Rethinking Asset Values in a Competitive Environment

Fortnightly Magazine - February 1 2000
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Power plants can bid on more than one product. That's why most spark-spread studies miss the mark.

Forward energy prices can make it look easy to place a value on a power plant. Yet something is missing. Plants can sell more than one product. One price may be up while another is down. As Einstein said, a theory should be as simple as possible, but no simpler.

That is why it is worth reexamining the methods commonly used to calculate forward price curves and estimate the expected revenues and profits of generating assets.

First, do the relevant calculations include all products that the asset's revenue will depend upon? Do they meaningfully incorporate those rare events having large price effects over an extended time horizon? These questions go to the heart of whether a method is either appropriate or adaptive to asset valuation in the future electricity market.

When the forward price curve is focused solely on energy, the assumption is made that generators would passively accept whatever price the forward energy market offers, exclusive of other markets. In practice, a generator operator will seek to maximize income by seeking profits and advantage across all available markets. In order to reveal the full earnings potential of the asset, valuation must also include the revenues that operators might earn by participating in the lucrative ancillary service and spot markets. The price risk that characterizes power markets is too considerable to suppose that market participants will not continuously compare the levels of profit potentially available in the various product markets.

Black's Model: Not Practical for Multiple Bids

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