Hedging Strategy and Electricity Contract Engineering - IFOR

90 Contract engineering
The decision whether to continue to produce or not is somewhat different. If
the spot price exceeds the marginal cost, we should keep on producing, since
the total marginal costs decreases, while we have a positive additional cash
flow in that period. Also when the spot price equals the marginal cost we
should continue, even though it does not contribute to a positive cash flow,
since that keeps our option open for the coming periods. Even in the case
where S e C m it is not clear that one should quit producing. A trade-off
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between having to take an additional shut-down cost and inquiring a negative
cash flow of S e C m has to be done.
To summarize, there are two complications with the coal plant and the oil
plant, compared to the gas turbine. The first one is the start-up time, which
may force us take the dispatch decision without knowing the prices. This
destroys some of the plant’s option value and shifts the plant in our contract
engineering framework towards a future contract. The second complication is
shut-down costs, which forces us to produce, not in one-periodic buckets, but
in multi-periodic buckets. This feature also destroys some of the option value
and may also force us to make a dispatch decision based on uncertain spot
price forecasts. The exercise conditions, when to produce or not, are therefore
not explicitly known. The decision to continue to produce or not will also
differ from the decision to start a production phase or not.
By assuming that the start-up time is short enough and that the shut-down costs
are negligible, the coal plant and the oil plant equal a series of hourly call
options with the marginal cost as strike. If the fuel price is not hedged through,
for example, storage then the plants equal a series of call options on the fuel
electricity spread, as is the case for the gas turbine. For oil plants these spread
contracts were developed already in the 1980s by Morgan Stanley [Tha00].
4.5. Nuclear plant
In the nuclear plant uranium fissions, producing heat in a continuous process
called a chain reaction. As in fossil-fuel thermal plants, the heat is used to
produce steam, which spins a turbine to drive a generator, producing electricity.
Nuclear plants are typically large scale production units with a typical size