Valuing Cross-Border Capacity as a Real Option

Abstract

The right to use a certain amount of capacity in an electrical cable between two countries for the purpose of trading energy is an asset that can be bought. Each hour of capacity can be seen as a real spread option with the energy prices of each country being the underlying processes. In this thesis we build a model to find the fair value of a month of cross-border capacity and use it to predict this value for the Germany-France andNetherlands-Germany border for the months of July-October 2021. Our model is implemented as an IOHMM with 4 states following a multinomial distribution and a non-stationary Normal Inverse Gaussian distribution for each output distribution. We use SPOT prices of each bordering country to create a ’spread process’, which are then used as target values. As inputs various market drivers for each respective country were used. The model produces a mixture probability distribution for the spread for each hour of the month. Taking the discounted expected value then gives the hourly capacity value; certain Greek calculation is also possible. The results show that the capacities follow a comparable trend to the market. The predicted values for September and October fall short of the realized prices; we expect this to be due to unprecedented volatility in the energy market. Finally, we tested whether certain key drivers were mapped to the spreads as one would expect; this was the case for the Dutch and French drivers, but not for the German drivers.