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Hedging Strategy and Electricity Contract Engineering
IFOR Events
Seminar:
'Optimization & Applications'
(see information & program)
Feb 20 - May 28, 2012
IFOR Mitteilungen
This booklet informs about ongoing projects and future events at the IFOR and appears once at the end of the year.
| Author |
Gustaf Unger |
| Abstract |
This thesis studies risk management in the electricity market in general and the interaction between physical production and electricity contracts in particular. From a risk management point of view, a power portfolio differs substantially from a traditional financial portfolio. Electricity is non-storable, which together with the marginal production cost characteristics creates jumps in the spot price. The return of a power portfolio is hence typically heavy-tailed, and a risk measure, such as CVaR, that captures this heavy-taildness is needed. To be able to compare production and contracts on a unified basis, we identify the set of contracts that corresponds to each power plant. These contracts build up a replicating portfolio of the power plant. This engineering of contracts allows us to risk manage these often complex contracts, through production. Further, a producing electricity company can through a simple absence of arbitrage argument assess these contracts by studying the costs associated with the corresponding power plant. Flexible production units, such as a gas turbine, relate to options whereas inflexible units, such as a nuclear plant, relate to futures. The electricity market is heavily incomplete, why perfect hedges are not achievable for a number of contracts. Hence we introduce the concept of best hedge. The best hedge is found through an optimization, where risk, measured as CVaR, is minimized subject to a constraint on the expected profit. It turns out that this problem can be solved with linear programming, allowing us to handle problems of substantial size. When a whole portfolio is considered we try to utilize our risk mandate at the best possible way. This leads us to the well-known problem in finance of portfolio optimization. However, this problem needs to be tailored for the electricity market because of the special characteristics of power portfolios. An optimal portfolio implies also an optimal dispatch of the production assets. We focus on the challenging hydro storage plant, which because of its flexible nature corresponds to a series of options. These options are however interdependent through the stored water in the reservoir. An exercise of an option, i. e. production, decreases the amount of stored water and may prohibit production at a later point in time. We develop a dynamic dispatch strategy, which takes this interdependence into account. The optimization of a portfolio consisting of a hydro storage plant and electricity contracts hence needs to derive the optimal portfolio of contracts and the optimal dispatch strategy, or with financial terms the optimal exercise conditions for the corresponding options. We solve the problem with linear programming by maximizing the expected profit over a specified time horizon under the constraint that CVaR of the portfolio may not exceed some threshold, typically determined by the risk preferences of the firm. It turns out that a simultaneous optimization of the dispatch and the contracts is needed, since the dispatch depends on the volume risk in the entered contracts. A main result is the high value related to the operational flexibility of the hydro storage plant. By studying the dual of our linear portfolio optimization problem, we can actually quantify this value. In a performed case study it is shown that this value of flexibility can be substantial. Any valuation that does not take this operational flexibility into account may hence underestimate flexible power plants. |
| Download | PDF, PS, PS.gz |
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