Finalización del Contrato 54. Terminación de

The basic principle of flexible decision frameworks is to take advantage of the inter-temporal resolution of uncertainty present in all dynamic systems under uncertainty [25] This way, it is possible to shift from ‘now-or-never’ sequential decisions to an optimal strategy that is optimally prepositioned to the different possible outcomes and takes into account the planner’s managerial flexibility to adapt to the eventual scenario realization. For an investment project to have significant option value, three criteria must be fulfilled. We analyze them and explain how the current landscape of the energy sector meets these conditions, necessitating the inclusion of flexibility in investment appraisal and transmission expansion models.

45

2.2.4.1 Learning

Without learning, the state of knowledge about the future remains unchanged. Under this condition, there is no value to delaying decisions as no uncertainty is resolved over time. When a stochastic process is characterized by learning, the difference between the expected value of the random variable and its conditional expected value given the preceding parent state must be different to zero. Generation investment is based on expected profitability and influenced by factors such as the regulatory framework, use of system charges and investment costs, which may be beyond the decision maker’s immediate control but are directly observable and can be monitored. Given that transmission investment is a dynamic process, it can be materially informed by the evolution of these parameters over the planning horizon. In addition, since generation investment consists of distinct stages (e.g. planning permission acquisition, construction, commissioning), key trigger events can be identified and used in the decision process as informed indicators for subsequent state transitions. For example, consider that a prospective wind farm has been granted planning permission. Given the above, the expected value of its size in the future is higher than its expected value calculated in the absence of this knowledge. Part of the uncertainty has been resolved, rendering some scenarios more probable while other outcomes deemed credible at first may be rendered obsolete on the updated information.

2.2.4.2 Flexibility

The flexibility of a transmission project is two-fold; timing flexibility and sizing flexibility. We define timing flexibility as the ability to undertake a particular investment when its value is maximized. In contrast to some types of financial options that have an expiration date, real- world investments do not face such limitations as the system planner has no exogenous time restrictions. An investment project can be carried out optimally with respect to time so as to maximize its net benefits, subject to the available information and the planner’s risk profile. Sizing flexibility is embedded in the technical and economic nature of transmission projects that are largely characterized by economies of scale [26] and upgradeability. The system planner can choose to bear some large upfront costs and invest in a large project beyond the current needs of the system for the option of utilizing its full potential in the future. Transmission capacity reinforcement decisions frequently involve a range of candidates with different embedded upgradeability options. For example, a large 400kV line may be constructed but may warrant the upgrade of a number of substations for the utilization of its

46 full transfer capability. These upgrades can be carried out on a conditional basis if the need arises. Similarly, a new double-circuit line can be constructed with only one side strung. The planner can decide to upgrade it in the future at a fraction of the cost of commissioning a new line. Another example can relate to undergrounding of cables in areas with severe environmental constraints. A larger tunnel than currently needed can be constructed, so that it may house a cable of a larger rating and diameter in the future.

2.2.4.3 Irreversibility

The energy sector is characterised by investment in assets with high capital costs and long lifetimes spanning several decades. The majority of these assets has very low or zero salvage value and thus it is critical to ensure that committed funds provide long-lasting value for money. Another important parameter is that large capital projects are characterised by considerable pre-construction costs due to extended interactions with planning processes. In a recent report by KEMA investigating capital expenditure on new project proposals in GB [28], pre-construction costs are identified to be of the same order of magnitude as constructing and commissioning the project. It follows that a significant portion of funds have to be sunk to a project from the very first stages, rendering optioneering on a practical level an expensive exercise. This highlights the importance of being confident that an undertaken project will deliver substantial gains in the long-run while avoiding projects that lock-in irreversible future investment paths with uncertain long-term benefits. Investing in assets that may eventually be stranded or under-utilized leads to severe welfare loss.

Clearly, all the above factors characterise investment decisions in the energy sector today, leading to a very material value of flexibility and necessitating its consideration in transmission investment planning.