Real Options and Transmission Investment: the New Zealand Grid Investment Test

Abstract

Responsibility for approving proposed transmission investment programmes in New Zealand has recently been placed in the hands of a newly-formed government regulator. In this paper we develop an analytical framework for conceptualising the investment test proposed by this regulator. Our framework reveals that the test involves a complex set of tradeoffs between economies of scale the time value of money and flexibility in the timing level and location of transmission investment assessment of which requires explicit recognition and valuation of real options.