Real Options and Investment Decision Making

1. Introduction 4
2. NPV and real options analysis 5
Why is a real options framework important? 5
What is a real option and what determines its value? 6
When does a real option approach to investment potentially provide a materially different answer to a NPV approach? 8
Why is real option analysis likely to be useful in the energy sector? 9
Conclusion 12
3. Real options in energy networks 13
Introduction 13
Network investment: an expansion option 13
Network investment: a deferral option 15
4. Conclusions 20
Appendices 21
Appendix 1 - Consultation Response and Questions 22
Appendix 2 – Regulatory Precedent 24
Introduction 24
New Zealand 24
Australia 25
Appendix 4 - Feedback Questionnaire 26