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Are We Making Any Money Yet?

Measures of generator unit performance are uncertain.

Fortnightly Magazine - February 2006

was assessed using deterministic and stochastic market prices.

We examined a typical steam unit with a 9,800 Btu/kWh full load heat rate and average operational parameters. The combustion turbine was modeled using a 10,500 Btu/kWh heat rate. Finally, the combined-cycle unit had a full load heat rate of 7,100 Btu/kWh.

In this assessment, the unit value was examined using two approaches. In the first, we examined value in a deterministic setting in which fundamentals based fluctuations in the expected load, gas, and hydro generation were not captured. Global Energy defines the resulting net operating revenues under this setting as deterministic or intrinsic value. Under the second approach, we assessed value in a setting in which volatility is captured through a set of estimated parameters that represent the inherent uncertainty of load, gas price, and hydro generation in the Southeast region.

In this stochastic analysis, the inclusion of volatility allows one to capture the optionality value of these generating units. A unit with greater flexibility to respond to volatile fuel and fundamentals-driven market clearing prices can capture additional revenues beyond those shown in the deterministic analysis alone. This is often referred to as the plant’s real option value. The difference between this value and the deterministic value is called a stochastic or extrinsic value associated with volatility.

To calculate deterministic and stochastic value, we used our Planning & Risk model, which explicitly permits the input of spot electric price volatility and gas price volatility and seasonal correlation parameters. Historical data in the Southeast region was used to derive these parameter estimates. Two-hundred-and-fifty Monte Carlo estimates of future market outcomes were projected to estimate the plant’s real option value.

Overall, stochastic analyses capture the optionality value of a flexible resource missed by deterministic analyses. However, advanced trading schemes such as complete delta hedging are necessary to capture the full real option value indicated in our analysis. Of course, this also requires significantly greater trading liquidity for future prices than what presently exists in today’s power markets.

The asymmetric distribution of market-clearing prices produces a greater probability that prices will increase substantially under adverse circumstances than they will decrease under favorable circumstances. This is especially true in a geographic area such as the Southeast region where natural gas plays a dominant role in the power market with respect to both energy supply and reliability.

Volatility and uncertainty are permanent fixtures in every regional energy market. Understanding how some key measures of margins, profitability, and performance under uncertainty can affect asset valuation, materially can affect the performance of an asset or portfolio.



1. The formula is Market Heat Rate = Electricity Price ($/MWh) / Fuel Price ($/MMBTU) x 1,000.The multiplication by 1,000 is to correct for the net impact of converting the dimensions of the equation. In trading terms, a generator with a heat rate lower than the market heat rate is “in the money” and can profitably sell electricity.

2. The percentile prices, sometimes referred to as P10 and P90 prices, indicate an 80 percent confidence band for the price forecast. In other