Hedging Strategy and Electricity Contract Engineering - IFOR

30 The electricity market
why these contracts are generally called swing options. A broad definition of a
swing option with a life time from 0 to T is that both the instantaneous load D t
and the total energy
T
0 D tdt are constrained as
A 1 D t A 2 t 0 T
B 1
0
T
D t dt B 2 (2.1)
The contracts that the retail customers enter with their electricity suppliers
are essentially swing options, where the maximum load is determined by the
fuse, say 30 Ampere. Below this threshold the customer is allowed to swing
his demand. The volume risk of a retailer, who has to deliver the demanded
power, with a large number of customers, will be diversified down a bit. Still, a
substantial uncertainty in the demanded volume will remain. A retailer without
own flexible production capacity will therefore need to transfer this risk to
other players. This is typically done through swing options in different forms.
A typical swing option is the load factor contract. It has a fixed amount of
energy and is often a one year contract with 5000 hours utilization time. Since
there are 24 365 8760 hours in a year, the contract is said to have a load
factor 25 50006 of 8760 57%, a measure of the flexibility inherited in the
contract. Assume that the load factor contract has a 10 GWh limitation, then the
maximum power of the contract, the maximum drawdown, 10GWh6 is 5000h
2 MW.
2.7.2.8. Interruptible contract
Some contracts have a clause of interruptibility, meaning that, normally the
seller has the right to curtail the supply at predefined number of occasions, in
exchange of course for lower prices. Hence an interruptible contract has built-in
options. The intuitive connection between the interruptible contract and options
is verified in [GV92], where the equivalence between interruptible contracts
and forward contracts bundled with a call option is described. These types of
contracts was introduced as part of demand-side management programs, where
25 The load factor is given by the ratio of the average load to the peak load.