Hedging Strategy and Electricity Contract Engineering - IFOR

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4 Introduction The uncertainty is however not necessarily negative for electricity producers. As a matter of fact, flexible power plants can take advantage of volatile prices. Traditional approaches to handle uncertainty in the electricity market was focused on meeting a fluctuating load, where prices where assumed to be deterministic. Since this is not the case anymore, a new approach to manage risk in the electricity market is needed. The liberalization of the electricity markets brings along a lot of risks for the players, but also plenty of possibilities and chances. One of the keys to success in the liberalized market is the ability to manage these new risks. 1.2. Goal and purpose The goal of this thesis is to investigate risk management in the electricity market in general and the interaction between physical production and financial and physical contracts in particular. The focus of this work is on how an electricity producer can utilize the operational flexibility in power plants as a risk management tool. 1.3. Structure of the thesis In Chapter 2 the electricity market in general is investigated. Its special characteristics, which are needed as background for the further analysis, are highlighted. In Chapter 3 some general risk management ideas are presented followed by a short investigation of the risk measures currently used in the traditional financial markets. After analyzing their suitability as risk measures in the electricity market, the so-called Conditional Value at Risk is presented. The chapter is closed by studying the traditional valuation techniques and their shortcomings in the electricity market. In Chapter 4 the notion of contract engineering is introduced and the set of contracts corresponding to each type of power plant is systematically derived. The importance of flexibility in a power plant is highlighted as a key value driver. In Chapter 5 some traditional hedging strategies are introduced and once again the limitations of these traditional approaches in the electricity market are pinpointed. Instead the concept of best
1.3 Structure of the thesis 5 hedge is introduced. In Chapter 6 portfolio optimization in the electricity market is introduced. A, for the electricity market, new approach, accounting not only for expected profit but also for risk, is presented, where a portfolio of production assets and power contracts is optimized in a profit and Conditional Value at Risk framework. The importance and assessment of operational flexibility in production is investigated and the chapter is concluded by a positioning of contracts and plants, where the attractiveness of different assets is estimated. In Chapter 7 an optimization of a real power portfolio is conducted and the results of this case study are presented. Finally, in Chapter 8 our conclusions are presented.
Page 1: Diss. ETH No. 14727 Hedging Strateg
Page 5 and 6: Abstract This thesis studies risk m
Page 7 and 8: Zusammenfassung Die vorliegende Sch
Page 9 and 10: Contents Acknowledgements ¡ ¢ ¡
Page 11 and 12: Contents xi 5.1 Overview . . . . .
Page 13 and 14: List of Figures 2.1 Illustration of
Page 15 and 16: List of Figures xv 7.6 Marginal val
Page 17 and 18: List of Tables 2.1 Spot market bid.
Page 19: Chapter 1 Introduction 1.1. Motivat
Page 23 and 24: Chapter 2 The electricity market 2.
Page 25 and 26: 2.1 Overview 9 Generation ¥ Distri
Page 27 and 28: 2.2 Liberalization of the electrici
Page 29 and 30: duction cost Marginal pro © 2.3 Su
Page 31 and 32: 2.4 Transmission costs 15 10 Peak l
Page 33 and 34: 2.4 Transmission costs 17 destinati
Page 35 and 36: 2.5 Demand 19 2.5. Demand Compared
Page 37 and 38: 2.6 Special characteristics of elec
Page 39 and 40: 2.7 Electricity contracts 23 tions.
Page 41 and 42: 0& K $ 0& K K % + $ 2.7 Electricity
Page 43 and 44: 2.7 Electricity contracts 27 2.7.2.
Page 45 and 46: 04 04 2.7 Electricity contracts 29
Page 47 and 48: 2.8 Power exchanges and pricing mec
Page 49 and 50: 2.8 Power exchanges and pricing mec
Page 51 and 52: S 0 eH aIKJ 2.9 Price dynamic 35 To
Page 53 and 54: 2.9 Price dynamic 37 400 2000 350 1
Page 55 and 56: 2.9 Price dynamic 39 simple sinus f
Page 57 and 58: 2.9 Price dynamic 41 1800 1800 1600
Page 59 and 60: 2.10 Summary 43 To deal with the un
Page 61 and 62: Chapter 3 Risk management 3.1. Over
Page 63 and 64: 3.3 The risks in the electricity ma
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3.4 Traditional risk management mod
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3.4 Traditional risk management mod
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l H xg yLihkjml f 3.5 The need for
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3.5 The need for a new risk measure
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R S x GaRKV is convex and continuou
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R P 3.6 Multi period risk managemen
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“ “ “ 3.7 Valuation models 67
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3.7 Valuation models 69 storability
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3.7 Valuation models 71 by introduc
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“ 3.7 Valuation models 73 formula
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Chapter 4 Contract engineering 4.1.
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4.2 Gas turbine 77 2000 1800 1600 1
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4.2 Gas turbine 79 220 200 Capped l
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4.3 Hydro storage plant 81 facilita
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¢ 4.3 Hydro storage plant 83 I k L
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x k xœk x «k š xœk 0 š x «k 0
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4.4 Coal plant and oil plant 87 4.4
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4.4 Coal plant and oil plant 89 cor
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4.5 Nuclear plant 91 of 1000 MW. Ov
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4.7 All production plants 93 possib
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4.8 Transmission lines 95 Unit type
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4.9 Real option theory 97 The scien
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4.10 Value of different production
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4.12 Summary 101 like the capped sp
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Chapter 5 Hedging strategies 5.1. O
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È È È È È 5.2 Traditional hedg
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É È É È Ì 5.2 Traditional hedg
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5.3 Relevance for electricity hedgi
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5.4 Best Hedge 111 that the expecte
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5.4 Best Hedge 113 that they alread
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Chapter 6 Power portfolio optimizat
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6.3 Power portfolio optimization in
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6.3 Power portfolio optimization in
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6.4 Modeling of plants and their op
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6.6 Power portfolio optimization wi
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è á 6.6 Power portfolio optimizat
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ö 6.6 Power portfolio optimization
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ö Ü 6.6 Power portfolio optimizat
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ö S kã j á 6.6 Power portfolio o
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¢ ¢ 6.6 Power portfolio optimizat
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î yú1 î é yú1 á ¢ 6.6 Power
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6.7 Summary 167 opportunity set wou
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Chapter 7 Case study In this chapte
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171 3200 140 3000 2800 120 2600 240
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S7 D7 min 8 0 if S i or D p otherwi
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175 Production Spot price Demand [C
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7.1 Efficient frontier 177 lG x 6 9
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7.2 Spot position 179 of the old po
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7.3 Hedging value of water 181 The
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7.4 Value decomposition 183 expecte
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MWh CHF/ P 7.4 Value decomposition
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7.6 Summary 187 2500 2000 Dispatch
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7.6 Summary 189 We have quantified
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Chapter 8 Conclusions The special c
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a4q V a4q G 1 V H a4q 6 Appendix A
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8 _ 195 Proof The results follow im
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g b4i d G9:7j b4 j G 1 9j7j H b4 j
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Ax 3 V AxK1 G 1 V H AxK2 V b 1 G 1
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Bibliography [ABA98] [AD80] [ADEH97
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Bibliography 203 [BS73] [BS98] [BT0
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Bibliography 205 [GR92] H. Gravelle
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Bibliography 207 [Mer76] R. C. Mert
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Bibliography 209 [SC89] [Sch90] [Sc
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Curriculum Vitae Personal Data Name
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