Financial optimization in the Turkish electricity market: Markowitz's mean-variance approach

Abstract

Electricity constitutes the input into many products that produced by industry and used by people. Hence, it can be considered as a product or service that has vital importance in human life and economy. Since it has such special properties of instantaneous production and consumption obligation and unfeasible storage, electricity market is not like other markets. In a competitive electricity market, generation company faces price risks and delivery risks. So that risk management is an important part of a generation company and can deeply effect companies’ profitability. This paper focuses on electricity generation asset allocation between bilateral contracts, such as forward contracts, and daily spot market, considering constraints of generating units and spot price risks. The problem is to find the optimal portfolio based on known electricity generation total costs, bilateral contract prices, it employed Turkish historical balanced market hourly system marginal and day-ahead hourly market prices between of 2006 and 2011. There are limited studies about portfolio optimization in electricity markets in literature and this paper should be considered frontier study taking spot market's hourly prices separately as risky assets. Markowitz mean-variance optimization which is claimed to be the beginning of modern portfolio theory in financial sector is used to demonstrate this approach. Mean-variance optimization has been successfully applied to all cases that modeled for electricity market. Some suggestions for future work are also listed in this paper.