Realizing Maximum Value from Generation

This 2-day course provides a more sophisticated view of the optionality embedded in cycling generation with an emphasis on methods for extracting profitability from this extrinsic value.

Day 1

Core Concepts in Energy Risk Management

Embedded Optionality in Generation

• Extrinsic value in power generation

• Realizing earnings from owned optionality

• The trading approach to extracting value from options

Synthetic Transport Using a Swap

• Using a basis trade to fixed transport cost

• Basis swap vs. basis spread

• Buying and selling basis

Risk Identification

·
Directional price risk

·
Differentiating physical vs. price risks

Energy Options

·
Broad concept of optionality for energy

·
“Real” options

·
Hedging energy risk with puts and calls

·
Reverse engineering to unbundled embedded options

·
Synthetic puts and calls

·
Put-call parity implications to option valuation

·
The profile of time value

Group Review

Heat Rate & Spark Spread Structuring

Heat Rates & Spark Spreads

·
Trading natural gas against electricity

·
Conversion factors for thermal efficiency

·
Understanding heat rates and thermal efficiency

·
Spark spreads and the effect of heat rates

·
Structuring and pricing spark spread swaps

·
Structuring heat rate swaps

·
Dark spreads

·
Calculating required tonnage

·
Swaps as synthetic generators

Trading and Structuring Spark Spreads Transactions

· Hedging generators’ spark spread margins with a swap

· Pricing spark spread and heat rate swaps

· Heat rate implications on spark spread pricing

Optionality on Basis

• Pipeline capacity ownership as option on basis

• Rainbow options on basis

• Swing swap options on basis

Heat Rate Swaps & Tolling

·
Direct and reverse tolling

·
Synthetic generation

·
Synthetic tolling – heat rate swaps

·
Quoting and pricing tolls and heat rate swaps

Market Implied Heat Rates

·
The decision to generate or shut down

·
Evaluating the economics of tolling alternatives

·
Market heat rtes for coal generation

Optionality Embedded in Generation

Optionality in Generation

·
Real options

·
Generating capacity as a long spark spread position

·
Generating capacity as optionality

·
Identifying the option embedded in generation

Using Market vs. Historic Pricing in Deciding to Generate or
Shut Down

·
Optionality on the spark spread vs optionality on
power natural gas

·
Cases of illiquidity

·
Lack of price transparency

How a Generator’s Cost of Cycling Changes the Breakeven Spark
Spread

·
Spreading rampup/ramp down costs to determine cost per
MWh

·
Add the cost of cycling in determining breakeven
spread for ramping up

·
Subtract the cost of cycling in determining breakeven spread
for ramping down

·
Option strike price gradient from cycling costs

Multiple Levels of Generating Optionality

·
Levels of optionality in generation

·
Owning call options when spreads widen

·
Call option conversion to put option when exercised

·
Put option conversion to call option when exercised

·
Optimizing value by stacking option exercises

Valuing Generation Optionality

·
Approaches to option valuation

·
Closed-form calculation of spark spread volatility

·
Calculating spark spread volatility for varying heat
rates

·
The impact of correlation on the value of generation
optionality

**Group Review**

Day 2

Monetizing Optionality in Generation I

Methods of Value Extraction for Generators

·
Unbundling co-mingled price and volatility risks

·
In-the-money payout

·
Structuring to earn an out-of-the-money payout

·
Sell embedded optionality

·
Load serving/full service supply contracts

·
Volatility trading

·
Dynamic hedging of embedded options

Delta Hedging

·
Isolating volatility risk from directional price risk

·
Calculating the delta value

·
Delta as a hedge ratio

·
Delta as a statistical measure of the likelihood of
option exercise

·
Positive vs. negative delta values

Cost of Adjusting Delta

·
Dynamic hedging

·
Need to adjust the hedge

·
Cost of each hedge adjustment

·
Variability of hedge adjustment costs

·
Constraints on delta hedging in the energy markets

Gamma

·
Measuring the cost of delta hedge adjustments

·
Calculating gamma

·
Interpreting gamma

·
Positive vs. negative gamma

·
The profile of gamma and relationship to time value

·
Theta as the offset to gamma

Portfolio Aggregation
Option Risk

· Portfolio aggregation of Delta

· Need to segregate position into “time buckets”

· Interpreting portfolio delta

· Managing aggregated portfolio gamma positions

· Need for stress testing

Monetizing Optionality in Generation II

Trading Around Generation Options

·
Separating co-mingled volatility and price risks

·
Optimizing value with trading strategies

·
Converting generator’s call options to puts when spreads
narrow

Crystallizing Value from Generating Options

·
Selling puts on the spark spread

·
Selling calls on the spark spread

·
Selling heat rate options

·
The effective heat rate of a generator including non-fuel
expenses

·
Selling out-of-the-money generation options

·
Revenue stabilization and enhancement strategies for
generators

·
Dispatch options

Dynamic Hedging of Generation

·
Delta hedging a spread

·
Re-balancing a spark spread hedge

·
Delta hedging generation option as a call vs. a put

·
Delta hedge of generation by re-balancing power only

·
Gamma profile and generator heat rates

·
Portfolio aggregation of generating option risks

Monetizing Generation Optionality through Load Serving Contracts

·
Volumetric swing and the ‘ruthless exerciser’

·
Value of risk (short optionality) taken on by power seller
in volume swing

·
Lower risk to power seller owning generation

·
Reduction due to embedded ‘knock-out’ provisions and lower
volatility

·
Optionality value-added from ownership of generation

Risk of Load Serving without Ruthless Exercise

·
“Ruthless Exercise”

·
Generator’s short ‘Straddle’ option position

·
Load determined by operating needs, not market price

·
Correlation of customer load with power and fuel prices

·
‘Knock-out’ provisions

·
Valuing knock-out ‘straddle’ option risk

·
Calculate the fair value fee charged to load serving
customer

·
Valuing the optionality monetized by generator through
load serving

**
Group Review**

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