How to price new load-servicing contracts while incorporating market-risk analysis into such deals.
Why have basic generation service auctions historically been overly competitive given the prevailing market prices at the time? The answer requires an exploration of the concept of "charging" for market risk and then incorporating the existing risk profile of the bidding organization. EnergyCo – a hypothetical yet typical 5,000-MW vertically integrated energy company with a relatively balanced portfolio of generation, customer load, and wholesale trades – will help illustrate these points, showing how an organization can price a new load-servicing contract in isolation and then in conjunction with its existing portfolio.
Generation and customer demand have complicated dynamics. They are not easily understood because they are subject to a number of simultaneous uncertainties. The market-price uncertainty related to power and fuel prices create a spread-option portfolio that could be managed using financial derivative theory. However, generation plants also are subject to a range of operational factors (e.g., start-up and shut-down costs, ramp rates, forced outages, environmental constraints, etc.) that have a material impact on the plant's performance. Customer demand has a significant level of volumetric uncertainty as well. Much of it can be explained by the region's weather conditions.