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
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