Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005...

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Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets

Transcript of Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005...

Page 1: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

Measuring and managing risks on deregulated electricity markets

EIPM – Archamps, sept. 23, 2005

Pierre Buffière de Lair

Area Manager on European Markets

Page 2: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Organization of our presentationPresentation of various OTC products

• Standard Products• Options• Indexed Products• Swaps

Using these products for optimal portfolio management

Page 3: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Standard Products (POWERNEXT)

Bal

an

cin

gS

po

tF

utu

res

½ h

1 h

Day

Week

1 Month

3 Months

Year

- Basis - - Peak -

OT

C

PN

XT

PN

XT

RT

E

1 h

Day

Week

1 Month

3 Months

Year

Page 4: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Standard products on French OTC marketsThe French Over-The-Counter market is offering products with various deliveries, „base“ and „peak“ (08.00-20.00)

Short-term markets

• Daily intraday market : hours and hourls „blocks“• Whole days + 3 days • Week-ends + 1 week-end• Weeks + 2 to 3 weeks

Futures markets

• Months + 2 to 3 months• Quarters + 2 quarters• Years + 2 years• Occasionally, „industrial year“, as of November 1st.

Page 5: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Standard products on the French OTC market

With respect to spot markets, short-term products are traded continuously on OTC markets.

• There are arbitrage possibilities between OTC‘s traded in the morning and the clearing of the spot markets

Payment after delivery, no margin calls important credit risk.

Utilization by market actors :

• Short-term : breakeven of energy balance• Long-term : price risk management

Distribution Hedging profit margins in commercial contracts

Producer Hedging a cash flow with respect to production cost

Consumer Hedging supply prices

Speculator Betting on the evolution of product price

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What are the determinants of forward prices?Forward prices should at all times forecast the average level of the spot over the delivery period.

• Arbitrage possibilities

There is very little information available on the physical situation at the time of future delivery.

Thus, one might forecast in terms of:

• Macro-economic situationPrices of fossil fuels (marginal costs)

Growth (GNP, consumption)

• Legal frameworkProduction facilities

Liberalization

Market structure

• Production technologies

Unexpected situations on spot markets are the main elements that can change forward prices.

Page 7: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Are futures markets able to predict spot prices?

En 2003: no! Unusual conditions (hot summer, et conversely very mild winter)

Since april 04: significant improvement, since conditions were stable and

„normal“

Since feb. 05 : Important volatility, combined with unexpected climatic events

Forward = average value of negociation of one monthe

before maturity.

Spot = average value of all separate days

Page 8: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Development of forward prices

Increasing by 30 % since the beginning of 2003

„Bulky“ product but time-volatile. Determinants of quotations are varying in

time accoring to expectations of market participnts

Page 9: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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OptionsOption buyers receive the right to either buy or sell electricity at a fixed price defined beforehand, whatever the price of power at the time of delivery.

Importants elements • Various options

Call (Right to buy)Put (Right to sell)European, American, Exotic

• Various time horizons • Option on a standard product - Baseload or annual peak (to hedge against medium-

term volatility)Hourly Option (can be valued on short-term market)

This is an insurance against adverse price variations, with a premium which is a function of:

Price of underlying Exercise (or strike) priceTime and rules for delivery Type of optionVolatility of underlying (in %)Intérest rates

The premium is payable upon conclusion of the contract. If the option is exercised, energy is payable at delivery.

Page 10: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Payment scheme for buying « Plain Vanilla » options

Price of underlyingin €/MWh

Val

eur

de l’

optio

n en

€/M

W

Call Option

Put Option

Exercise or strike price

Optionpremium

Option premium

Page 11: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Special options

VPP

• Right of drawing on a contract with a pre-defined marginal cost• Payment of a premium

Swings

• Right of drawing on a contract during a certain number of hours at a pre-defined marginal cost

• With or without premium• Example : «  Pumping -Turbining Swing  (without marginal cost)»

The buyer has the right to ask for 25 MW during 500 hours between january 1, 2005 and december 31, 2005 and will supply 25 MW during 2000 hours over the same period of time

Page 12: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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EDF’s VPPs : An example of a daily option

VPPs are daily options with a previously known strike : • VPP « Base » : 8 €/MWh, VPP « Peak » : 33 €/MWh

The profitability of a VPP depends upon the price which is reached in the daily auction ( speculation).

In order to maximize the value of a VPP, one has to manage it with respect to the spot market, not with respect to the load.

• A VPP constitutes a good physical hedging if there is a strong correlation between the load and the spot price

• The strike is quite low, so that the option will almost always be exercized the product is very close to a forward.

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SWAPS

Principle : exchanging (or swapping) some price structure against another one.

The SWAP is the financial part of the transaction. It can either be linked, or not be linked with physical delivery of energy.

Some examples

• Cross Commodity SWAPIndexation of the price of electricity on the price of another commodity

• Fix-for-floating SWAPExchange between a spot indexation and a fixed price

• Geographical SWAPExchange of energy in some price area against another price area

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Principles for evaluation of SWAPS

SWAPS are priced by premiums, whose values depend upon:

• The correlation between prices of the two underlying products• The prices of underlying products at the time of transaction, as well

as their futures prices

Evaluation methods:

• Historical prices • Black-Scholes• Monte-Carlo simulations

Page 15: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

Portfolio optimization with OTC products

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Structured products are combinations of various toolsValorization of flexibility

• Selling of daily options by a consumer/distributor, valued by supplier on the spot market or on the « balancing market »

• Type of flexibilitySelf-producer

Flexibility in production process or customers portfolio

Commodity/interest rate indexed products

• Commodity related to the client’s income• Possibility to link energy costs to income and to reduce variations of

margins.

Weather Derivatives

• Weather derivatives (small market)• Possibility to insure against climatic hazards with some impact on

turnover

Page 17: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

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Using forwards for optimization of supplies: example

Base load (OTC)

Base load (PNXT)

Peak load (PNXT)

Peak load (OTC)

Total needs

Power [MW]

0 - 24 hours

Individualhours (PNXT)

Cannotbe planified

Can be planified in the short term

Can be planified in themedium/long term

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Portfolio management – Stuctured Puchasing

Possibilities for optimization d’optimisation• Timing of buying • Calendar of buying• Choice of the most liquid products • Dynamic management of positions• Short-term optimization on spot markets• Cross-management with other balancing areas

Contract structure• Contract for balancing services or «hosting in third-party area»• Distinct contracts for access to the network• Framework contracts with OTC counterparties• Participation contracts with Powernext Spot and Futures or « contracts for

access to the market » with third party

Requirements with respect to internal structure• Definition of a long-term strategy (price limits)• Ongoing activity on electricity markets• Information systems for portfolio management• Forecasting and floow-up of load

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Possibility to (voluntarily) reduce consumption is valorized on markets

Liberalization of markets led to a significant decrease in capacities to voluntarily interrupt one’s supplies (EDF’s EJP tariffs and other similar schemes).

Electricity suppliers with access to the market can optimize flexibility by trading on spot and intraday markets, thereby significantly decreasing costs of purchasing.

The value of the possibility to voluntarily interrupt one’s supply is a function of the flexibility of the production unit, in particulier of its

capacity to interrupt supplies :

• At a given time• For several ongoing hours• And as fast in time (real time) as possible

Electricity suppliers thus can make their clients participte in such a value creation, thus decreasing costs of purchasing.

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Valorization of flexibility –« Interruptible contract »Possibilities for optimization

• Timing of purchases• Choice of the most liquid products • Optimization of spot market flexibility and/or on an adjustement

mechanism

Contract structure• Contract for balancing area responsibility or for «balancing area

hosting»• Separate contracts for access to network• Framework contracts with OTC counterparties

Requirements pertaining to internal structure• Elaboration of a medium-term strategy• Ongoing activity on power markets• Mastering of production processes or self-production in order to be

able to sell flexibility

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In order to minimize profit margin risks - «indexed contract»

Possibilities for optimization• Timing of purchases subject to evolution of power and commodity

markets• Choice of the most liquid products

Contract structure• Contract for balancing area responsibility or for « balancing area

hosting»• Separate contracts for access to network• Framework contracts with OTC counterparts (EFET)

Requirements pertaining to internal structure• Elaboration of a medium-term strategy (price limits)• In-depth experience of power markets and of turnover-related

commodity markets• Ability to forecast load curve

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Conclusions

There is a very large number of possibilities for combining products.

The more specific the product is, the less liquid it will be, and the less competitive and transparent its market prices will be.

Every product has its peculiar characteristics, so that it requires highly skilled pricing staff.

The Risk Manager’s advice :

Never work with products that you do not understand, or with risks that you do not know how to manage or cover.

Use expert services !

Page 23: Measuring and managing risks on deregulated electricity markets EIPM – Archamps, sept. 23, 2005 Pierre Buffière de Lair Area Manager on European Markets.

Thanks for your attention !