EEW 2015 21-22 Sept. Milan
Agenda
• Energy risks
• Price Risk
• Price Risk Hedging and Hedging Strategies APM Classic
Barriers Curve Index
• Volume Risk
• Volume Risk Hedging Production Insurance
• Cannibalization Risk
• Cannibalization Risk Hedging
Energy risks
Business Risk is generally defined as the possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit.
Business risk is influenced by numerous factors, among them, energy costs. BREAKING DOWN ENERGY RELATED BUSINESS RISK
Focusing on energy risk, consumers and producers share some common risks due to: • price uncertainty
• volume uncertainty
• correlation between volumes and prices (renewable)
Starting from a current value based on current forward market prices and expected consumption/production volumes, uncertainty comes from price volatility, volumes variations and the impact that a volume variation has on market prices
Price Risk
That’s the variability of energy prices and con be simulated based on historical data and volatility
For Italian spot simulation we use an Orstein-Uhlenbeck process + Brownian motion,
For zonal simulation we add additional jump processes following a Pareto distribution
Fwd price
Price Risk
C P
Price Risk Hedging
1- Fix Price for all volumes
(then wait and hope)
2- Do Nothing
(then wait and hope)
Price Risk Hedging (2)
1- Fix Price
Betting that prices will go up, being fully exposed to a decrease in prices
2 – Do Nothing
Betting that prices will go down, being fully exposed to an increase in prices
Not managing your risk position
•
What’s the desired risk
level you can live with?
Price Risk
Price Risk Hedging Strategy - APM
Active Portfolio Management is just a box of instrument to help you MANAGE the price risk of your energy portfolio, where the portfolio is your consumption/production
Hedging strategy
Strategy A (APM classic). In agreement with your risk policy, go for different fixing at different times -
Price Risk Hedging Strategy - Barriers
Strategy B (Barriers). (based on Budget) set a desired “Stop Loss” or “Take Profit” levels – cut tails of your risk curve
BUDGET
Can be implemented with two mandates to buy volumes SL or TP levels
or through a COLLAR structure (they work in the same way only if prices settle above/below as the collar still leave the possibility for prices to bounce back)
Price Risk
C P
Price Risk Hedging Strategy - Curve
Strategy C (Curve). Look at the forward curve and define risk strategy on more than 1 year
Sell a PUT option to AXPO:
AXPO will grant a discount on 2015 and/or 2016 spot mkt prices for the You have a % of your portfolio at spot price on Cal 15
Cal 16 reaches a level in line with budget/expectations You want to have Cal 16 closed at this level or open
Price Risk Hedging Strategy - Index
Strategy D (in-Dex).
Stabilize your margins by linking your energy costs to your revenues when the spread guarantees desired returns or to your core business cost/revenues to optimize hedging activity
Example 1 – Refinery
Costs linked to Brent while Revenues linked to refined products
Risk strategy aim is to optimize crack spread (difference between refined products and Brent)
Index electricity to Crack Spread
Example 2 – Liquid Biomass producers
Costs linked to Palm oil while
Revenues linked to electricity prices
An index linked to palm oil will stabilize margins
Locked in spread
Price Risk
C P
Volume Risk
For consumers and traditional producers uncertainty in volume risk is mainly due to small or predictable changes of the plant operations. There is still some volume risk component, which can vary depending on the industry and operating modes of the production sites. For renewable producers volume risk is considerably higher, as production volumes varies sensibly according to weather conditions, strongly affecting the overall revenues. This is particularly true for wind production, while solar shows more recurrent patterns.
In order to simulate actual production and volume risk, we mainly consider a: • Stagional shape inferred from historic production
• Correlation with prices from linear regression between differences from the shape
and realized prices
• Stochastic component from maximum likelyhood estimate of the residual differences
from realized production
Volume Risk Hedging – Production insurance
Volume risk can be hedge with insurance-style product that can guarantee a minimum level of revenues (volume*price), therefore higher cash flow and revenue certainty and higher asset value.
Volume Risk
P95 P90 P85 P80 P75 P50
Guaranteed Production Insurance Limit
Can either be structured as a swap: Producers pays variable monthly amount
and receives fixed monthly amount guaranteed by AXPO
Or a put option on volumes:
Producers pays an upfront premium and receives the maximum between actual and minimum guaranteed revenues
% of p0 · V0 Nordic DE DK NL UK FR IT_ wind IT_ solar N -1% 1% -1% 0% 0% -1% -1% 0%
Cannibalization Risk
no significant biasWind Producers - Analysis on 2005-2014 data / Solar ITA 2011-2014 Effect on Revenues Correlation risk or cannibalization risk derives from the
effect that volumes might have on prices, i.e. an higher solar/wind production volume, causes lower prices therefore lower revenues for the producer.
Correlation risk is negligible for consumer, while it can have an important effect for producers.
∆p * ∆V
__ __
Price-Volume correlation
price
Cannibalization Risk Hedging
Hedging strategy
Complex risks, where best hedging strategy is defined by considering n different outcome of n different strategies, with price and volumes are simulated according to historical
correlation
• Hedging products
• m+1,+2,+3, Q+1,+2, cal, for peak and offpeak
• Hedging limits
• Quantity hedged less than monthly expected
consumption/production
• Hedging strategy can be obtained minimizing the
variance of the payoff simulating prices and production
Cannibalization Risk
The result of the model is a combination of traded products that minimizes the variance of the simulated payoffs.
Cannibalization Risk Hedging Results
Red: pnl without hedging
Black: pnl with hedging
Blue: expected production
Green: hedging strategy
Multicolors: simulated production
30 35 40 45 50 55 60 0 10 20 30 40 50 60 70 Cannibalization Risk 35 40 45 50 55 60 0 10 20 30 40 50 60 Solar Wind
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