Optimal investments in power generation under centralized and decentralized decision making

This paper presents a novel modal for optimization of investments in new power generation under uncertainty. The model can calculate optimal investment strategies under both centralized social welfare and decentralized profit objectives. The power market is represented with linear supply and demand curves. A stochastic dynamic programming algorithm is used to solve the investment problem, where uncertainty in demand is represented as a discrete Markov chain. The stochastic dynamic model allows us to evaluate investment projects in new base and peak load power generation as real options, and determine optimal timing of the investments. In a case study, we use the model to compare optimal investment strategies under centralized and decentralized decision making. A number of interesting results follow by varying the assumptions about market structure and price response on the demand side.