Realistic Power Plant Valuations - How to Use Cointegrated Spark Spreads

The large investments in new power generation assets illustrate the need for proper fi nancial plant evaluations. Traditional net present value (NPV) analysis disregards the fl exibility to adjust production decisions to market developments, and thus underestimate true plant value. On the other hand, methods treating power plants as a series of spread options ignore technical and contractual restrictions, and thus overestimate true plant value. In this article we demonstrate the use of cointegration to incorporate market fundamentals and calculate dynamic yet reasonable spread levels and power plant values. A practical case study demonstrates how various technical and market constraints impact plant value. It also demonstrates that plant value may contain considerable option value, but 33% less than with the usual real option approaches. We conclude with an analysis of static and dynamic hedges affecting risk and return profi les.