Optimal capacity expansion in the presence of capacity options

This paper studies optimal long-term electric power capacity strategies with capacity options. Gencos (Generation Companies) can sign contracts with Discos (Distribution Companies), where such contracts take the form of capacity options that may or may not be executed by Discos at some prespecified maturation date. Capacity not offered in the options market, or for which options by Discos are not executed, can then be offered in the spot market. The purpose of this paper is to derive the optimal capacities for Gencos in the long-run given full knowledge of the short-term equilibria as characterized by previous literature. We determine the best response strategies for each Genco in the game derived from the short-term outcome resulting from capacity decisions. We then characterize the long-run equilibrium and derive an efficient algorithm to compute it when it exists. This also allows us important insights into the nature of technologies that can survive in the long-run.