The value of flexibility : application of real options analysis to electricity network investments

Abstract

This thesis assesses electricity distribution network investment decision-making methods using a three-step approach, to explore the possible value of flexibility. By applying a simple quantitative framework to an illustrative distribution network decision, it finds that current methods that fail to consider flexibility can result in higher cost investments and lost value. First, it presents the recent developments in the electricity sector and outlines how the current state of network planning is no longer fit for purpose. Second, it proposes a flexible design approach for electricity network investments, and determines the value of this flexibility by developing a simple model and applying real options analysis. Third, it identifies the practical challenges to effectively implementing a flexible design methodology, before proposing recommendations for electricity utilities and regulators. The proposed flexible design methodology found that building in flexibility through Non-Wire Alternatives provided a greater Expected Net Present Value than current robust techniques using traditional investments. This thesis confirmed that the value of this flexibility increased as uncertainty over future electricity demand increased. This thesis finds there is a strong case that the use of a flexible design approach can increase the cost-effectiveness of network investment decisions. However, there remains significant uncertainty regarding key parameters that determine the value of these cost savings. As such, this thesis concludes with a discussion of evidence gaps and priorities for future research.