Valuing Generation Assets

As the electric utility industry becomes more competitive, the question of how to value generation assets becomes critical. This problem is typically approached by defining the generator in terms of its efficiency (heat rate) in converting fuel to electricity. Based on this rating, the valuation is performed by modeling the generator as a spread option between the price of the fuel used and the price of electricity [44]. The payoff from such an option is given by $$C{F_k} = \max \left\{ {{\rm P}_k^e - C\left( {{\rm P}_k^f} \right),0} \right\}$$ where $${\rm P}_k^e$$ is the price of electricity and C is the cost marginal cost of production as a function of the fuel price $${\rm P}_k^f$$.