Real Options Analysis applied on Residential Energy Systems using least Squares Monte Carlo Simulation

Fossil fuel technologies still play a major role in residential heating, but the transition to cleaner alternatives such as heat pumps, photovoltaics, and energy storage is crucial. For the economic assessment of these residential energy systems discounted cash flow analysis is usually utilized e.g. by calculating the net present value (NPV). This approach's shortcoming is its neglect of flexibility in the decision-making process, as it values each system assuming an immediate investment. To address this issue, we apply real options analysis considering the real option to defer an investment to account for future changes of the investment conditions. To value the real option, we use a least squares Monte Carlo simulation option pricing model and calculate the enhanced net present value (ENPV) of each system. A typical single-family house located in Germany is used as a case study. Photovoltaics, battery storages, electric air-to-water heat pumps and condensing gas boilers as well as combinations of these technologies are considered as investment options. The results show that incorporating the real option value leads to a shift in the economic assessment of the systems. In the long-term, the highest ENPV are reached by the combination of a heat pump with photovoltaic whereas with the traditional NPV the economic most favorable decision is a new gas boiler. Furthermore, an examination of different scenarios for heat pump subsidy schemes and CO2 price trends is presented. The analysis shows that the heat pump subsidy schemes lead to a substantial increase of the ENPV even for low deferral periods. In contrast, CO2 price trends alone do not offer the same level of encouragement for an early optimal investment time but provide a significant long-term economic incentive for transitioning to cleaner technologies in the residential heating sector