Real options theory applied to electricity generation projects: A review

Abstract

Real options (RO) theory is well known for enhancing the value of projects under uncertainty. This is achieved by modelling the flexibility that managers possess to adjust the projects in response to changes in their environments. Based on this, RO theory could be used to tackle current energy and environmental issues by enhancing the value of electricity generation projects (EGP), especially renewable energy projects (REP). The potential of RO theory to increase the value of EGP and REP has been a driver for new research in the topic. However, existing literature is still scarce, diverse, and tends to neglect the state of the art of RO theory (e.g. RO in the design of projects). RO studies tend to ignore the use of RO in the design of projects as they are difficult to formulate without the help of experts on the projects' designs. This paper aims to encourage novel research in the application of RO theory to EGP and REP. For this purpose, a critical review of RO theory, its state of the art, and its applications to EGP and REP is presented. This review identifies current areas of interest and gaps in knowledge in this research area. It is concluded that new and novel RO research should address the state of the art of RO theory, and uncertainties that are exclusive for specific types of projects. This future research will require the involvement of electrical engineers specialised in the design of EGP and REP. © 2012 Elsevier Ltd.