Financial engineering in the power sector
Historical data about power prices do not provide an adequate basis to implement risk-minimizing strategies. Rather, engineering economic modeling should be used to assess volatility and correlation of electricity prices, which exhibit some surprising and unique characteristics. Many players in the electric power industry face risks from unexpectedly high and/or low wholesale electricity prices. The mechanisms for managing these risks are familiar from other industries which have long been deregulated. These include some well known tools, such as futures prices and options, and less familiar approaches, including forward price curves, cross commodity hedges and portfolio valuation. These mechanisms all require information about the volatility of power prices and correlations between prices in different markets. Risk management experts with experience in financial instruments and traded commodities would expect to use historical price information to estimate volatilities and correlations. Unfortunately, as the power industry makes its transition toward full deregulation, there will be an interval in which historical price information will be inadequate. During this period, engineering economic models can be used to supplement historical assessments of prices and volatility. These models have been used more widely in the power sector, for both short and long term commodity price assessments, than in any other industry. The authors` conclusion reflect some of the relatively unique features of electricity markets, including the general lack of available energy storage, and - surprisingly, to those familiar with the high capital cost of coal-fired and nuclear plants - low capital intensity. The capital cost share of total electricity costs is low now that gas-fired plants dominate capacity expansion.
- OSTI ID:
- 443483
- Journal Information:
- Electricity Journal, Journal Name: Electricity Journal Journal Issue: 1 Vol. 10; ISSN ELEJE4; ISSN 1040-6190
- Country of Publication:
- United States
- Language:
- English
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