Hedging Strategy and Electricity Contract Engineering - IFOR

4.7 All production plants 93
possibilities, which in combination with the low marginal costs forces the run
river plant to produce as soon as water is available, and the dispatch is given by
x k min I k
š p max › š kž
Since the inflow of water and hence the potential energy of the water is
stochastic, the output will be highly uncertain. Wind velocity and sun radiation
are two other very uncertain quantities, why the output from the wind plant
and the solar plant will also be random.
In contrast to, for example, the gas turbine, where the owner can determine
the output, or the nuclear plant, where the output hardly can be changed, but
where the output is at least known, the run river plant, the wind plant and the
solar plant have a negative flexibility in the sense that the output is not only
non-controllable, but also stochastic. Volume risk is therefore indeed present,
which makes these three plant types the most inflexible production units. This
of course should be reflected in the value of such a plant, especially for a risk
averse investor. This negative flexibility corresponds to having sold swing options,
since the owner of the plant is not in the position to determine the output.
Someone else makes the ’decision’, namely the weather. Hence the run river,
wind and solar plant are not only inflexible, they exhibit a negative flexibility.
There is however a difference between a swing option and these plant types.
Whereas the owner of a swing option will typically withdraw power during
peak hours, when prices are high and it hurts the seller the most, the owner
of an inflexible plant will not be subject to these rational decisions. The corresponding
contract would hence be a swing option bought by an irrational
player, where the maximum power A 2 in (2.1) is given by the maximum output
of the plant, the minimum power A 1 by zero. The maximum and minimum
energy B 2 and B 1 are however unknown and ’determined’ by nature.
4.7. All production plants
The possibility of a power plant to benefit from the optionality is dependent on
its flexibility and availability. So far we have only discussed the first factor, the
flexibility, but just as important is the availability of the plant. Every plant is