How to set reserve levels for full requirements auctions.
Andy Dunn is a partner at Risk Capital Inc., in charge of the firm’s solutions practice. He offers simulation-based risk measurement and valuation software to vertically integrated utilities and other energy merchants.
Last month, Risk Capital's Tom Brady identified numerous risk factors that should be considered when pricing load-following contracts. These risks included various temperature, load, and price risks that create enormous uncertainty around the cost to serve such commitments. This month, we present a method for estimating reserves for load and price risk using sophisticated modeling techniques. In addition, because all models have flaws, we present one approach for accounting for this model risk in the bid price.
The analysis presented uses historic examples from 2003 market price and load levels in the PJM region to demonstrate how bid prices can incorporate market price and model risk. We use the PSEG load market in 2003 as a basis for our discussion.
Our initial example centers on estimating a bid price for a typical full-requirements contract. These contracts have a variable amount of demand. This deal has a historical load maximum of approximately 300 MW. A load servicer will enter a bid price that the customers will pay for the energy. The load servicer then must supply this energy at the prevailing spot price (assuming it does not have any other sources of owned generation or contractual supply). This contract is defined as serving the period from February 2003 through September 2003.