Hedging Strategy and Electricity Contract Engineering - IFOR

7.2 Spot position 179
of the old portfolio and the weather derivative, only decreases to -2.3 million
CHF. As seen in Figure 7.3, the weather derivative is not attractive to the
utility, since the new portfolio, marked (3) is suboptimal even with respect
to the smaller investment opportunity set building up the efficient frontier of
the original portfolio. Instead the utility wants to take more advantage of the
operational flexibility and is considering to sell a load factor contract, giving
the buyer a large flexibility both on the load and energy side. The price is
consequently high and the product is priced at 43 CHF/MWh. By adding this
load factor contract to the original portfolio, the expected profit would increase
to 8 million CHF and the risk would increase to -1.4 million CHF, marked by
(2). Despite the large increase in risk, the contract would be attractive to the
utility, since it could not utilize the additional risk with such an increase in
expected profit given the original investment opportunity set. Together with
performing contract engineering to identify the corresponding contracts of a
plant, the positioning of contracts and plants can in this sense be very helpful
in pinpointing the contracts or plants that make optimal use of the current
assets and their flexibility characteristics.
7.2. Spot position
The average spot price over the two weeks is 39.66 CHF/MWh, whereas the
two-week future is traded at 39 CHF/MWh just before the beginning of the
first period. 4 The future is hence priced almost 1.7% lower than the average
spot price. When we impose no, or a very loose, risk constraint the optimal
portfolio goes long in the futures market and sells the corresponding electricity
in the spot market at a somewhat higher expected price. When we tighten the
risk constraint, the slightly higher expected spot price does not make up for the
highly uncertain and hence risky profit any longer, which inevitably is the effect
of a large spot position. The future position is therefore increasing in the risk
constraint C until it hits its upper boundary of 10000 MW, as seen in Figure 7.4.
Absence of volume risk, 5 would in the case of a risk minimization imply
4 This implies that the producers require a risk premium for selling electricity on the risky
spot market instead of on the futures market.
5 This would in our case correspond to no uncertainty in production volume and no un-