Liquidity risks on power exchanges

Financial derivatives are important hedging tool for asset’s manager. Electricity is by its very nature the most volatile commodity, which creates big incentive to share the risk among the market participants through financial contracts. But, even if volume of derivatives contracts traded on Power Exchanges has been growing since the beginning of the restructuring of the sector, electricity markets continue to be considerably less liquid than other commodities. This paper tries to quantify the effect of this insufficient liquidity on power exchange, by introducing a pricing equilibrium model for power derivatives where agents can not hedge up to their desired level. Mathematically, the problem is a two stage stochastic Generalized Nash Equilibrium and its solution is not unique. Computing a large panel of solutions, we show how the risk premium and player’s profit are affected by the illiquidity.illiquidity, electricity, power exchange, artitrage, generalized Nash Equilibrium, equilibrium based model, coherent risk valuation

The valuation of power futures based on optimal dispatch

The pricing of contingent claims in the wholesale power market is a controversial topic. Important challenges come from the non-storability of electricity and the number of parameters that impact the market. We propose an equilibrium model based on the fundamentals of power generation. In a perfect competitive market, spot electricity prices are determined by the marginal cost of producing the last unit of power. Electricity can be viewed as a derivative of demand, fuels prices and carbon emission price. We extend the Pirrong-Jermakayan model such as to incorporate the main factors driving the marginal cost and the non-linearities of electricity prices with respect to fuels prices. As in the Pirrong-Jermakayan framework, any contingent claims on power must satisfy a high dimensional PDE that embeds a market price of risk, as load is not a traded asset. Analyzing the specificity of the marginal cost in power market, we simplify the problem for evaluating power futures so that it becomes computationally tractable. We test our model on the German EEX for "German Month Futures" with maturity of June and September 2008.power contingent claims, PDE valuation of financial derivatives, unit commitment, market price of risk, EEX

What Models Tell us about Long-term Contracts in Times of the Energy Transition

Uncertainty is a major hindrance to attracting investment for the energy transition. Yet European market design is mainly discussed with a focus on short-term efficiency. Based on computational results from market models for gas and power we derive lessons on the importance of contracts and the implications of incomplete markets. Specifically, we show that short-term efficiency is not sufficient to guarantee a well-functioning long-term market, whether expressed in standard welfare-maximization terms or with respect to the EU criteria (security of supply, sustainability or affordability). The end result can drastically depend on the extent to which one can deal with risk. This result is in line with economic theory

The Role of Electrification in the Decarbonization of Central-Western Europe

Scenario studies of energy transition generally point to the central role of electricity. This notion is ambiguous as its interpretation can range from an electricity-only policy to portfolios of different energy vectors with a dominance of electricity. This ambiguity adds to the uncertainty that already pervades today’s investment environment. This paper examines the centrality of electricity through a so-called “variational scenario” analysis with policies obtained by a mix of electricity-only and green gas penetration while maintaining constant decarbonization objectives. Electricity is a complex product that can only be further complicated by the high penetration of renewables and its interaction with the production and use of synthetic fuels. The variational scenario analysis is conducted with sufficiently fine (hourly) granularity to produce an adequate representation of these phenomena. It shows that tilting the central role of electricity to a mix of electricity and green gas offers several advantages in terms of efficiency, flexibility of investment strategies, and robustness with respect to major uncertainties. It shows that the variational scenario analysis can be extended to more complex mixes of policies

On the multiplicity of solutions in generation capacity investment models with incomplete markets: a risk-averse stochastic equilibrium approach

Investment in generation capacity has traditionally been evaluated by computing the present value of cashflows accruing from new equipment in a market with globally optimized capacity mix. The competition and risk that now prevail in the sector may require a more refined analysis. We consider a competitive market with agents investing in some mix of capacities: the risk exposure of a plant and the attitude towards risk of the owner depend on the plant and the portfolio of its capacities. They may also depend on hedging contracts acquired by the investor on the market if such contracts exist. We represent these effects through equilibrium models of generation capacity in incomplete markets. The models come in different versions depending on the portfolio of physical plants and hedging contracts. These modify the long-term risk of the plants, the attitude of the owners towards risk, and hence the incentive to invest. The models involve risk-averse producers and consumers, and their behavior is represented by convex risk measures. We use degree theory to prove existence and explore multiplicity of equilibrium solutions