Transmission capacity between Norway and Germany: a real options analysis

Interconnection of two electricity markets provides revenues to the owner of the line. In this paper we study the alternatives that are available to an investor holding a unique right to construct transmission capacity between Norway and Germany. The alternatives are either to construct a 700 MW cable with a subsequent expansion option, or to construct a 1400 MW cable. We use a real options valuation (ROV) framework to decide which capacity should be chosen, and when the investment should be carried out. Our scientific contribution is to apply the ROV framework where sequential investment is allowed on transmission capacity investment. Furthermore, we combine information from a bottom-up model, which estimates the reduction in average price differences due to the investment itself, and a top-down model for finding the values and optimal decisions.