A production-inventory problem for an energy buy-back program

This paper considers a production-inventory problem in which the manufacturer participates in an energy buy-back program, which offers probabilistic opportunities with rewards for not using electricity. That is, the manufacturer will get paid for stopping production to save on electricity. The amount rewarded in a period will depend on the electricity market condition at that time. The market condition in any given period is represented by M + 1 states: normal (i.e., nonpeak), peak type 1,..., peak type M, and the reward amount in the period will be O, K ₁,..., and K _M, respectively. The occurrence of each state in a period is dictated by a known probability distribution. The objective is to determine from the manufacturer's perspective, whether to take such an offer when it arises. Under a mild assumption, we show that in the normal market condition, the production decision is partly a base-stock policy, whereas under peak type m condition, the manufacturer, upon accepting the offer, produces according to an (s _m, S) policy, where m = 1,..., M. The numerical experiment demonstrates that the cost savings due to buy-backs can be substantial. It also shows that the always-participating strategy (i.e., the firm shuts down production whenever the buy-back program is activated) can perform much worse than the never-participating strategy. © 2007 IEEE.