Finding and applying the efficient frontier.
James Letzelter is a partner at Webb, Scott & Quinn Inc. Contact him at Jim_Letzelter@wsqi.com.
Electric power industry participants spend a great deal of time deciding how to invest in power generation assets. Typically, though, their process focuses exclusively on the potential financial impacts of acquiring an individual asset—not on the impacts to the generation portfolio as a whole. The result can be an unbalanced, undiversified portfolio of power assets that is inconsistent with the organization's desired risk profile. Worse yet, the organization may not understand the relationship between the expected return of an asset portfolio and the risk it faces. Implementing an efficient frontier approach to portfolio assessment can solve this problem and set the foundation for a successful power generation asset base.
With the evolution of power markets toward deregulated wholesale markets, there has been a fundamental shift in power-plant asset ownership. Accordingly, non-traditional power-plant owners have emerged in the form of investment banks, private equity funds, and energy hedge funds. As a result, power generation assets are more widely distributed among a larger field of owners. Wall Street's entry into the power business has created a flurry of transactional activity.