A Real Options Market-Based Approach to Increase Penetration of Renewables

We propose a framework for trading real options through which flexible sources are incentivized to mitigate the effect of renewable intermittence and show that such options can increase renewable penetration while ensuring the delivery of reliable power and guaranteeing that no market participants are worse-off. We consider that renewable generators are required to bid in a day-ahead market and incur a penalty if, in real-time, they are unable to meet their day-ahead schedule. As a hedge against uncertainty, these non-firm generators purchase options for reserve from sources of flexibility such as natural gas power plants (NGPPs) in an ex-ante options market. Through an option, NGPPs offer to reserve some fuel to be used in case of renewable shortage, while renewable generators purchase the right to request use of that reserve if needed. We solve for the optimal strategies for the generators in the coupled day-ahead and options markets and show that such options increase the amount of generation from renewable sources that is taken by the grid, and provide adequate payment for flexibility providers.