Valuing flexibility in transmission expansion planning from the perspective of a social planner: A methodology and an application to the Chilean power system

Abstract We study the value of adding flexibility to Transmission Expansion Planning (TEP) projects from the perspective of a social planner using real options. Due to the deregulation of electricity markets, TEP projects currently face multiple uncertainties. These uncertainties often cause traditional project valuation methods to recommend sub-optimal investment decisions. Additionally, to incorporate the effects of uncertainties on the valuation of TEP projects, current literature rely on some critical simplifications that do not fit well with the real operations of a power market. This paper models the power market in a realistic way by combining an equilibrium model, to assess the power market equilibrium that the TEP project will generate, with a valuation model based on real options, to incorporate the value of flexibility. The methodology is applied to determine the value of adding capacity expansion flexibility to a portion of the rigid TEP project that connects the main two interconnected systems in Chile since 2018. Our results show that, in this case, adding flexibility increases the net expected social welfare by $14.03 million. Several sensitivity analyses confirm that this flexibility has more value when uncertainty is higher and/or investment costs are lower.