Electricity Trading and Hedging

ExecutiveSummary

Preface

Introduction

What is price volatility?

The fundamentals of electricity: drivers of electricity demand

The fundamentals of electricity: supply and generation capacity

Joining demand and supply: the dispatch process underderegulation

What is risk management in electricity markets?

How Electricity Markets Work

Failure of futures markets to dominate

Varied menu of traded assets

Transmission services and traded power

The menu of electricity transactions

Discos and RFPs for standard offer service

The new long-term contract

Medium and short-term contracts

The instruments of electricity hedging: forwards, futures,options, weather derivatives and insurance

Futures

Exchange-traded versus OTC options markets

Over-the-counter and through the Web

Weather derivatives

Insurance

Blended instruments

Volatility issues

The results: the hours of terror, weeks of boredom

The gas crack

The markets for capacity and ancillary services

Arbitrage

Conclusion

Market Analysis

Inputs to electricity price analysis

Demand for electricity

Weather forecasting

Capacity analysis: outages, additions and constraints ongeneration and transmission

Input fuel

Oil

Natural gas

Integrating the inputs: the dispatch process

Electricity market depth, liquidity, herding behaviour and pricevolatility

The heat event of June 7-8, 1999

Herding behaviour

Are margins mean-reverting?

Hedging and Trading in Electricity Markets

Hedging instruments

Purposes of hedging electricity

Volatility reduction

Hedge gain maximisation and other extensions of risk management

Hedgemasters and portfolios

Types of hedging and trading programmes

Trading examples

Forward market strategies

Pure options strategies

Selling options

Options combinations

Hedging by condition: backwardised and contango markets

Self-insurance with finite risk instruments

Weather derivatives

Conclusions

Winners and losers

Energy consumers

Conclusions: Transition, Adaptation, Concentration

First conclusion: second decision must be better than the first

Second conclusion: cannot avoid power trading

Third conclusion: develop new energy products

And in the end 114

Notes