linz – kickoff workshop september 8-12, 2008. 1 · linz – kickoff workshop september 8-12,...
TRANSCRIPT
Linz – Kickoff workshop September 8-12, 2008. 2
Power and Gas Markets
Challenges for Pricing and Managing Derivatives
Peter Leoni, Electrabel
Linz – Kickoff workshop September 8-12, 2008. 3
OutlinePower Markets:
•Spot Market
•Forward Market
Gas Markets
Derivatives
•Plain Vanilla Products
•Exotic Products
Conclusions
Linz – Kickoff workshop September 8-12, 2008. 5
Power MarketElectricity is unique:
• cannot be stored (flow commodity)
•No flavours
•Transport is limited
•Production = Consumption (auction)
Trading Power is relatively new
2 Different Markets
•Spot Market
•Forward Market
Power Markets – Spot Market
Day-ahead auction per market (~country)
•Power supply:– Nuclear Power plants
– Gas-fired power plants
– Coal-fired power plants
– Hydro-power plants
– Transport Capacity (import)
– …
Linz – Kickoff workshop September 8-12, 2008. 6
Power Markets – Spot Market
Day-ahead auction per market (~country)
•Power demand:– Transport Capacity (export)
– Industrials
– Home users
– …
Linz – Kickoff workshop September 8-12, 2008. 7
Power Markets – Spot Market
Day-ahead auction per market (~country)
•Auction for each hour of the next day
•Price = (Supply meets demand)
•Price is set by marginal cost
•Price reflects the consumption pattern
Linz – Kickoff workshop September 8-12, 2008. 8
Power Markets – Spot Market
CASE STUDY: NORDIC MARKET
•Considered as Very liquid
•Hydro-driven (closest to storability)
Linz – Kickoff workshop September 8-12, 2008. 9
Power Markets – Spot MarketDay-ahead auction per market (~country)
(example: Nordic System Price Pattern)Linz – Kickoff workshop September 8-12, 2008. 10
0 10 20 300.8
1
1.2
1.4WINTERWEEKDAY
0 10 20 300.9
1
1.1
1.2WINTERWEEKENDDAY
0 10 20 300.8
0.9
1
1.1
1.2SUMMERWEEKDAY
0 10 20 30
0.8
1
1.2
1.4SUMMERWEEKENDDAY
Power Markets – Spot MarketIntraday Price Pattern
•Very weather-dependent
•Depends on type of day (weekday/Saturday/Sunday/Holiday)
•Depends on Month
•Very volatile with respect to the ‘average’ profile
•Unpredictable
Linz – Kickoff workshop September 8-12, 2008. 11
Power Markets – Spot MarketTime Series of the Spot Price (Nordic)
Linz – Kickoff workshop September 8-12, 2008. 12
Daily Price Curve
Power Markets – Spot Market
Features:
•Very FAT tails
•Prices expected to be – Higher in the winter / Lower in the summer
– Higher during the Week / Lower during the weekend
– Higher During PeakHours / Lower during offpeak (night)
•Mean-reversion(?)
Linz – Kickoff workshop September 8-12, 2008. 13
Power Markets – Spot Market
Linz – Kickoff workshop September 8-12, 2008. 14
-1 -0.5 0 0.5 10
50
100
150
200
250
300
350
400
-4 -2 0 2 4-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Standard Normal Quantiles
Qua
ntile
s of
Pow
er R
etur
ns
QQ Plot of Power Returns versus Standard Normal
-0.1 -0.05 0 0.05 0.1-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
SX5E Returns Quantiles
Pow
er R
etur
ns Q
uant
iles
Power Markets – Spot Market
0 1 2 3 4
x 104
0
20
40
60
80
100
120HYDRO SYSTEM
0 1 2 3 4 5 6 7
x 104
0
500
1000
1500
2000
2500NO HYDRO SYSTEM
Linz – Kickoff workshop September 8-12, 2008. 15
SPIKESFAT TAILS Hourly Price Curve
The need to manage Risk on the Spot Market
led to
the development of the Forward Market
Power Markets
Linz – Kickoff workshop September 8-12, 2008. 16
Power Markets – Forward Market
Forward Contracts F(t, T1, T2):
•Price at time t for the commodity to be delivered (in a constant ‘volume’ during the entire period [T1;T2]
• [T1;T2] = delivery period
•Payment done during the delivery period, usually settled on a monthly basis (swap)
•Price is fixed and constant during delivery
•Forward price is an estimate of the AVERAGE realised Spot price during delivery period.
Linz – Kickoff workshop September 8-12, 2008. 17
Power Markets – Forward MarketDelivery period is bucketed into
•Days – Weeks on the short-end of the curve
•Months / Quarters
•Years
Cascading Mechanism:
•1 Year 4 Quarters
•1 Q 3 Months
•1M 4 Weeks
•1W WEEKEND + DAYS
Linz – Kickoff workshop September 8-12, 2008. 18
Power Markets – Forward Market
Linz – Kickoff workshop September 8-12, 2008. 19
0 0.5 1 1.5 2 2.5 3 3.5 4 4.554
56
58
60
62
64
66
68
70
72
74
Forward Curve
Power Markets – Forward MarketSeasonality is very obvious in the Forwards
Forward Market Organised in
•Exchange (Futures)
•Brokered OTC Market (very liquid and transparant)
Linz – Kickoff workshop September 8-12, 2008. 20
Power Markets – Forward MarketSome numbers on the Nordic Market:
•First liberalised Market in Europe
•About 150 players in the Forward Market
•About 15 (active) players in the Vol market
•About 3-5 option trades per day
Linz – Kickoff workshop September 8-12, 2008. 21
Gas Markets
Gas is storable to some extent
•Pipelines
•Day-storages
No Hourly market
No spike-behaviour
Still seasonal, still very fat tails, very physical as wellLinz – Kickoff workshop September 8-12, 2008. 23
Derivatives: Plain Vanilla Products
Option Expires before delivery period starts
Power:
•Options on Futures (Exchange)
•Swaptions: Options on the ‘Forward’ (OTC)
• ‘Liquid’ Markets: Nordpool, Germany
Gas:
•Options on Summer/Winter Forwards
•Strip of Options on Summer/Winter (most liquid)
Linz – Kickoff workshop September 8-12, 2008. 25
Derivatives: Plain Vanilla Products
Study (Koekebakker and Ollmar, 2005):
•Multifactor (geometric Brownian) forward dynamics
•2 factors explain 75% of volatility of the forward curve
•10 factors capture 95%
•Low correlation between short-end and long-end
Linz – Kickoff workshop September 8-12, 2008. 26
Derivatives: Plain Vanilla Products
Typically only a few expiries per product
Volatility ‘Term Structure’ refers to underlying forward curve
•Short-end of the forward curve: HIGH VOL
•Long-end of the forward curve: LOW VOL
Seasonality in Volatility
•Winter Vol (relative) high
•Summer Vol (relative) lowLinz – Kickoff workshop September 8-12, 2008. 27
Derivatives: Plain Vanilla Products
Challenges for the ‘Plain Vanilla Options’
•Option market is thin (implied vol quotes not always reliable)
• Implied Vol quoted according to bad model (model for forwards rather than swaptions)
•Bid/Offer spreads in the underlying (hedging cost)
•Fat tails (as any market)
•Liquidity
Linz – Kickoff workshop September 8-12, 2008. 29
Derivatives: Plain Vanilla Products
Bid/Offer spreads for Forwards:
•Days: 0.75% - 5% (sometimes even 15%, for SUN)
•Weeks: 1.25% - 6%
•Months: 0.5% - 2% - 5%
•Quarters: 0.10% - 3%
•Cals: 0.25% - 2%
Linz – Kickoff workshop September 8-12, 2008. 30
Derivatives: Plain Vanilla Products
Liquidity in Forwards:
•Can dry up easily and fast
•Risk premium: implied vol is much higher than realised vol (difference about 10%)
Linz – Kickoff workshop September 8-12, 2008. 31
Derivatives: Plain Vanilla Products
Underlying does not (yet) exist
•Strip of Options on Winter/Summer products
•6 Options each expiring right before Monthly-Forward goes into delivery
•Monthly forwards may not be traded at the time of writing the option
•Basis Risk: “Hedging of Untradable Assets,”N. Vandaele, P. Leoni and M. Vanmaele (in preparation)
Linz – Kickoff workshop September 8-12, 2008. 32
Derivatives: Plain Vanilla Products
Skew is rather small
About 15 players in the vol marketLinz – Kickoff workshop September 8-12, 2008. 33
0.7 0.8 0.9 1 1.10.516
0.517
0.518
0.519
0.52
0.521
0.522
0.523
0.524Q4-2008 Nordic
0.8 1 1.2 1.40.47
0.475
0.48
0.485
0.49
0.495Q1-2009 Nordic
Derivatives: Exotic Products
2 Examples and their risks:
•Hourly Option (power)
•Swing Option (gas)
Linz – Kickoff workshop September 8-12, 2008. 35
Derivatives: Exotic Products: Hourly Option
Specifications
•Strip of options expiring on the SPOT market
•For each hour of the day, for each day over the period (typically 3 years), the owner has a right:
•Call/Put
•Fixed strike (can be floating as well)
•For each hour: ‘nomination’ or exercise has to be decided on a day-ahead basis
•Settlement can be financial or physicalLinz – Kickoff workshop September 8-12, 2008. 36
Derivatives: Exotic Products: Hourly Option
Model - Risks:
•Year-to-Quarter-to-Month-to-Week-to-Day profile
• Intraday profile (hourly profile)
•Volatility on each scale
Challenges
•Pricing the product
•Hedging the product (profiles cannot be hedged perfectly)
Linz – Kickoff workshop September 8-12, 2008. 37
Derivatives: Exotic Products: Swing Option
Swing Option:
•Very complex product in an imperfect market
•Traded very often because of physical nature of the (Gas) Market
Linz – Kickoff workshop September 8-12, 2008. 38
Derivatives: Exotic Products: Swing Option
Specifications
•A certain volume of gas can be bought at Strike Price (Call Option)
•Strike can be fixed/floating (oil-related)
•Nomination on day-ahead (or month-ahead)
•Constraints:– Total Volume between Vmin and Vmax
– Daily nomination between Dmin and Dmax
– Monthly nomination between Mmin and Mmax
Linz – Kickoff workshop September 8-12, 2008. 39
Derivatives: Exotic Products: Swing Option
Challenges
•Usual model risks (fat tails, stochastic vol,…)
•American features: “Do I nominate today or do I wait”
•Optimizing the nomination process within constraints
•Correlation/Comovement across the curve
•Highly dimensional: daily level (sometimes hourly)
Linz – Kickoff workshop September 8-12, 2008. 40
Conclusions
Derivatives in Power/Gas
•Combination of hedgable risk and unhedgable risk
•Discrete hedging to its fullest extent
•Liquidity premiums
Market is growing rapidly
Physical nature cannot be forgotten
Matching Spot Model and Forward Model
Linz – Kickoff workshop September 8-12, 2008. 42