Real option based approach for generation investment decision-making and generation capacity adequacy analysis

Deregulation of the power industry brings not only more uncertainties and risks for investors in making generation investment decisions, but also a new challenge to the government or the regulator for designing an effective market mechanism to ensure adequate generation capacity and hence reliable power supply. Provided that the load growth uncertainty is assumed to be the major source of uncertainty, a new methodological framework for generation investment decision-making is presented based on the well-developed real option approach (ROA), with competition for generation investment from other investors taken into account. A mathematical model is developed and a solving approach is presented for this purpose. Finally, the proposed method is illustrated by a numerical example, and the effects of different market mechanisms on generation investment incentives and hence the generation capacity adequacy are also investigated in a quantitative way.