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Why Flexibility

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Energy Investments

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Abstract

This chapter sets the scene for the application of real options reasoning by first demonstrating the nature of energy market volatilities. Specifically, the chapter examines how supply costs differ for fossil fuel-based technologies and renewables, and how their uncorrelated volatilities hedge portfolio payoffs through variable prices. Managerial flexibility is observed to create portfolio value by not supplying when supply costs exceed energy prices, in order to avoid losses. Volumes are scaled up or down when demand varies. The choice of supplies mix is used to optimise hedges. Mixed portfolios embed a call option on rising payoffs under increasing prices or a put option on future fuel costs liabilities. These values are compared with NPVs, when fixed prices or volumes result from rigid obligations to supply.

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Authors and Affiliations

  1. IESE Business School, University of Navarra, Barcelona, Spain

    Ricardo G. Barcelona

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  1. Ricardo G. Barcelona
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Correspondence to Ricardo G. Barcelona .

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Barcelona, R.G. (2017). Why Flexibility. In: Energy Investments. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-59139-5_5

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