Coal Mines Risk Modelling Using Energy Spread

Abstract

The growing importance of the cost of electricity in coal mining, changes in the value chain in recent years and new commodity exchanges cause that mine operators independently or vertically integrated with power plants have possibility to buy and sell coal and electricity and create a specific spread. The study of risk based on the concept of a new indicator: an intrinsic spread. The intrinsic spread is calculated as a difference between the income from the sale of coal and the cost of purchasing the energy required for the coal production. This indicator shows a market risk in the coal mine in a better way, because except for income it includes a part of the cost of exploitation which can be hedged in the exchange market. Spread calculations were made on historical data and simulation modelling. Based on time series of coal and energy prices for various contracts and spot prices obtained from the EEX the impact of the type of contracts on the volatility of the intrinsic spread in subsequent periods measured by the standard deviation of returns has been analysed. It was found that hedge using futures helps to reduce the risk in the mine. Modelling of coal prices and electricity was carried out by conventional financial market econometric models. The best-fitting econometric models are multivariate models and models based on the copulas. The simulation results show that the use of futures contracts contributes little to reducing the intrinsic spread volatility. An econometric model with the technical and economic parameters of the mine typical for hard coal mine has been built. Changes in fixed and variable costs have been simulated based on triangular distributions. Parameters for simulation were estimated based on the economic data from the mines. Additionally, coal and energy prices were dependent on the market volatility. Based on the economic model and Monte Carlo simulation it has been found that the proposed method may be helpful in reducing the coal mine market risk.