Invest in Power Arie Kapulkin Active Power Investments LLC Niagara Falls, ON 19 September 2012.

Invest in Power

Arie KapulkinActive Power Investments LLC

Niagara Falls, ON19 September 2012

2

Outline

• Overview of Energy Trading

• Development of Nodal Power Markets

• Financial trading in Nodal Power Markets

• Risk Management

• Opportunities for investors

• Conclusions

Copyright © 2012 by Active Power Investments LLC All Rights Reserved

3

What is Energy Trading?

• A purchase or sale of energy, paper or physical, for consumption or resale

• Purchase or sale for consumption or resale in the very short time frame refers to spot energy trading; energy trading in the future refers to futures/forwards

• Why Trade? Energy Trading results in realization of gains from trade – there is no different from other trading of commodities or goods

• Examples include: oil, gas, power, coal, emissions, weather, etc.; all these commodities can be traded

• We can trade products and their derivatives; derivatives are instruments that derive their value from the underlying product


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Traded Products: Temporal Dimension

• Spot (cash) market is same hour/day (Example: Real-Time (RT)) for immediate production or consumption

• Day Ahead (DA) is a type of the short-term hourly or block-based forward market for the next day

• Futures or forward market is trading for some remote time period

• Examples: balance of the month, prompt month, 3 to 5 years out Henry Hub on NYMEX


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Traded Products: Spatial Dimension

• Energy is traded worldwide

• Oil is traded on major energy exchanges: NY Harbor, WTI – Cushing, Gulf Coast, North Sea, Singapore

• Gas is traded at Henry Hub in LA and AECO in Alberta and a number of secondary gas hubs; Ze Brugge terminal in Europe, etc.

• Electricity is traded at great many locations due to its local production and consumption nature: All over the world (Example: Electricity Hubs in the US)


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Where is Energy Traded?

• One-to-one: individual bilateral deals

• Many-to-one: marketers • Model pioneered by Enron

• Requires the company to actively match buyers and sellers

• Many-to-many: ICE, Nodal Exchange, Futures Markets• Platform to enable clearing b/w multiple participants

• Organized power markets• New ways to transact: central clearing of locational bids by system

operators (ISOs and RTOs)


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Outline




• Risk Management


• Conclusions


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generation

customerservice

distribution

transmission

IPP self-generation

CUSTOMERSTheory


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generation

customerservice

distribution

transmission

IPPself-generation

CUSTOMERS PracticeCopyright © 2012 by Active Power Investments LLC

All Rights Reserved


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power exchangegeneration

customerservice

distribution

transmissiongeneration

customerservice

distribution

transmission

ISO

marketing

trading

ancillary srvcs

Transition

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Power Marketing and Energy Trading Explosion

• Utilities, financial houses, marketers, brokers, generating entities, and speculators are buying, selling, and swapping power/energy on an ever-increasing scale

• The total volume of trade is multiples of the value of the underlying commodity

• Power marketing / brokering has grown tremendously since the start of deregulation


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North American Regional Transmission Organizations


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Move from the Zonal To FNM – Nodal Market

• No intra-zonal constraints enforced • Internal Congestion Zones – Constraints enforced between zones

• Full Network Model (All constraints enforced) • Locational Marginal Pricing at each node

NP15

SP15

ZP26


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Why Nodal?

• Efficiency: minimization of production cost– System-wide, incentive-compatible

• Advanced locational signal for buyers and sellers to match next day needs and supplies

• Economic signal (LMP) to Gens and Demand Response while protecting load

• Congestion risk management (CRR/FTR/TCC) and transmission planning


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Locational Marginal Prices in Nodal Markets


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Outline




• Risk Management


• Conclusions


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Financial Instruments

• Virtual Trading: trade DAM vs. RTM– Virtual Supply (Financial Generator): sell DA buy

RT– Virtual Demand (Financial Load): buy DA sell RT

• Congestion Revenue Rights (aka FTR or TCC)– Buy or sell congestion between two nodes– Buy in monthly/seasonal, settle in DAM


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Virtuals as Purely Financial Instruments

• Used to capture the price difference between DAM and RTM at a location

• If the location price in DAM is expected to be greater than RTM, then an Inc at that location would be the correct tool

• If the location price in DAM is expected to be less than RTM, then a Dec at that location would be the correct tool


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Incs and Decs as Financial Instruments

Inc Payoff ($)

RT LMP ($)DA• RT2

RT1

P1

P2

Dec Payoff ($)

RT LMP ($)DA

•RT2

RT1

P1

P2


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FTR/CRR/TCC: Traffic Power


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Regular Congestion


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Extreme Congestion


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FTR Properties

• Financial settlement, no physical delivery• Can be acquired centrally or from another

participant • Can be bought or sold b/w any two pricing

locations (aka injection and withdrawal points, or source and sink) defining a path

• Can cover on-peak or off-peak• FTR payoff can be either positive or negative


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Financial Perspective

• Hedgers: offset the expected congestions• Speculators: look for most profitable paths• Look at FTRs as a stand-alone financial

instrument• Purchase Forward Contract for congestion

difference at a set price• Delivery is based upon DAM price differences


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Financial Perspective cont.

• Goal of FTR spec bids: Buy the FTR in the auction at less than the total amount of the congestion revenue which will be paid to the FTR holder throughout the auction period

• These financial instruments could be thought of as investments that get future “earnings”


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Outline




• Risk Management


• Conclusions


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FTR Holder Risks

• FTR Holder purchased an FTR with anticipation of congestion happening in one direction

• Actual system conditions can change from auction assumptions

• System conditions and DA market clearing can be different than holder’s assumptions


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VaR: Portfolio Mapping

West Portfolio

East Portfolio


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VaR and Electricity

• Market Prices have relatively short histories compared to financial indexes

• Price distribution: Fat tails, Outliers, Price Jumps in spot prices

• High Volatilities, Unstable Correlations


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Oil & Gas Impact


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Stress Testing

• Focus on potential sources of risk that– Impact the portfolio seriously– Have not occurred in the recent past

• No standard/scientific way to reliably measure risk– Scenarios tailored to the portfolio

• Stress testing looks for the worst outcome in contrast to VaR which looks at extreme movements in price distribution

• Stress testing is more effective when the portfolio has fewer sources of risk



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Outline




• Risk Management


• Conclusions


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Recent and future developments

• CA• TX (ERCOT)• SPP

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Why invest in power nodal markets?

• New less efficient markets, higher spreads• Higher barriers to entry (talent, data, analysis,

process, ISO / regulatory compliance)• Uncorrelated with equity, debt, FX, real estate• No to very low correlation with other energy

commodities such as oil or NG• Multiple independent power markets –

diversification of opportunities



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0

50

100

150

200

250

300

350

400

450

500

0

1

2

3

4

5

6

$/M

Wh

$/M

MBt

uDaily Price Comparison NG - Power

Carthage HUB_North

Correlation: 0.0516(Pearson linear correlation coefficient)


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-6

-4

-2

0

2

4

6

8

-60

-40

-20

0

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60

1/1/2010 2/1/2010 3/1/2010 4/1/2010 5/1/2010 6/1/2010 7/1/2010 8/1/2010 9/1/2010 10/1/2010 11/1/2010 12/1/2010 $/M

Wh

$

S&P 500 vs SP15 MCC - NP15 MCC

S&P 500 MCC Spread

Correlation: 0.004

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Key Points and Conclusions

• Virtual Offers/Bids– Prediction of RT price with some degree of

accuracy is a must to achieve the goal– Diversification across pricing points is a key factor– Offers financial participants risk premiums when

arbitraging DA – RT price differences


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Key Points and Conclusions

• FTR –Congestion patterns change over time– Short-term congestion is harder to predict

(month-to-month, day-to-day)– Long-term congestion may be more predictable

but does change based on new generation/transmission construction (or retirements)

– FTRs are a tool that can provide profitable opportunities for financial participants


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Questions?


Invest in Power Arie Kapulkin Active Power Investments LLC Niagara Falls, ON 19 September 2012.

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