Journal of Energy Markets

Risk.net

Real input-output energy-switching options

Roger Adkins and Dean Paxson

ABSTRACT

We provide quasi-analytical solutions to models for real options embedded in flexible energy facilities that have stochastic inputs and outputs with switching costs. We show the facility value and the optimal switching input and output triggers when the possibility for multiple switching between operating and not operating exists. The facility value and optimal shutdown triggers are also calculated when there is only a one-way switch between operating and suspension (which amounts to abandonment). An illustration is provided for a heavy crude oil production field that requires natural gas as an input, with shutdown and restart switching costs. More general applications in the energy field include the operational spark (and dark spark) spread with switching costs. It may be appropriate to extend these models to many manufacturing, distribution and transportation activities.

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