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

Group Review
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

Group Review

·        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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