Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

Are We Making Any Money Yet?

Measures of generator unit performance are uncertain.

Fortnightly Magazine - February 2006

If prices are perceived to increase sharply under abnormal conditions ( e.g., higher expected load), a premium may be built into the forward price to reflect this. Finally, differences in perceived weather conditions will result in different projections. Both the fundamentals-based forecast and all forward markets are “forecast” or projected using potentially differing input assumptions.

While we know that traders prefer futures as a benchmark for deals, we believe that fundamentals-based forecasts provide a quantifiable basis for determining the resources likely to be on the margin and hence a reasonable indication of future spot-market prices. Where differences are identified between the fundamental forecast and forward markets, market participants would best be served by understanding the basis for both forecasts.

Putting the Uncertainty in Context

Figure 3 compares historic with our forecasted wholesale on-peak prices through 2008.

Power prices have remained fairly volatile due to high natural-gas price volatility. We are witnessing the longest period of high gas prices in recent history, far surpassing the temporary spikes observed during most of the 1990s and early parts of this decade. Power prices are forecast to fall in the near term as a result of falling natural gas prices in combination with high reserve margins across the Southeast.

Figure 4 compares the forecast with actual on-peak market heat rates. As the Southeast markets gradually grow out the historic overbuild, we expect market areas within the region to witness some heat-rate recovery in 2006 and beyond. By 2008, summer on-peak market heat rates will approach 12,000 BTU/kWh. Thereafter, market heat rates in the Southeast will continue to rise, signaling gradual market recovery.

Assessing Volatility Using Stochastic Analysis

Volatility, due to many factors, has the potential of moving a market like the Southeast into the higher-cost portion of the supply curve where scarcity premiums can come into play. Participants in power markets in the Southeast need to be aware of these possibilities and have contingency plans for dealing with them.

The traditional ways of evaluating power generation assets can be seen to have the following shortcomings:

  • Many deterministic models do not capture the value associated with the inherent flexibility of assets to respond to future changes in market conditions. As such, they may understate asset value, particularly for those that are mid-merit or peaking.
  • Many “real-option” financial models do not capture the complex operational constraints associated with actual plant operations. As such, they may overstate the asset value.
  • Many models do not directly capture the changing relationship between fuel and power prices over time, which is the key to asset valuation. As such, they may under or overstate the asset value.

Starting with a consistent price forecast, developing the stochastic parameters and then running the alternative simulated price paths through a full dispatch model often is the most appropriate methodology for generation asset valuation under conditions of uncertainty or volatility.

Generally, the term “stochastic” is used to indicate that a particular subject is seen from a point of view of randomness, as part of a probability theory that can predict how likely a particular outcome is.