The Value of Flexibility in the Design of Hybrid Energy Systems: A Real Options Analysis

Abstract

In this paper, the impact of incorporating flexibility in the design of hybrid energy systems (HES) is considered. Flexibility is introduced by considering the option to upgrade or reconfigure HES configurations at some point in the future in response to economic and technological changes that are initially unknown and uncertain. Such flexibility has been studied previously in real options analysis. We first investigate the impact of flexibility on the most preferred design alternative and its value. Simply considering the option to upgrade or reconfigure the system affects the design choice. The most preferred design alternative for a flexible system will often sacrifice some initial technical or economic performance to better take advantage of a future option. For the HES case study, the most preferred flexible design alternative is more valuable than the most preferred inflexible alternative. In other words, flexibility adds value as is reflected in an increase of the expected utility of the net present value. Second, we investigate the impact of the size of the uncertainty on the option value. Unexpectedly, for the HES case study considered here, increasing uncertainty does not strongly affect the value of flexibility. Furthermore, investigation is necessary to determine whether this relationship holds more generally or is specific to this case study.