives Res 5:5–50CrossRefzbMATHGoogle Scholar
  10. 10.
    Deng S-J, Oren SS (2003) Incorporating operational characteristics and startup costs in option-based valuation of power generation capacity. Probab Eng Information Sci 17(2):155–182MathSciNetzbMATHGoogle Scholar
  11. 11.
    Niemeyer V (2000) Forecasting long-term price volatility for valuation of real power options. In: Proceedings of 33rd Hawaii international conference on system science, HICSS’00. IEEE Computer Society Washington, DC, 2000Google Scholar
  12. 12.
    Tseng C-L, Lin KY (2007) A framework using two-factor price lattices for generation asset valuation. Oper Res 55(2):234–251MathSciNetCrossRefzbMATHGoogle Scholar
  13. 13.
    Fleten S-E, Näsäkkälä E (2003) Gas-fired power plants: investment timing, operating flexibility and abandonment. In: Proceedings of the 7th annual international conference on real options. University Library of Munich, GermanyGoogle Scholar
  14. 14.
    Wang C-H, Min KJ (2006) Electric power generation planning for interrelated projects: a real options approach. IEEE T ENG Manage 53(2):312–322MathSciNetCrossRefGoogle Scholar
  15. 15.
    Fleten S-E, Maribu KM, Wangensteen I (2007) Optimal investment strategies in decentralized renewable power generation under uncertainty. Energy 32:803–815CrossRefGoogle Scholar
  16. 16.
    Hull JC, White A (1994) Numerical procedures for implementing term structure models I: single-factor models. J Derivatives 2(1):7–16CrossRefGoogle Scholar
  17. 17.
    Hull JC (2003) Options, futures, and other derivatives, 5th edn, Finance series. Prentice-Hall – Pearson Education, Inc, Upper Saddle RiverzbMATHGoogle Scholar
  18. 18.
    MATLAB, The Mathworks, Inc.
  19. 19.
    Spanish Royal Decree (2007) RD 661/2007, on 25th May 2007, for regulating the activity of energy production in a special regime.
  20. 20.
    Operador del Mercado Ibérico de Energía – Polo Español, S.A. (2008). Accessed 18 May 2009

Copyright information

© Springer-Verlag Berlin Heidelberg 2012

Authors and Affiliations

  • José I. Muñoz
    • 1
  • Javier Contreras
    • 1
  • Javier Caamaño
    • 2
  • Pedro F. Correia
    • 3
  1. 1.E.T.S. de Ingenieros IndustrialesUniversity of Castilla – La ManchaCiudad RealSpain
  2. 2.E.T.S. de Ingenieros IndustrialesUniversity of País VascoBilbaoSpain
  3. 3.Instituto Superior TécnicoTechnical University of LisboaLisbonPortugal

Personalised recommendations