Overview of transmission expansion planning using real options analysis

Deregulation of the electric industry has opened the doors for competition and this has caused a significant difference in what information is needed to evaluate how much an transmission expansion investment is worth as well as the risk involved. The change comes from the fact that, in the past, the risk associated with regulated investments in transmission would be covered by the government and a project would be chosen based on minimum cost while meeting the requirements such as reliability, power flow, etc. Due to this change, there is a push for better ways to evaluate the worth and risk of transmission expansion investments. This paper discusses the method of real options analysis and how it can be used to value transmission expansion investments. The paper also discusses the difference between this approach and other approaches. One key difference is that real options analysis does not assume the decision making process is static like traditional methods do. Instead, it allows for these managerial options to be considered, expanded, abandoned, etc. Thus, by doing so, it provides a better estimate of the investment´s worth. There are multiple real options methods from Black-Scholes to Monte-Carlo Simulation to trees (binomial, trinomial, etc.) and more. This paper discusses Monte-Carlo simulation & trees only.