Decision makers throughout the world are introducing risk and market forces in the electric power industry to lower costs and improve services. Incentive based regulation (IBR), which replaces cost of service ratemaking with an approach that divorces costs from revenues, exposes the utility to the risk of profits or losses depending on their performance. Regulators also are allowing for competition within the industry, most notably in the wholesale market and possibly in the retail market. Two financial approaches that incorporate risk in resource planning are evaluated: risk adjusted discount rates (RADR) and options theory (OT). These two complementary approaches are an improvement over the standard present value revenue requirement (PVRR). However, each method has some important limitations. By correctly using RADR and OT and understanding their limitations, decision makers can improve their ability to value risk properly in power plant projects and integrated resource plans.
All Science Journal Classification (ASJC) codes
- Management, Monitoring, Policy and Law
- Electricity resource planning
- Options theory
- Risk adjusted discount rates