A Tailored Derivative Instrument to Mitigate the Price-and-Quantity Risk Faced by Wind Power Companies

Abstract

The intermittent nature of wind generation combined with the well-known volatility of electricity spot prices expose Wind Power Companies (WPCs) committed to long-term forward contracts to the so-called price-and-quantity risk. Several instruments were designed in the past years to mitigate this risk exposure. However, most of them were mainly constructed to cope with only one of its parts, i.e., price or generation uncertainty. To tackle this issue, in this work, we propose a tailored derivative instrument for WPCs leveraging the principles of options and renewable indexes. The effectiveness and attractiveness of the proposed instrument, referred to as the Wind-Indexed Option (WInd-Op), are evaluated with real data from the Brazilian sector through an equilibrium setup. We show that Solar Power Companies (SPCs) can be relevant candidates to back these derivatives. Additionally, when compared to the traditional put-and-call options as a benchmark, results indicate that the equilibrium obtained with the new derivative exhibits a significantly higher traded volume (2.9 times greater), lower premium prices (54.7% lower), and greater welfare gain (2.7 greater).