Abstract
Holders of energy swing options are free to specify the amounts of energy to be delivered on short notice, paying a fixed price per unit delivered. Due to the complexity of potential demand patterns, risk elimination by replication of these contracts at energy exchange markets is not possible. As a consequence, when selling delivery contracts, the energy producer has to explicitly consider the risk emanating from fluctuations in supply cost. The impact of these risk factors can be mitigated by the contract seller, who is an energy producer, to a certain extent: Supply cost fluctuations can be absorbed by the own generation portfolio whereas demand uncertainties can be influenced by the choice of the strike price, implicitly changing the buyer’s behavior. Considering this, the determination of the optimal strike price can be formulated as a stochastic bilevel problem where the optimal decision of upper level player (price setting and production) depends on the optimal decision of a lower level player (demand depending on the price). We present a solution algorithm tailored to the resulting specific stochastic bilevel problem. We illustrate the effects of the behavioral pricing approach by studying behavioral price setting for natural gas swing options, highlighting in particular the influence of the seller’s production and contract portfolio as well as of the market liquidity on optimal exercise prices.
Highlights
1.1 Energy portfolios from a financial point of viewIn this paper, energy derivatives and energy portfolios are studied
We assume a financial point of view: objectives will be formulated, and all risks will be measured in terms of money
Energy derivatives are contracts specifying the physical delivery of energy and/or cash transactions which depend on energy prices
Summary
Energy derivatives and energy portfolios are studied. We assume a financial point of view: objectives will be formulated, and all risks will be measured in terms of money. Energy derivatives are contracts specifying the physical delivery of energy and/or cash transactions which depend on energy prices. Real time or balancing markets are ignored for the sake of simplicity Under this assumption, all physical energy flows from the portfolio (generation, consumption, transportation etc.) can be offset by trading on spot markets. Since all assets can be analyzed by the (net) cash flow generated by quantifying energy flows at spot market prices, we will refer to all elements of an energy portfolio, including assets, as energy derivatives (or as a synonym, contracts). The financial point of view allows us to neglect the difference between “physical” and “financial” energy, there is still one distinction to be made: rigid contracts deliver a pre-specified amount of energy, with the most prominent example being futures contracts (or swaps). Examples for flexible contracts are all types of options, in particular swing options on which we will put our focus in the rest of the paper
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