By Petter L. Skantze
The demanding situations presently dealing with members m aggressive electrical energy markets are certain and dazzling: unparalleled rate volatility, a crippling loss of historic industry info on which to check new modeling techniques, and a always altering regulatory constitution. assembly those demanding situations would require the data and event of either the engineering and finance groups. but the 2 groups proceed to mostly forget about one another. The finance group believes that engineering types are too precise and intricate to be essentially acceptable within the quickly altering marketplace setting. Engineers counter that the finance versions are in basic terms statistical regressions, missing the required constitution to trap the genuine dynamic homes of complicated strength structures. whereas either perspectives have advantage, neither workforce has through themselves been in a position to produce powerful instruments for assembly demanding situations. The objective of this e-book is to exhibit the basic modifications among electrical energy and different traded commodities, and the effect those modifications have on valuation, hedging and operational judgements made by way of marketplace individuals. The optimization difficulties linked to those judgements are formulated within the context of the industry realities of state-of-the-art energy undefined, together with an absence of liquidity on ahead and strategies markets, constrained availability of old facts, and always altering regulatory structures.
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Extra resources for Valuation, Hedging and Speculation in Competitive Electricity Markets: A Fundamental Approach
Unless otherwise specified we will from now on assume that financial forwards settle ex-post. 4 The Derivatives Markets A number of options and other derivative contracts are traded in the electricity marketplace. They can generally be grouped into three categories: temporal, locational, and inter-commodity derivatives. Temporal derivatives are the most common, and are used to hedge against future movements in the spot price of power at a given location. They include simple call and put options, as well as more sophisticated swing options and look-back (reference) options.
From a strictly theoretical point of view, we could therefore conclude that each spot, forward and derivative contract, for each delivery period, at every location in the network, should be modeled as a separate state of a dynamic process. This modeling approach, however, is highly impractical. The dimension of the state space would be so high that we would be unable to solve even the simplest optimization problems, not to speak of defining consistent methods of estimating model parameters. The focus in this section of the book therefore is on finding a reasonable compromise: a model which preserves the unique characteristics of electricity production, consumption and transmission, while limiting complexity.
An increase/decrease m the forward price will put upward/downward pressure on the spot price. 2. A spike/drop in the spot price will put upward/downward pressure on the forward price. Consider the following scenario. Tomorrow OPEC announces that it will reduce its annual production of oil by 50%. Based on this news, the forward price of oil increases sharply. Next, arbitreurs recognize the disparity between spot and forward prices, igniting a buying spree on the spot market. This 26 causes an immediate spike in the spot price of oil.