Option Valuation Applied to Implementing Demand Response via Critical Peak Pricing

Abstract

The purpose of this paper is to examine the economic and technical perspectives of critical peak pricing plan as an active demand response(DR) program. To implement a good DR program, there are three perspectives to be considered: regulatory, economic, and technical perspectives. This paper will assume that the regulatory perspective of DR is determined as critical peak pricing(CPP) plan and examine the other two. The economic perspective of CPP plan is the incentive of the plan conductor, or the profit of an energy service provider(ESP). The technical perspective is a method to maximize the incentive of CPP plan, or an ESP's profit. An ESP should decide when to call critical peaks within certain constraints to maximize her profit. This is done by predicting the market prices and following a similar method as evaluating a swing option. The numerical example will show the optimal critical peak decisions.