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How to update yesterday's IRP model to account for tomorrow's risk profile.
The process we know today as integrated resource planning (IRP) got its start back in the 1980s, when regulators first came to grips with nuclear plant cost overruns and urged utilities in effect to hedge that risk-to give equal weight to conservation, "negawatts," and demand-side management (DSM) as sources of new electric capacity.
Times Have Changed, Even If IRP Hasn't
Today's utilities face a bevy of new risks in this post-Enron, post-crash, post-blackout world. This litany of new dangers includes such risks as: (1) gas price spikes; (2) thin and illiquid trading; (3) suppliers with poor credit; (4) boom-and-bust cycles; and (5) merchant power bankruptcies. And this new set of risks demands a fresh look at traditional IRP.
In the standard IRP approach, utilities first develop a long-range load forecast. Then they evaluate their existing supply-side resources and prospects for DSM to determine uncommitted needs. Lastly, they select among competing supply- and demand-side programs that appear most viable and economic, develop alternative portfolios, and test those portfolios against selected scenarios to see which portfolio will best satisfy a set of economic, regulatory, and environmental mandates.
The tools most typically used in this traditional IRP involve forecasting, shaping, and characterization of load, plus price forecasting for power and fuels. Other tools are used to model power plant dispatch.
However, the standard IRP process was not designed to efficiently address a host of new factors, such as:
- Market volatility and the correlation of markets for power, demand, and fuels;
- Market liquidity and poor market information;
- Risks associated with poor and declining supplier credit;
- The greater number of supply options (build, buy, toll, financial and physical hedges); and
- Utilities' risk tolerance.
Integrating Resource Planning With Risk Management
Managing in today's energy environment requires the proper identification, measurement and mitigation of risks associated with the extreme volatility in fuel and power markets, as well as regulatory issues, counter-party credit risk, operational risk, and others. Risk management tools that provide executives the feedback required to mitigate market risk typically are focused on an operating horizon of one to five years. Those same tools may also play an effective role in long-term resource planning by adopting a new integrated risk perspective.
The current tools used by utilities for resource planning were developed in the 1980s, but today's industry is characterized by immense volatility. The deterministic resource modeling of the regulated era needs to be upgraded. Instead, a probabilistic framework should be deployed to identify not only the expected outcomes for rates, supply costs and earnings, but also a distribution of potential outcomes consistent with observed characteristics of any significant volatile elements. This stochastic approach will help utilities support their decision-making process more effectively to mitigate the potential for intolerable outcomes.
For short-term exposures, Value at Risk (VaR) is a valuable tool. At specified intervals, VaR can identify the risk of imminent migration of commodity prices (fleeting hedging opportunities) as a function of market volatility. Price variability can be estimated directly from market quotes, or as