Optimization-Based Generation Asset Allocation for Forward and Spot Markets

Abstract

One of the most important daily decisions that a Genco has to make is to allocate generation assets between the forward and spot markets. That is, how much capacity should be contracted in the forward market and how much should be kept to bid in spot market? This paper focuses on generation asset allocation between monthly forward contracts, such as bilateral contracts, futures contracts, options contracts, and daily spot markets, considering operating costs and constraints of generating units, as well as spot price risk. The problem is to find the optimal hedging position based on the known forward price and the forecasted hourly spot prices and is formulated based on the model of PJM market. The double dynamic programming method is applied to solve this optimal asset allocation problem with all the short-term operating constraints of the generating unit satisfied. Three types of forward contracts that are commonly used in practice are considered and their impact on generation asset allocation are analyzed and compared. The analytic relationship between the optimal contract quantity of a particular type and spot generation is established. Based on this relationship, the applicability and characteristics of a particular type of contract are discussed. Furthermore, with the solution to the generation asset allocation problem as a basis, the pricing strategy in the forward market is analyzed. A Nash game model is established and an iterative process is developed to determine the equilibrium pricing of futures contracts. Numerical testing shows that the method for the generation asset allocation is effective. Various factors influencing the decision of generation asset allocation and the relationship between futures contract price and spot price are tested and analyzed.