The graphic below illustrates the different decision points and options available to both customers and utility managers. The intra- and interrelation of customer and utility decision points/options requires the use a more sophisticated optimization model. This model provides the user with decision support to guide investments in microgrid equipment and operations.
Previously, customers making decisions about microgrids have relied upon a standard discounted cash flow model (“DCF”). Applied research published in engineering and economics journals now suggests a very large benefit to microgrid owners and customers and utility rate payers/shareholders from using more complex decision-support models based on real options analysis (“ROA”).
DCF calculates NPV by discounting net cash flows on a year-by-year basis over an assumed operating period based upon an initial investment in microgrid equipment. Quantitative financial analysts refer to this process as backward recursion. However, backward recursion does not account for so-called forward path dependencies. For example, managers have flexibility going forward to make operating decisions in each year that improve the overall NPV of a project and knowledge of the probability of such decisions may change the amount and types of investment. ROA uses off-the-shelf solution algorithms to simultaneously solve equations describing the interrelated investment and operating decisions.
DCF also typically does not account for the fact that many different decisions of microgrid owners and an independent utility company will impact microgrid investments/operations and that these decisions will impact one another simultaneously. Using game-theoretic solution techniques, ROA has been adapted to solve for an optimal portfolio of interrelated decision making.
Many investment banks that make loans for microgrid development and private equity investors in microgrid development prefer the use of ROA. Also, numerous regulatory commissions have endorsed ROA as a superior means of efficiently investing in and operating microgrids. Though more complex than traditional DCF calculations, ROA has proven to be significantly more accurate at accounting for the decision flexibility contained within a microgrid.