Estimating ‘option value’ at the edge of the National Electricity Market

Electricity supply to the Eyre Peninsula in remote South Australia and is presently by means of a single transmission line, which was installed by the Electricity Trust of South Australia in 1967. The line requires replacement in the next few years.

Our experts assisted ElectraNet in conducting a Regulatory Investment Test for Transmission (RIT-T) – a publicly consulted on cost benefit assessment to identify the most prudent and efficient network investment – to assess options for upgrading the electricity transmission service on the Eyre Peninsula.

The Eyre Peninsula RIT-T was the first in the National Electricity Market to incorporate real options analysis by formally estimating ‘option values’. Option value arose in relation to three ‘flexible’ options for upgrading the network, each of which involved building additional network capability now to gain the ‘option’ of upgrading the network, or part of it, to a greater capacity at a later point in time, in response to exogenous trigger events. Key future triggers for the Eyre Peninsula relate to the development of mining loads and/or renewable generator connections.

Option value analysis essentially extends the range of future states of the world that can be considered and so enables a more sophisticated treatment of uncertainty. Structured modelling techniques allowed formal consideration of the relationships between different uncertain parameters, and how probabilities may change over time. Overall, applying real option value techniques allowed a far greater number of futures states of the world to be evaluated in this RIT-T than under a simple ‘scenario analysis’.

The Eyre Peninsula RIT-T concluded that the most efficient way to provide a reliable supply going forward is to adopting one of the flexible solutions. This enables the peninsula to be ‘future proofed’ for cost-effective expansion of network capacity when needed in the future to accommodate potential larger mining developments and/or renewable energy investment.

Our experts undertook all of the modelling analysis underpinning this RIT-T, including of the option values as well as of the wholesale market element of the National Electricity Market and the required cost-benefit assessment modelling.

More on this RIT-T can be found here.

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