Value of Investment in a Microgrid under Uncertainty in the Fuel Price

H.Asano, Member, IEEE, W.Ariki, Non-member, S.Bando, Member, IEEE

national program because they have a significant share of renewable energy in a microgrid. The sites are in Hachinohe, Aichi and Kyoto[1]. These projects demonstrated technical feasibility of microgrids with renewable energy, but economic and environmental benefits have not been shown yet. The economic evaluation of the microgrids is still challenging. We developed a method to design the number and capacity of each piece of equipment in a microgrid under certainty of fuel price and electricity price[2]. We analyze the profitability of microgrids with high efficient gas engine generators in Tokyo. Although incentives for introducing distributed energy system increase these days, volatile natural gas prices make its investment in gas-fuel DGs risky. Therefore, it is important to evaluate the risk under uncertainty and find flexible strategies which reduce the exposure to volatility. Siddiqui and Maribu [3] deals with optimal investment strategy in a microgrid under fuel price risks in California. The sequential strategy, which invest a base unit of DG first, and upgrade to either a peak DG unit or a HX, is less risky than direct investment in full set of DGs. Fleten et al[4] illustrates the model using an example with small-scale wind power alternatives for an office building in Norway. Increased electricity price volatility increases the investment price thresholds of wind power and can increase the value of the investment opportunity for larger projects. The previous studies do not deal with multi-stage investment for multi-unit of generators and PV system under fuel and electricity price uncertainty. This paper presents a method for finding optimal investment strategies in a microgrid with an uncertain future electricity price, from the perspective of the developer. We take the real option approach to analyze investment decision. Finding optimal investment strategies includes finding both the optimal capacity and the timing of the investment. The methodology can be applied to all types of distributed energy systems including wind power and photovoltaic power. This paper discusses investment strategies in a microgrid system consisting of cogeneration system and renewable power generation, under uncertainty in the natural gas price. II. MULTI-STAGE INVESTMENT A. Stochastic long-term fuel and electricity price process The choice of price description is important in an investment analysis. Due to the simple solutions obtainable for geometric Brownian motions, we assume the long-term 1

Abstract-- This paper discusses investment strategies in a microgrid system consisting of cogeneration system and renewable power generation under uncertainty in the natural gas price. Although incentives for introducing distributed energy system increase these days, volatile natural gas prices make its investment in gas fuel distributed generation systems risky. Therefore, it is important to evaluate the risk under uncertainty and find flexible strategies which reduce the exposure to fuel price volatility. We take the real options approach to analyze investment decision. By varying the parameter of price volatility, we find that the optimal investment strategy depends on the level of uncertainty. As volatility increases, strategies with installation option of renewable power generation, here, photovoltaic generation, become attractive in terms of risk reduction. Index Terms Microgrid, Real options, Renewable electricity technologies, Stochastic fuel price, Distributed generation

ISTRIBUTED generation (DG) has many potential systems benefits, such as reducing risks in investment due to modularity of capacity under uncertain economic conditions and expected emission reduction. DGs include small renewable energy (RE) such as photovoltaic (PV) and wind power, combined heat and power (CHP) system. DGs are expected to play a significant role with the network energy in the future electricity supply. With the advance of these DG technologies and the ongoing deregulation of the electricity market, the microgrid concept is expected to be widely implemented in the coming years[1]. Japanese government has set a goal of 53 GW PV deployment in 2030. Penetration of renewable source without negative impacts on the existing power systems is essential to realize sustainable energy system. The coordinated operation of intermittent renewable energy such as PV and controllable DGs such as gas engine generators together with battery storage is a key to the success of microgrids. The New Energy and Industrial Technology Development Organization (NEDO), Japan conducted three demonstrations on microgrids with RE, called by the Regional Power Grid with Renewable Energy Resources Project until 2008. These projects were qualified for the
H.Asano is with Central Research Institute of Electric Power Industry, 211-1 Iwadokita Komae-shi, Tokyo, Japan and the University of Tokyo. W.Ariki is with Mitsubishi Heavy Industry. S.Bando is with the University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, Japan.

I. INTRODUCTION

978-1-4244-6551-4/10/$26.00 2010 IEEE

natural gas prices follow a geometric Brownian motion, where the change in price over a small time interval is written as;

dC = Cdt + Cdzt

(1)

programming and optimization). The objective function to be minimized is defined as follows:

Z1 = U gas FGGi (i, j T ( j ) + FGB ( j T ( j ) + FGL ( j T ( j ) ) ) ) j j i, j + U Ebuy ( j Ebuy ( j T ( j ) U Esell ( j Esell ( j T ( j ) ) ) ) )
j j

where is the annual risk-adjusted growth rate and is the annual volatility. Zt is stochastic process with normal distribution. We assume city gas prices as fuel prices and electricity prices fluctuate with natural gas prices. B. Now-or-never investment evaluation of a microgrid The authors have developed a methodology to design the number and capacity for each piece of equipment in a microgrid with combined heat and power (CHP) systems (Fig.1) with battery storage (BAT), heat exchanger (HE), steam absorption refrigerator (RS), gas boiler (GB), and gas absorption refrigerator (RG)[3]. Seasonal average output of PV measured in Yokohama is used for simulation. Small capacity of battery (1 hour long for leveling) is accompanied with PV.
Electricity Demand BAT PV GE1 GE2 HEhw
COP 0.9

+ U CD (12 CD + max( K GG (1.1 + 1.1 0.3 11)) )

i, j i, j

+ U mtn E GG i (i , j T ( j ) + U DGG K GG i (i D GG i (i , j T ( j ) ) ) )

+ R ( ICGE ( KGE (i )) + ICRS ( KRS ) + ICGB ( KGB ) + ICTR ( KTR ) (2) + ICGL ( K GL )) / 365

Purchased Electricity GB
COP 0.92

Hot water Space Heating Space Cooling

HEw
COP 0.9

RGw
COP 0.9

City Gas

RS
COP 0.9

RGc
COP 1.35

Waste Heat

Electricity Thermal Energy Gas

Fig. 1.

Structure of a microgrid

where Z1 is annual cost, T is the number of day for each representative day in a year, Ugas [JPY/m3] is energy charge rate of gas, F [m3] is volume of gas consumed, UEbuy [JPY/kWh] is the charge rate for energy purchased from the utility, UEsell [JPY/kWh] is the charge rate for energy sold to the utility, EGG [kWh] is the sum of the electricity generated by a generator, CD [kW] is the contract demand from the utility, Umtn [JPY/kWh] is the maintenance cost of a GG, UD GE [JPY/number] is the cost of starting and stopping a GG, D [-] is the number of startups and shutdowns of a GG, R [-] is the capital recovery factor, IC [JPY/kW] is the initial cost of each equipment, K [kW] is the rated power of each equipment, i is the unit number of GEs, and j is time. The subscript GG is generator driven by gas (gas engine), GB is gas boiler, RS is steam-absorption refrigerator, GL is gas/hot water-absorption refrigerator, and TR is turbo refrigerator. In the formulation, the assumed lifetime of every equipment, such as gas engines, is 15 years. The interest rate for capital cost is 0.03. The constraints to this problem enforce the energy balance and are expressed as follows:
Pd ( j ) + P ( j ) + Paux ( j ) = PGGi ( j ) + PEbuy ( j ) PEsell ( j ) TR

First, deterministic optimization of capacity of generators in a microgrid is evaluated. Annual cost is minimized by considering the partial load efficiency of a gas engine generator (GE) and its scale economy, and the optimal number and capacity of each piece of equipment and the annual operational schedule are determined by using the optimal planning method[2]. Annual cost is defined as the sum of the operating cost and the annual initial cost (capital cost). The annual operational cost is calculated for a total of six representative days: three seasons (summer, winter, and spring & fall) and two day of week, weekdays and holidays. Decision variables are composed of design (capacity) and operational variables. The capacity of PV is set from the roof space of buildings(30 kW). The gas engine generator can be operated at a load factor between 50% and 100%. The problem formulated here is a Mixed Integer Non Linear Programming (MINLP) because it includes nonlinear consumption of fuel and includes the number of gas engines in operation and the number of times the gas engines are start-up and shut-down. The formulated problem is then solved by using GAMS (a modeling system for mathematical

(3) (4)

(5) QCW ( j ) = Q RS ( j ) + QGL ( j ) + QTR ( j ) Energy demand of case study building was estimated for each 24 hours on the six representative days in a year. The estimated maximum demand was about 310 kW. Table I summarizes the representative values of equipment performance, initial cost, and utility prices. Table II shows the cost of three cases; without DG, two units of GE, and one unit of GE and PV. The optimal generation mix is 2 units of gas engine generators assuming the current fuel and electricity prices. PV is not economical under the current fuel price and initial price of PV.
TABLE I Model Parameters GE PV Load factor constraint Unit price Unit price 0.5-1.0 13,000 500,000 JPY JPY/kW

Q ST ( j ) = Q S ( j ) + QGB ( j ) Q RS in ( j ) QWS ( j )

BAT City Gas

Unit price

Inverter capacity Energy charge

50,000 50,000 65 11.56 1638 16.6 15.9 14.5 9.2 0.03

JPY/kW JPY/kWh JPY/Nm3 kWh/Nm3 JPY/(kW month) JPY/kWh JPY/kWh JPY/kWh JPY/kWh

Heating value of city-gas Demand charge Peak period (13:00-1600 in summer)

Electricity Price

Energy charge

Shoulder period (summer) Shoulder period (other seasons) Off peak period (22:00-8:00, Sunday, holiday)

State 2: GE1 and PV State3 : two units of GE, GE1+GE2 The following five strategies can considering economics of investment; Strategy 1: state 0 state 3 Strategy 2a: state 0 state 1 state 3 Strategy 2b: state 0 state 1 state 2 Strategy 2c: state 0 state 3 state 1 Strategy 2d: state 0 state 3 state 2

be

possible,

Interest rate

TABLE II Breakdown of operating and initial costs Without DG GE1 rated power(kW) GE2 rated power(kW) spec PV capacity(kW) contract demand(kW) gas contract demand(Nm3) 0.0 0.0 0.0 310.3 60.6 GE1+GE2 142.5 90.0 0.0 118.3 101.9 GE1+PV 142.5 0.0 30.0 154.7 85.8 Fig. 2. State transition diagram of a microgrid

running cost

purchased electricity (JPY/year) GE gas charge(JPY/year) Others (JPY/year)

)

D. Investment value The economic value of a microgrid is annual income from the optimal operation. The annual cost in k-state is expressed as a linear combination of gas price;
k Z year (C ) = a k C + b k

2.02E+07 1.80E+07 3.82E+07 7.09E+06 7.09E+06 4.53E+07

8.80E+06 1.46E+07 1.02E+07 3.36E+07 2.53E+06 5.25E+06 7.78E+06 4.13E+07

1.20E+07 9.66E+06 1.21E+07 3.38E+07 1.55E+06 1.01E+06 6.24E+06 8.80E+06 4.26E+07

(6) (7)

The annual income can be expressed as;

0 k Z year Z year = ( a 0 a k )C + (b 0 b k ) = Ak C + B k

Total (JPY/year) GE (JPY/year) initial cost PV (JPY/year) Others) (JPY/year) Total (JPY/year) total cost (JPY/yr)

The value function is given as the present value of project;

PValuek (C ) = B k e rt dt + [Ct | C ]Ak e t dt
0 0

Be PValuek (C ) = r

k rt

t k t + 0 Ce A e dt 0

i) Include maintenance cost and start-up cost ii) Includes costs of heat activated equipment and battery C. Multi-stage Investment strategy We here consider a multi-stage investment problem. The microgrid may find it more beneficial to modularize its investment rather than installing all of the DG units, two units of GE and PV in this case, at once. The sequence of possible transitions among states is outlined in Figure 2. Electricity is supplied by purchased power from the local utility and thermal demand is supplied by the city gas in state 0. The capacity of GE1 is 142.5 kW, that of GE2 is 90.0 kW, and that of PV is 30.0 kW as shown in Table II. We have four states; State 0: DG is not installed. State 1: One unit of GE, GE1

B k C A k e ( )t B k Ak C + = + = r r 0

r risk free interest rate expected risk-adjusted return

convenience yield of fuel price

(8)

E. Option vale We analyze an one-stage investment problem, in which investment in a single DG, GE1, by the real options approach as an example. The value of option, V0Cand the value of a microgrid,V1C are derived by constructing a risk-free portfolio, .

V0 (C ) V0 ' (C )C

(9)

The option to invest, V0(C) is derived from the following stochastic differential equation by applying Itos Lemma; 3

2 The value of the option to invest becomes worthless as the gas price increases without bound if we apply the boundary condition lim V0 (C ) = 0 . Then the solution to the problem
C

C 2V0 " (C ) + (r )CV0 ' (C ) rV0 (C ) = 0 (10)

(10) ;

V0 (C ) = A2 ' C 2

if

C C*

(11)

A2 is a positive constant. 2 is the solution of characteristic quadratic equation; 2 ( 1) + (r ) r = 0

2

the

It has the following roots;

1 =

1 r 2r r 1 + 2 + 2 >1 2 2 2
2

(12)

1 r 2r r 1 2 + 2 < 0 (13) 2 2 2 The option of a microgrid, V1Cis discounted present value; (14) V1 (C ) = PValue(C )

2 =

convenience yield on fuel price is set to equal to the risk-free interest rate as in the previous study [2]. Table III shows the thresholds of gas price to invest, abandon and replace a equipment in the microgrid for each case, depending on the volatility of gas price . The first column of the table shows a case of investment in each strategy, say, 2a_1 means the first investment in GE1 under the strategy 2. We also assume technological progress within 5 or 10 years of PV, and the initial cost of PV system will be reduced 250 thousand JPY per kW, half of the current price. It shows a case of (PV25) in the lower part of Table III. The threshold of gas price for investment decreases as its volatility increases. Stable gas price is favorable for investment in GE1. The current gas price is 4.4 JPY/kWh. The historical volatility is 0.12 during 1988 to 2008, and 0.25 during 1972 to 2008. The current price of PV system, 500 thousand JPY/kW is not attractive from strategies 2b_2 2c_2 and 2d_2. On the other hand, lower price of PV system makes attractive, comparing the strategy 2c and 2d. Because threshold becomes less strict in 2d than in 2c. The threshold decreases, comparing 2d_2 and 2d_2. (PV2). It means less risky to investment in PV when its initial cost decrease.
TABLE III Threshold of gas price[JPY/kWh]
0. 0. 2 0. 3 0. 4 0. 0. 2 0. 3 0. 4 1 6.8 5.1 7 3.9 4 3.0 5 2a_1 7.85 5.92 4.51 3.49 2a_ 5.19 3.91 2.98 2.31 2b_1 7.85 5.93 4.53 3.51 2b_1 (PV25 ) 6.01 4.58 3.54 2b_2 41.30 54.75 71.82 92,92 2b_2 (PV25 ) 9.63 12.64 16.35 2c_1 7.52 5.71 4.46 3.53 2c_2 9.22 12.2 3 16.0 4 20.7 5 2d_1 7.19 5.60 4.41 3.51 2d_1 (PV25 ) 7.64 5.77 4.50 3.57 2d_2 11.11 14.73 19.33 25.01 2d_2 (PV25 ) 9.11 12.07 15.84 20.49

The constant A2 ' as well as the investment threshold price C * are determined by using the value-matching condition (12) and smooth-pasting condition (16); (15) V0 (C*) = V1 (C*) (16) V ' (C*) = V ' (C*)
0 1

Generally the right hand of equation (15) is a difference of the value and the initial cost of the system. The annualized cost of a microgrid includes the initial cost of the system in this formulation. Therefore, the irreversibility of investment is weekly formulated when some equipment of the system is abandoned before its lifetime. We expand this framework to allow for not only in a singlestage investment but also in a multi-stage investment/abandon investment. The value of option and net present value of each state in a strategy 2d , V0 (C ) V3 (C ) V2 (C ) as an example of the multi-stage investment;

Note: threshold without shadow is the upper limit of gas price for investment. Threshold with shadow is the lower limit for investment.

V0 (C ) = A2 C 2
V3 (C ) = PValue (C ) + B1C
3

(17)
1

(18)
Ratio of Investment Thresholds (use Strategy1 as the basis)

The second term in equation (15) is the option value to abandon GE2 and invest in PV. In order to solve for the constants and investment thresholds numerically, we use the value-matching condition and smooth-pasting condition as in the single stage investment. III. RESULTS A. Investment threshold We assume a microgrid for an office building in Tokyo as a case study. The risk-free interest rate is 6% and the

V2 (C ) = PValue (C ) A2 and B1 is unknown constants.

2

(19)

1.18 1.16 1.14 1.12 1.1 1.08 1.06

Comparion of Natural Gas Price Investment Thresholds (1st step Investment)

2a_1 2b_1 2c_1 2d_1 2b_1(PV25) 2d_1(PV25) 0.2 0.24 0.28

0.16

0.32

0.36

0.4

Fig. 3.

Relative gas price threshold for investment

Next, we compare risk of investment under each strategy by using normalized threshold, that is the ratio of gas price threshold to the that of strategy 1. The normalized threshold in all strategies in figure 3 shows more than 1. It means all of variations of strategies 2 is less risky that strategy 1. Strategy 2b_1(PV25) is the least risky in the broad range of gas price volatility. The PV system can avoid risk of microgrid investment. B. Project value Fig.4 shows the relative project value to strategy 1 as the basis. The project value is the maximum value of option value or net present value. Strategy 2b is less return of investment because it do not include the state of two units of DGs which bring significant return of investment under the inexpensive initial gas price. Other family of strategy 2 except for strategy 2b has flexibility of multi-stage investment and brings larger economic value. The value of PV is small because the capacity of PV system is relative small in the capacity of the microgrid as shown in comparison of value under strategies 2c and 2d.
Comparion of Project Values 1.1

disasters. The power electronic interface including fast switching device is economically justified for these highly reliable power supply applications. In Sendai City, Japan a microgrid consisting of two 350-kW gas engine generators, one 250-kW MCFC, and various types of compensating equipment has being evaluated to demonstrate four levels of customer power. Two of the service levels will have compensating equipment that includes an integrated power quality backup system that supplies high-quality power that reduces interruptions and voltage drops. Two additional lower service levels have only short-term voltage drops compensated by a series compensator. When the utility grid has an outage, this system becomes an islanding system via a gas engine generator islanding operation[5]. Findings gained from this demonstration project will be used to make general-purpose multiservice-level power supplies in the future. V. REFERENCES
[1] N.Hatziargyriou, H.Asano, R.Iravani and C. Marnay , Microgrids for Distributed Generation, IEEE Power and Energy Magazine July/August 2007 S. Bando, H. Watanabe, H. Asano, S. Tsujita "Impact of Various Characteristics of Electricity and Heat Demand on the Optical Configuration of a Microgrid", Electrical Engineering in Japan, vol.169 (2), pp.6-13, 2009 Afzal Siddiqui, Karl Maribu; Investment and Upgrade in Distributed Generation under Uncertainty, IAEE International Conference (CDROM), (2007) S.-E. Fleten, K.M. Maribu, I. Wangensteen; Optimal investment strategies in decentralized renewable power generation under uncertainty, Energy, Volume 32, Issue 5, May 2007, Pages 803-815 Keiichi Hirose, Takashi Takeda, and Akiyoshi Fukui, Field Demonstration on Multiple Power Quality Supply System in Sendai, Japan, 9th International Conference Electrical Power Quality and Utilization (EPQU2007), Oct.2007

[2]

[3] [4]

1.05
Ratio of Project Values (use Strategy1 as the basis)

1 0.95 0.9 0.85 0.8 0.75 0.16 0.2

Fig. 4.

2a 2b 2c 2d 2b(PV25) 2d(PV25)

[5]

VI. BIOGRAPHIES
Hiroshi Asano received B. Eng., M. Eng. and D. Eng. degrees in Electrical Engineering from the University of Tokyo. He is presently a Senior Research Scientist with the Central Research Institute of Electric Power Industry in Tokyo, Japan, a Research Fellow, Institute of Industrial Science, The University of Tokyo, and a Lecturer, Graduate School of Engineering, The University of Tokyo. His research interests include systems analysis of distributed energy resources and power markets. From 1988 to 1989, he was a Visiting Scholar at the Energy Modeling Forum for Stanford University. He was an Associate Professor from 1993 to 1995, and a professor at the University of Tokyo from 2005 to 2008. He is a member of the Institute of Electrical and Electronics Engineers, the Institute of Electrical Engineers of Japan, the Japan Society of Energy and Resources, and the International Association for Energy Economics. Wakako Ariki received a B. Eng. degree and M. Sci. in Mechanical Engineering from the University of Tokyo. She is presently working for Mitsubishi Heavy Industry. Shigeru Bando received a B. Eng. degree in Mechanical Engineering and M. Sci. and Ph.D. degrees in Environmental Studies from the University of Tokyo. He is presently an assistant professor at the University of Tokyo, Japan. He was a research associate from 2005 to 2008. He is a member of the Institute of Electrical and Electronics Engineers, the Institute of Electrical Engineers of Japan, the Japan Society of Energy and Resources, and the Japan Society of Mechanical Engineers.

0.24

0.28

0.32

0.36

0.4

Comparison of Project Values

IV.

CONCLUDING REMARKS

This paper takes a real options approach to analyze the investment and operational decisions of a microgrid for office building. Threshold gas prices are derived for triggering investment in gas-engine generators and renewable power generation, here, photovoltaic generation, PV. By varying the gas price volatility, we find that the optimal investment strategy in a microgrid with gas-engine generators depends on the level of uncertainty. Strategies with installation option of renewable power generation become attractive in terms of risk reduction. Additional value of microgrids with capability of islanded mode operation is avoidance of outage costs. In particular, data centers, financial institutes and public facilities require highly secured supply of electric power even in