Keywords: Monte Carlo, Valuation, Gas Storage
Published in: Journal of Derivatives
Publication year: 2008 (Spring)
Co-Author 1: Alexander Boogert

Developed countries increasingly rely on gas storage for security of supply. Widespread deregulation has created markets that help assign an objective value to existing and new to build storages. Storage valuation is nevertheless a challenging task if we consider both the financial and physical aspects of storage. In this paper we develop a Monte Carlo valuation method, which can incorporate realistic gas price dynamics and complex physical constraints. In specific we extend the Least Squares Monte Carlo method for American options to storage valuation. We include numerical results and show ways to improve computational speed.

Keywords: Power Baseload, coal, fuel mix, emissions trading
Published in: World Coal
Publication year: 2004
Co-author 1: Kasper Walet

Currently, there is a lot of debate going on in the Netherlands whether the deregulation of the electricity market is actually working yes or no. The power-consuming industry believes the prices are artificially placed on a too high level and are undermining their competitiveness. It is expected that due to the upcoming CO2 emissions trading in the European Union the power prices will rise even more. With coal generally being the fuel with most CO2 emissions, emissions trading will certainly have its impact on the place of coal in the fuel mix for the power production. Surprisingly though, some large power-consumers recently announced plans to build a new coal-fired plant by themselves to undercut the power of the oligopoly of power producers in the Benelux. They believe coal is an excellent fuel for cheap baseload power generation Then maybe the prospects for coal as a fuel for power are not so bad? Kasper Walet and Cyriel de Jong of Maycroft Consultancy guide you through these issues and the impact on the coal industry.

Keywords:
Published in: Energy Risk
Publication year: 2003

Here we describe the optimal operation and valuation of gas storage based on a real option methodology. Using Zeebrugge gas prices as a practical example, Cyriel de Jong clarifies the optionality in gas storage, analyse its valuation and discuss hedging strategies to secure part of the storage value

Keywords:
Published in: Energy Risk
Publication year: 2003
Co-author 1: Kasper Walet

The Bunde-Oude natural gas hub on the German-Dutch border is the most likely candidate to become the Henry Hub of Europe, according to a survey of European natural gas experts conducted by Maycroft Consultancy Services

Keywords: power plant, real options, spark spread, hedging, valuation, optimal operation
Pulished in:
Publication year: 2003

In this paper we describe the decision problem of the manager of a power plant. The plant manager needs to decide on the production levels of the facility based on current and future spark spreads and production costs. Furthermore, decisions need to be made on the optimal hedging strategy with tradable financial contracts in the electricity output and the input fuel. We show that optimal production decisions and optimal financial contracting decisions depend largely on the flexibility with which the facility can be operated, and thus on the level of volatility that may be exploited. On one side of the spectrum, so-called baseload plants will be generating power almost continuously, and hedging financial risks is done with tradable long-term forward contracts, which yields a direct value based on option theory (Margrabe, 1978). On the other side of the spectrum, so-called peaking plants will be generating power only in short periods of high demand, and hedging financial risks is only possible to a very limited extent, since financial contracts on future short-term delivery periods are barely traded. As long as the risk preferences of the plant owner are taken into account, real option valuation and optimal operating decisions can however be obtained for peaking plants by simulating the appropriate market prices in combination with the least squares Monte Carlo simulation approach (Carriere, 1996; Longstaff and Schwartz, 2001).

Keywords:
Published in: Commodities Now
Publication year: 2003
Co-author 1: Michael Sewalt

In this paper we describe how liberalisation has lead to the segmentation of trading opportunities for electricity with different periods to delivery. We clarify the price characteristics in each segment, including the extreme volatility in short-term prices and the phenomenon that electricity prices can become negative close to the time of delivery. With the Dutch market as an example, we show the implications for risk management and the valuation of derivatives. We argue that a distinct price model is required for risk management and derivative valuation in each market segment. Derivative valuation goes beyond the financial contract itself and can be very useful for taking strategic decisions on flexible generation assets

Keywords:
Published in: Studies in non-linear dynamics & econometrics
Publication year: 2006

Due to its non-storable nature, electricity is a commodity with probably the most volatile spot prices, exemplified by occasional spikes. Appropriate pricing, portfolio, and risk management models have to incorporate these characteristics, and the spikes in particular. We investigate the nature of power spikes in a number of different markets. We test what time-series model is best able to capture the dynamics of these disruptive spot prices. We use regime-switching models to infer whether the price spikes should be treated as abnormal and independent deviations from the ‘normal’ price dynamics or whether they form an integral part of the price process. We test the time-series models on day-ahead markets in Europe and the US. We find that regime-switch models are better able to capture the market dynamics than a GARCH(1,1) or Poisson jump model. We also find clear differences between the markets and attribute part of the differences to the share of hydro-power in the total supply stack: hydro-power serves as an indirect means to store electricity, which has a dampening effect on spikes.

Keywords: wind power, pricing, price - wind correlation, hedging, investments
Published in: WorldPower 2008
Publication year: 2008
Co-author 1: Hans van Dijken

Effective Pricing of Wind Power - Uncertainties in Wind Production Often Priced at Too Low Levels

This article describes the pricing and hedging of wind power contracts. It demonstrates that substantial discounts relative to baseload power prices are reasonable to cover the negative wind-price correlation and to cover the difficulty of hedging price risks.

In this article, we outline a sound approach to the assessment of wind power projects, based on a careful analysis of project returns. In particular, we describe a number of hedge mechanisms and highlight some common pitfalls in
structuring wind power purchase agreement (PPA) deals. Wind power is one of the most viable options to meet renewable energy targets. The attractiveness to investors depends on investment costs, expected future power price and (heavily) on the subsidy regime. But with the steady increase of wind
production, the ability to secure future cashflows and to manage the risks becomes a key issue as well.

Wind power contracts typically contain discounts relative to the market forward prices. This derives from the difficulty in forecasting wind production and the variability in wind production, the correlation with market prices (imbalance and day-ahead). In the case presented, the correlation between day-ahead prices and wind production was already responsible for a discount of €6/MWh. A typical discount for imbalance costs has about the same magnitude, leading to an expected revenue shortfall of €12/MWh – without
even taking into account the effects of the continuous increase of wind production on spot power prices. The analysis also demonstrates that a
considerable proportion of the price risks, both short-term and long-term, are
unhedgeable and should be incorporated in additional discounts. It is our experience that these risks are easily overlooked and wind power priced too optimistically.

Published in WorldPower 2009

Authors: Henk Sjoerd Los, Hans van Dijken, Cyriel de Jong. KYOS Energy Consulting

The large investments in new power generation assets illustrate the need for proper financial plant evaluations. Traditional net present value (NPV) analysis disregards the flexibility to adjust production decisions to market developments, and thus underestimate true plant value. On the other hand, methods treating power plants as a series of spread options ignore technical and contractual restrictions, and thus overestimate true plant value. In this article we demonstrate the use of volatility and cointegration to incorporate market fundamentals and calculate dynamic, yet reasonable, spread levels and power plant values. A practical case study demonstrates how various technical and market constraints impact plant value. It also demonstrates that plant value may contain considerable option value, but 64% less than with the usual real option approaches. We conclude with an analysis of static and dynamic hedges affecting risk and return profiles

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