Hedging Strategy and Electricity Contract Engineering - IFOR

100 Contract engineering
Flexibility
Á
Corresponding
contracts
Excess value
(over DCF)
Prevailing cost
Ã
Hydro storage plant
Gas turbine
¿
High
Bought options
¿
High
Marginal cost
(shadow cost)
CCGT
Oil plant
Coal plant
Ä
Mixed
Nuclear plant
½
Low
¾
Futures
½
Low
Run river plant
Wind plant
Solar plant
À
Negative
Sold
½o
ptions
À
Negative
Fixed cost
Â
Fig. 4.9: Ranking of plant types according to flexibility, corresponding contracts,
excess value and prevailing cost type.
4.11. Engineering of contracts
A good is homogenous if the objects are considered equal by the consumers.
They have no reasons for preferring one supplier for another. This is the case
for electricity; no one can separate whether the electricity they are consuming
is coming from Eon or EdF, if security of supply is taken for granted.
As known from traditional economics, essentially the only competitive
weapon that a company can use in a commodity market is the price. The
margin on commodities therefore tends to be low [Sam97]. From a sellers
point of view there is hence a driving force to de-commodities their products
and differentiate from their competitors. From Chapter 2.7 we know that
electricity contracts even in fairly standardized forms can be complex. Such
de-commoditiesed products will have to be differentiated enough to motivate
a higher price and will consequently be quite complex and typically not be
hedgeable in the standardized market.
A golden rule from the financial markets is to never enter a contract that one
cannot price or risk manage. That indeed also applies to the power markets,
where it is even more important, since the tools to price and manage risk are
less exploited and since the contracts generally are much more complicated.
However, in this chapter we have shown how very complex series of contracts
can be replicated by power plants. Hence with the back-up of own production
capacity, a large number of contracts can be engineered and also risk managed,