New energy generation and storage systems are continuously being developed due to climate change, resource scarcity, and environmental laws. Some systems are incremental innovations of existing systems while others are radical innovations. Radical innovation systems are risky investments due to their relevant technical and economic uncertainties. Prototyping can hedge these risks by spending a fraction of the cost of a full-scale system and in return receiving economic and technical information

more »

... regarding the system. In economic terms, prototyping is an option to hedge risk coming at a cost that needs to be properly assessed. Real options analysis is the project appraisal approach for these assessments. This paper aims to introduce and test an algorithm based on real options analysis to quantitatively assess the "option to prototype" in the energy sector. First, the interrelated research areas of prototyping, energy systems, and real options analysis are reviewed. Then, a novel algorithm is presented and applied to an innovative Generation Integrated Energy Storage system: Wind-driven Thermal Pumping to demonstrate the effectiveness of option to prototype and the main parameters influencing this decision. The paper shows that the cost of the prototype and the market size (number of identical systems to build) are key parameters. Highlights • Prototyping in the energy sector is crucial for testing radical innovation systems • Prototyping is a cost to be evaluated against the value of information received • Introducing an algorithm to evaluate the option to prototype • Algorithm applied to Generation Integrated Energy Storage (Wind-driven Thermal Pumping) • The prototype costs and market size are key parameters in valuing the option J o u r n a l P r e -p r o o f Nomenclature Abbreviations AACE Association for the Advancement of Cost Engineering CCS Carbon Capture and Storage DCF Discounted Cash Flow GIES Generation Integrated Energy Storage system PTES Pumped Thermal Energy Storage NPV Net Present Value O&M Operation and Maintenance PDF Probability Density Function RO Real Option ROA Real Options Analysis STOR Short Term Operating Reserve TES Thermal Energy Storage Wind-TP Wind-driven Thermal Pumping system Symbols α Cost for prototyping [%] , , and Three parameters for the PERT distribution Expected value for the PERT distribution Cost The most likely value for the generator capital cost of the system [£/kW] Cost The original generator capital cost of the system [£/kW] Cost ! Generator capital cost of the system with reduced uncertainty [£/kW] " Number of systems NPV System NPV of the system [M£] NPV &' ( ( The system NPV after prototyping [M£] NPV ) Maximum NPV threshold (determine to proceed with the project if above) [M£] NPV Minimum NPV threshold (determine to abandon the project if below) [M£] NPV ! Static NPV assuming no option is available [M£] J o u r n a l P r e -p r o o f J o u r n a l P r e -p r o o f