Valuing flexibility in electro-intensive industries: the case of an aluminum smelter

Abstract

Electro-intensive industries account for a significant proportion of the total industrial electricity consumption, and these industries usually possess co-generation assets, which can supply at least part of their energy needs. However, due to price uncertainty, it may be optimal for the firm to temporarily suspend production and sell the available energy. If this strategy creates value, governments can create incentives through price signals for these firms to take their plants offline and increase the supply of electricity during times of shortage. This study analyzes the case of an aluminum plant that has the choice of temporarily suspending operations and models its managerial flexibility as a bundle of European switch options. The suspension and modeling would occur under two simultaneous situations, uncertainty and asymmetric state switching costs under the real options approach, to determine whether the changes add value to the firm. The results indicate that this flexibility can add significant value to the firm.

Keywords:
Switch options; Asymmetric switching costs; Managerial flexibility; Aluminum industry