Market Risk of a Power Generation Business

Abstract

AbstractThis chapter examines the market risk of a power generation business by interpreting that business as a portfolio consisting of long positions in fuel futures and short positions in electricity futures. This empirical analysis assumes that the company buys oil, gas, coal, and carbon credits and sells power in the European market. We check the relationship between these markets and measure market risk. The total connectedness of the returns and volatilities are 18.71 and 20.14%, respectively. While the return spillover effects among the natural gas, electric power, and carbon credit are mutually strong, the volatility spillover effects from coal to carbon credits and between coal and natural gas are strong. The return spillover effect is explained primarily by factors within five days and the volatility spillover effect depends mostly on events before 21 days. The value-at-risk (VaR) and expected shortfall are 3.87 and 4.83%, respectively. The sudden withdrawal of the electric power business has a great impact on the economy. Therefore, this should not occur. The government should establish a method for measuring the market risk of power companies and regulate their accounting allowances and capital adequacy ratios for their risk.KeywordsFuelElectricityCarbon allowanceConnectednessPortfolio risk