Hedging Strategy and Electricity Contract Engineering - IFOR

88 Contract engineering
price is available. The problem is that such short futures are not offered in
Europe, the shortest futures now available are the daily futures.
4.4.2. Shut-down costs
The shut-down costs, in form of thermal losses, also causes deviations from
the option feature. One can handle the shut-down cost as a fixed cost that has
to be spread out on the periods in one connected production phase, adding up
the marginal cost. The longer the production phase is, the lower the additional
marginal cost.
Let us for simplicity assume that the start-up time is short enough to base the
production decision on known spot prices. Then, as long as the spot price S, in
one period is higher than the sum of the marginal cost C m , and the shut-down
cost C sd , i. e. a spot price higher than the one-periodic total marginal cost, the
decision is trivial, namely to produce. And if the spot price is lower than the
marginal cost the decision is also trivial, namely not to produce. The problem
arises when the spot price lies within the open interval š C m C m C sd . › Then
the question arises whether to produce or not, i. e. to exercise the option or not.
If the production would last for only one period, the total marginal cost C mT ot
C
would equal C sd
m 1
, which obviously exceeds spot prices in that interval.
It is therefore not economically defendable to produce only in one period. A
production phase with at least two periods is clearly needed. The total marginal
C
cost given that the production phase lasts for n periods is C mT ot C sd
m n .
In the existence of shut-down costs, the producer may have to take a decision
about the dispatching based on spot prices in periods where they are unknown.
This will, for example, be the case if the production phase extends over the
next day, where the spot prices not yet are determined. As with start-up times,
shut-down costs will destroy some of the option value in the plants, because of
the inability to make the exercise decision with perfect information.
Since the shut-down cost forces us to extend the production phase, our
decision is not anymore whether to produce in a specific period or not, but
rather whether to produce in one and its following say n 1 periods. This