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Resource Planning After the Crash

How to update yesterday's IRP model to account for tomorrow's risk profile.
Fortnightly Magazine - September 15 2003
  • are either bankrupt or their credit is close to junk bond status. Long-term contracting without owned generation is now considered risky and must be carefully managed;
  • The number of available hedging instruments has increased dramatically:
    • Physical hedges include the acquisition of a merchant plant to cover the POLR swing and market price hikes and credit issues or tolls to manage the fuel risk more directly; and
    • Financial hedges include annual, seasonal, or daily options, insurance to cover plant outage risk, etc.
  • Utilities are concerned about risk, but they may not have an accurate measure of earnings, revenues, costs, or rates at risk. Most utilities that do measure risk, measure only trading risk, and then only for short periods of time and not on an enterprisewide basis. For longer term decision-making, some utilities have no established risk measure at all.

Appendix: The Process

The RIRP TM approach begins with a review of company objectives and perspective on the company's tolerance for risk. All utilities focus on managing costs and rates, while most IOU's also focus on maximizing shareholder value through earnings and dividends. With policy-level objectives as a backdrop, the RIRP™ program consists of the following steps:

  • Define market risk exposures;
  • Reach consensus regarding objectives and risk tolerance;
  • Contrast risk exposures with tolerance and objectives;
  • Screen viable resource options;
  • Conduct simulation of market prices and volatilities to assess a distribution of future states;
  • Evaluate performance against objectives and tolerance for each plan alternative;
  • Address credit risk issues; and
  • Rank plan alternatives by key metrics.

The first steps in this process deviate from the traditional IRP approach. The process begins with an assessment of risk exposures and building a consensus perspective among the management participants of that risk. It is important to fully articulate the utility's circumstances and objectives. This serves three purposes:

  • It offers a framework to view risk from a clear and manageable perspective;
  • It formalizes those corporate, operational, and philosophical views that help formulate a targeted risk approach; and
  • The process fosters better convergence among all management participants in the articulation of directional objectives.

With a better understanding of the corporate objectives and business philosophy, the next step is to analyze the utility's risk exposure. For each energy-related risk element, we quantify market price volatility within statistical confidence bands. Most of the risk effects can be quantified from the understandings derived from the initial consensus-building combined with selected quantitative data, such as a forecast of natural gas consumption, forecast of electric generation and load requirements, correlation between fuels, water flow and electric generation/consumption, fuel and power commitments, rate pass-through mechanisms, and hedged positions.

The current risk profile presents the utility's commodity risk profile in terms of VaR, with an appropriate focus on the potential financial impact of commodity price movements to the utility and its customers. For purposes of evaluating plan alternatives, this measure could be extended to look at the VaR of the overall portfolio over an extended period so that longer-term decisions may be analyzed.

The risk profile considers both open-position risk as well as fixed-position risk. Open position