Three essays on risk management in electric power markets

1 CD-ROMThis dissertation has arisen in the context of the electric power markets, the study of risk management and the relations between physical production and the electricity transactions using financial contracts in particular. Electricity is very difficult to compare with any other commodity, since it has a peculiar characteristic; electricity “must be produced at exactly the same time as it is consumed”. The technological inability to store electricity efficiently and the characteristics of marginal production costs create jumps in the spot price. The electricity power market is heavily incomplete. Load-matching problems occur because electricity prices show volatility because of unexpected variations due to climatic conditions and other associated risk factors. A branch of the literature in risk management has tried to give a definitive answer to the question of how agents in the markets with non-storable underlying asset could hedge their exposure to volatile price and quantity. The first essay tackles the basis of this question, which is the implication of the price of risk when forward risk premia are presented. This essay also shows how the properties and variations of forward risk premia is explained by risk factors variations on expected spot prices, and unexpected changes on the available quantity of water to generate electric power. Forward risk premia are the measure, hour by hour throughout the day, of the price of risk that the agents pay to trade electric power using forward contracts. In this essay forward premia were measured from the unregulated market segment. The results indicate that the average expected forward risk premia could have a positive behavior in seventeen out of twenty-four hours. These results represent the equilibrium compensation for bearing the price risk of the electric power for one year. In the Colombian market, the risk taker is the marketer, specifically in the unregulated market segment, because they are assuming the price risk in the long-term negotiations. The marketer, represented by this demand, tries to ensure their future Profit and Losses P&L and so they sacrifice their premia. It is relevant for further studies to evaluate the efficiency of this market, and the characteristics to determine why the marketer is willing to pay forward risk premia and why the generator has a better position to receive this bonus. Exploring the optimization problem of portfolios my second essay asks whether the agents in the electric power market could hedge their exposure to uncertainties; price and quantity. We propose a close form solution for the optimization problem of portfolios composed by two claims, price and weather, according to factors influencing electric power markets such as price volatility, price spikes, and climatic conditions that influence volume volatility. Results show a positive correlation among price, quantity, and the weather variable. In order to apply the optimal static hedging that includes the second claim on weather indexes for seasonal countries such as United States and tropical countries such as Colombia, the third essay shows an application of the static hedging model, using parameters from US market(PJM), and Colombian market (WPMC2). For the PJM, I used weather indexes from Chicago Mercantile Exchange Group, and the hydrological index from WPMC which is based on the hydrological contributions of rivers on dam levels. We verify that El Niño and La Niña phenomena also influence quantity variations, and the agents in those markets are exposed to both price and quantity volatiles.Introduction – I. Modelling Risk for Electric Power Market -- Bibliography – Appendix – II. Optimal Static Hedging of Energy Price and Volume Risk: Closed-Form Results – III. Applications of Optimal Static Hedging of Energy Price and Volume Risk to markets in the US and Colombia -- IV. Final Discussion -- Bibliograph

Financial risk management and market performance in restructured electric power markets: Theoretical and agent-based test bed studies

Electric power systems have traditionally been operated as natural monopolies. Restructuring has entailed un-bundling of hitherto vertically integrated organizations into independently managed generation, transmission and distribution systems. As a result, electric power markets can be divided into wholesale and retail layers. The wholesale power market design proposed by the U.S. Federal Energy Regulatory Commission (FERC) in an April 2003 white paper FERC (2003) encompasses the following core features: central oversight by an independent system operator (ISO); a two-settlement system consisting of a day-ahead market supported by a parallel real-time market to ensure continual balancing of electric power supply and demand. In this new environment electricity is traded like other commodities in ISO organized power pools. However, power systems must be in instantaneous power balance, i.e. demand must equal supply at all times. Moreover, at present, electric power cannot be stored economically in substantial amounts. The power flows on transmission systems are governed by physical laws of power flow such as the Kirchoff\u27s law, and are constrained by the overall capacity of transmission lines. During the peak hours of electric power demand, the above mentioned constraints become binding affecting outcomes throughout the grid. Transmission constraints in particular create congestion, which can impede the generation and/or injection of electric power into the grid in merit-order , i.e., from least-cost generator to high-cost generators. Electric power prices can be very volatile and hence, new forms of risk have arisen due to the restructuring. As part of restructuring, congestion on electricity transmission grids is now handled in many energy regions by means of locational marginal pricing (LMP), i.e., the pricing of electric energy in accordance with the location of its injection or withdrawal from the grid. The LMP so calculated at a node k measures the least cost to supply an additional unit of load at that location from the resources of the system. The difference in LMPs at any two buses is known as congestion rent, which is collected by the ISO. In the case of grid congestion, LMPs can vary widely across the grid, which creates price risk for all market participants. Using existing market design features, this thesis investigates the risk management issues of market participants and overall efficiency of the wholesale power markets. Additionally, I also study the market rules dealing with renewable energy sources

Managing market risks in the Australian national electricity market

The restructuring of many national and state electricity industries over the last two decades has created new sets of laws and regulations, market design and participants. Along with those changes, industry risks have also been transformed significantly. Prior to restructuring, government-owned or carefully regulated monopoly private utilities would manage most of these industry risks. With restructuring, however, both the government, through their market regulators, and industry participants need to manage a range of previous,, yet also now new, risks. While the government’s risk management strategy is focused on the industry as a whole, participants are naturally more concerned with their individual risks. The Australian National Electricity Market (NEM) is one of the many electricity markets that were formed through the restructuring process underway worldwide. It created a number of new types of market participants facing different sets of risks. The main objective of this thesis is to examine the management of market risk by these different NEM participants. The methodology used in the thesis involves developing a fundamental understanding of electricity restructuring, the NEM and the various risks faced by the different NEM participants. Data on NEM spot prices, ancillary costs and forward prices are analysed to gain a better understanding of its relationship with market activities. Different risk management strategies, both proactive and reactive, that can be taken by the participants are discussed This thesis has highlighted some of the complexities involved in managing risks in a restructured electricity industry. Risks are never static and changes in market conditions alter the risk exposure of the participants. Therefore, participants will need to constantly monitor their risk exposure and update their risk management strategies. The Cash-Flow-at-Risk methodology is introduced as a possible tool to measure risk and analyse risk management options for different NEM participants

The Difficult Transition to Competitive Electricity Markets in the U.S.

This paper discusses the causes and consequences of state and federal initiatives to introduce wholesale and retail competition into the U.S. electricity sector from 1995. The development and performance of wholesale market institutions, the expansion of wholesale power trade, the entry of merchant generating capacity, and the financial collapse of the trading and merchant generating sector is discussed. Issues regarding the ability of evolving spot wholesale energy market institutions and market power mitigation mechanisms in the absence of some form of peak capacity obligation are discussed theoretically and evaluated empirically. The diffusion of retail competition and the performance of retail competition programs in eight states is examined empirically. The analysis leads to the overall conclusion that the development of efficient competitive wholesale and retail electricity markets continues to be a work in progress and faces many technical

Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design

Paul Joskow analyzes the Federal Energy Regulatory Commission's Notice of Proposed rulemaking (NOPR) regarding Network Access Service and Standard Market Design. This analysis focuses on two sets of issues. First, Joskow comments on the proposed regional long-term resource adequacy obligations. Second, he comments on several components of the proposed framework for stimulating efficient levels of transmission investment. He outlines an alternative approach to transmission investment and pricing, including a workable approach to pricing based on beneficiaries pay principles. Joskow's analysis provides theoretical and empirical support for and constructive criticisms of important components of the NOPR.

The Difficult Transition to Competitive Electricity Markets in the U.S.

This paper provides a comprehensive discussion of the causes and consequences ofstate and federal initiatives to introduce wholesale and retail competition into the U.S.electricity sector between 1995 and the present. Information about the developmentof wholesale market institutions, the expansion of wholesale power trade, theperformance of wholesale market institutions, the entry of merchant generatingcapacity, and the financial collapse of the trading and merchant generating sector ispresented and discussed. Issues regarding the ability of evolving spot wholesaleenergy market institutions and market power mitigation mechanisms to provideadequate incentives for investment in new generating capacity in the absence of someform of peak capacity obligation are discussed theoretically and evaluatedempirically. The diffusion of retail competition and the performance of retailcompetition programs in eight states is examined empirically. Imperfections intransmission governance arrangements and barriers to efficient expansion of thetransmission network are identified. The analysis leads to the overall conclusion thatthe development of efficient competitive wholesale and retail electricity marketscontinues to be a work in progress and faces many technical, institutional and politicalchallenges in the U.S. Suggestions for successfully confronting, or at least betterunderstanding, these challenges are presented.Technology and Industry, Regulatory Reform