Portfolio Management: An Electric Retailer's Perspective
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Transcript of Portfolio Management: An Electric Retailer's Perspective
1Choosing the Right Energy Supplier for Your Business
Portfolio Management: An Electric Retailer’s Perspective
Eric MeerdinkDirector, Structuring & Analytics
Hess Energy Marketing
Best Practices in Portfolio ManagementApril 4-5, 2013
2Choosing the Right Energy Supplier for Your Business
Background on Hess Energy Marketing
3Choosing the Right Energy Supplier for Your Business
One of the Largest Energy Suppliers on the East Coast
4Choosing the Right Energy Supplier for Your Business
Hess Energy: Robust Product Suite
Fuel Oil
Delivery to Commercial &
Industrial customers
Distributor sales from Hess terminals
110K BPD
Natural Gas
Marketing to Commercial &
Industrial customers
Wholesale to LDCs
1.5 BCF/day
Electricity
Marketing to Commercial &
Industrial customers
4,500 MWs/hr (RTC ) (enough
electricity to power 4 million
average homes)
#2 electric marketer on the
east coast
Green Suite
Reducing electric usage during times
of peak demand with Demand
Response programs
Support renewable energy sources,
such as wind, solar, biomass and hydropower
Balance your carbon impact from oil and natural gas with carbon offsets
Solutions
Providing turnkey solutions for a wide
range of energy projects
Products include fuel conversions,
energy efficiencies, asset optimization
and more
Energy supply and project funding offer
a comprehensive package
5Choosing the Right Energy Supplier for Your Business
Bayonne Energy Center
• 500 MW natural gas powered electric generating station serving New York City.
• Jointly owned by Hess Corporation and ArcLight Capital Partners.
• Located in Bayonne NJ and supplying power through a 6.5 mile 345 kV submarine cable under NYC harbor to Con Ed’s Gowanus substation in Brooklyn.
• Began operation in June 2012.
• 8 Rolls Royce Trent 60 turbines.
• Direct connection to Transco natural gas pipeline.
• Duel fuel plant that can run on ULSD.
6Choosing the Right Energy Supplier for Your Business
Hess Solar Energy
• Hess Solar Field.
• Began operation in summer 2012.
• 1.1MW of renewable energy located in Woodbridge, NJ on 6 acres of land adjacent to our NJ headquarters.
• Supplies 22% of our building’s electricity requirements.
• Annual environmental impact is equivalent to 250 cars off the road.
7Choosing the Right Energy Supplier for Your Business
Portfolio Management
8Choosing the Right Energy Supplier for Your Business
Hess Energy Marketing Risks
• Retail load contracts (MW, et al) - Bilateral contracts between supplier/end user
• Hess is subject to four types of risk in serving our retail and wholesale load:
○ Market Price Risk
■ Positive/negative price exposure
○ Volumetric Risk
■ Longer term positive demand/price correlation risk
■ Under Collection of Fixed Costs
○ Shaping Risk
■ Short term positive demand/price correlation risk
○ Migration risk
■ Wholesale customers
9Choosing the Right Energy Supplier for Your Business
What is the Appropriate Risk Measure?
• Why do firm’s hedge?○ To lock-in margins (all or part) and reduce earnings volatility
• What is risk in an MW portfolio? • How do we measure it?• What are the costs of financial distress?• Need a quantitative measure to evaluate risk and hedge structures• A quantitative measure needs to:
○ Realistically model price and customer load behavior (i.e. Volumetric/Shaping)
○ Fit the structure of the business and industry
○ Accurately model contractual terms• Propose that Gross Margin at Risk (GM@R) and stress testing are the appropriate
risk measures for a retail/wholesale electricity portfolio.
10Choosing the Right Energy Supplier for Your Business
GM@R Superior to VAR
VAR GM@R
Measure Probabilistic Probabilistic
Forward Market Prices Yes Yes
Holding Period 1 day to 2 weeks Through delivery
Spot Market Prices No Yes
Volumetric No Yes
Delivered Quantity Known and fixedEquals contract quantity
Probabilistic and correlated with market prices
Liquidity Market assumed to be liquid and continuous
Retail market not liquid or continuous
Calculation Methods Historic, Delta, Closed-Form, Simulation
Simulation
Appropriate Uses Forwards, Futures, Options (Trading)
Retail electricity contracts
11Choosing the Right Energy Supplier for Your Business
Stress Testing
• GM@R is only as good as our ability to MODEL price-load behavior
• Historic data on the price-load relationship at the hourly level captures the major driver of load and price volatility (i.e. Weather correlation)
• Other drivers exist that can have significant impacts on cash flows, but may have either a low probability of occurring or are difficult to model
○ Economy – Recession/technology/regulatory change during contract period? Load impact?
○ Extreme Events (e.g. Sandy, winter storms in the NE)
• Any hedging plan needs to incorporate STRESS TESTING as a basic tool to judge the effectiveness of the hedge structure and to look for holes in the portfolio
12Choosing the Right Energy Supplier for Your Business
Simple Risk “Profile”
What we know:
1. MTM2. 2 Stress Events3. Daily VAR
MTMStressTest I
StressTest II
BudgetBusiness Plan
(illustrative)
-$10.0 -$5.0 $0.0 $5.0 $10.0 $15.0 $20.0 $25.0 $30.0 $35.0 $40.0 $45.0 $50.0 $60.0 $65.0 PNL
13Choosing the Right Energy Supplier for Your Business
What we gain:
1. PnL Distribution
2. GM@R
3. Swing Risk
4. Better understanding of stress events.
5. Understand the impact of hedge policies.
Ideal Risk Profile
Xth
Percentile
GM@R
Swing Risk
StressTest I
StressTest II
MTM Budget
Probability ofachieving business plan
(illustrative)
-$10.0 -$5.0 $0.0 $5.0 $15.0 $20.0 $25.0 $30.0 $35.0 $45.0 $50.0 $60.0 $65.0 PNL
14Choosing the Right Energy Supplier for Your Business
Volumetric Risk: Swing
15Choosing the Right Energy Supplier for Your Business
Long-Run Correlation Between Price and Load
12-Month Rolling Average of Load and Price in PSE&G Zone
$0.00
$10.00
$20.00
$30.00
$40.00
$50.00
$60.00
$70.00
$80.00
$90.00
4,700
4,800
4,900
5,000
5,100
5,200
5,300
5,400
5,500D
ec-0
4
Mar
-05
Jun-
05
Sep-
05
Dec
-05
Mar
-06
Jun-
06
Sep-
06
Dec
-06
Mar
-07
Jun-
07
Sep-
07
Dec
-07
Mar
-08
Jun-
08
Sep-
08
Dec
-08
Mar
-09
Jun-
09
Sep-
09
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
Dec
-11
Mar
-12
Jun-
12
Sep-
12
Dec
-12
RT
C
LM
P
$/M
WH
Ave
rag
e M
W
Average MW $/MWH RTC
16Choosing the Right Energy Supplier for Your Business
Short-Run Correlation Between Price and Load
$0.00
$20.00
$40.00
$60.00
$80.00
$100.00
$120.00
$140.00
$160.00
$180.00
$200.00
07/12/10 07/13/10 07/14/10 07/15/10 07/16/10 07/17/10
$/M
WH
0
2,000
4,000
6,000
8,000
10,000
12,000
MW
Hourly Load and Price in PSE&G Zone 7/12/10 to 7/17/10
Load (MW)
Price ($/MWH)
17Choosing the Right Energy Supplier for Your Business
Short Retail Sale and Long Hedge
Long Hedge“Delta Hedge”
Short Sale
$/MWH
Short Retail Sale
-
$
Net: Swing Risk “Gamma”
+
18Choosing the Right Energy Supplier for Your Business
Simulated Swing (Gamma) Position
($1,600,000)
($1,400,000)
($1,200,000)
($1,000,000)
($800,000)
($600,000)
($400,000)
($200,000)
$0
$200,000
$400,000
$0 $50 $100 $150 $200 $250 $300 $350
Average On-Peak LMP
To
tal P
&L
Example uses NJ BGS CIEP Load for July.Approximately 80 MWs average load on-peak.
19Choosing the Right Energy Supplier for Your Business
3020100-10-20-30-40-50-60
0.04
0.03
0.02
0.01
0.00
Cash Flow
De
nsi
ty
Distribution: Swing Risk
19
Negative Skew:Swing Risk
Swing Cost
Excluding the expected covariance produces a distributionwith a negative expected value.
Mean
20Choosing the Right Energy Supplier for Your Business
P
Cha
nge
in P
&L
+
-
gamma
HedgeHow do we create this hedge?
Monthly Average
Price $/mwh
P
Short Gamma Hedge
21Choosing the Right Energy Supplier for Your Business
Creating a Gamma Position from Options
P
Use vanilla calls and puts to construct the gamma position.
Cha
nge
in P
&L
+
-
Monthly Average
Price $/mwh
P ˆ
22Choosing the Right Energy Supplier for Your Business
-$2,000
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
$16,000
$18,000
$20,000
$0.00 $20.00 $40.00 $60.00 $80.00 $100.00 $120.00 $140.00
Market Price
Ch
an
ge
in P
&L
($
00
0)
-Gamma
Estimate
Cost as of February 9, 2009.
Estimated gamma function for July 2010 PSE&G FP load.The option cost equals $1.89/MWH per MWH served.
Example of a Theoretical Gamma Function Estimate
23Choosing the Right Energy Supplier for Your Business
Reduce Cash Flow at Risk
3020100-10-20-30-40-50
0.06
0.05
0.04
0.03
0.02
0.01
0.00
X
Density
Accountnig or Actuarial w ith Options
Accounting Model
Cash Flow
Swing RiskReduced
Delta Hedged
Hedged withOptions
24Choosing the Right Energy Supplier for Your Business
Hedging in Practice
• In practice we cannot charge the theoretical cost of swing○ Too expensive ○ Uncompetitive
• In practice we cannot carry out the theoretical hedge○ Impractical○ Illiquid market
• Our practice for hedging swing risk:○ Calculate the GM@R. Decide on a GM@R percentage (5%)○ Goal is not complete elimination of risk but rather to reduce the GM@R by X%. (50%)○ Experiment with various hedge structures to meet the GM@R goal○ How? Combine options available in the market to achieve our goal at the least cost.
This could involve multiple portfolios■ Monthly Option (straddles and strangles) (Swing Risk)■ Daily Options (straddles and strangles) (Hourly Shaping Risk and Swing Risk)■ Spread Options■ Weather Derivatives
○ Present to management preferred plan/portfolio to reduce risk and the cost per MWH to achieve that reduction
○ Balance the risk-reward tradeoff
25Choosing the Right Energy Supplier for Your Business
Volumetric Risk: Under Collection
26Choosing the Right Energy Supplier for Your Business
Fixed Cost Hedge Example
CDD- CDDbFR L - LFR Collection Over/Under
LFR Collection
LFR FC
nCalculatio Rate Fixed L
FC FR
Customer to Charged Rate Fixed FR
L
ActualDays Degree CoolingCDD
(Expected) Normal Days Degree CoolingCDD
Usage Actual L Usage, Expected L
Costs Fixed Total FC
NANA
A
N
N
A
A
N
AN
NN
A
CDDbaL
CDDba
This looks just like thepayoff of a CDD Swap.
Linear in CDD
The under/over collection is a function of the deviation of weather from expected.We are naturally long CDD.
27Choosing the Right Energy Supplier for Your Business
Weather Derivative Payoffs
• Weather Swaps. A weather swap is a financially settled derivative written on CDDs and HDDs.
• Settles monthly on actual temperatures. The strike price is a temperature value such as the climatic normal or a temperature forecast (determined by market).
• The swap is converted into dollars using a fixed multiplier known as a tick. One contract has a tick size of $20, but this can be negotiated. Most swaps have a limited payout and loss (caps). Below is an example payoff for a short CDD swap.
• A weather option is a financially settled option written on CDDs and HDDs. They settle monthly (or daily). Monthly options can be European or look back. Daily options are struck like daily power options.
CDD -K tick Payoff
CDD,0 -K maxtick Payoff
tick = FR x b
28Choosing the Right Energy Supplier for Your Business
Model Outline
0
100
200
300
400
500
600
0 20 40 60 80 100
Average Daily Temperature
Av
era
ge
DA
ily M
W
0
100
200
300
400
500
600
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Cummulative %
July
CD
D
(30,000)
(20,000)
(10,000)
0
10,000
20,000
30,000
40,000
200 250 300 350 400 450 500 550
CDD
MW
H D
evia
tio
n f
rom
No
rmal
y = 2075.6x - 821313
R2 = 0.9982
($300,000)
($200,000)
($100,000)
$0
$100,000
$200,000
$300,000
$400,000
200 250 300 350 400 450 500 550
CDD
Ove
r/U
nd
er C
olle
ctio
n
Load –Temperature Model CDD Distribution
MWH Deviation from Normal
Over/Under Collection
29Choosing the Right Energy Supplier for Your Business
Swap Hedge
CDD$0
Net Collection offixed costs
CDD Swap w/ cap and floor
Pa
yoff
+
-
Net
30Choosing the Right Energy Supplier for Your Business
Generation/Tolling
31Choosing the Right Energy Supplier for Your Business
Generation is a Natural Hedge for Retail Load
• Generation - Natural hedge for retail load and visa versa
• High/low market prices
○ Increase/decrease generation profits
○ Retail margins decrease/increase
• Generation attributes other than energy that provide cash flow to retailers
○ Capacity
○ Ancillary services
32Choosing the Right Energy Supplier for Your Business
Generation is a Natural Hedge for Retail Load
• Physical generation also has an impact on collateral requirements
○ Retail LSE’s pay collateral to the ISO
○ Generator receives payments from the ISO
○ An LSE with generation assets can reduce this collateral obligation, i.e. Lower cost to serve
• Physical generation assets
○ Owned or tolled
○ Tolling has all the benefits, including collateral, without the operational requirements of running a plant
○ Financial options written on a physical plant do not have the benefits of a physical toll. No operational risk. Simple.
33Choosing the Right Energy Supplier for Your Business
Benefit of generation as a hedge for load
Reduction in GM@R
Net distribution of PNL has a lowerupper tail on PNL, but has a reducedvariance and a lower GM@R.
This value in reduced GM@R andhedging of swing costs can be calculatedand used in pricing.
Matching Load and GenerationReduction in GM@R
-$10.0 $0.0 $10.0 $20.0 $30.0 $40.0 $50.0 $60.0 $70.0 $80.0 PNL
34Choosing the Right Energy Supplier for Your Business
Appendix
35Choosing the Right Energy Supplier for Your Business
Theoretical Model
• It has been shown that a static hedge of plain vanilla options and forwards can be used to replicate any European derivative (Carr and Chou 2002, Carr and Madan 2001).
• Any twice continuously differentiable payoff function, , of the terminal price S can be written as:
• Our payoff function is the terminal profit. It can be decomposed into a static position in the day 1 P&L, initially costless forward contracts, and a continuum of out-of-the-money options. F0 is the initial forward price.
)(Sf
0
0
0000
F
FdKKSKfdKSKKfFSFfFfSf
InitialP&L
DeltaPosition Gamma Hedge: “Swing Risk”
36Choosing the Right Energy Supplier for Your Business
Theoretical Model, Cont.
• The initial value of the payoff must be the cost of the replicating portfolio.
• Where P(K,T) and C(K,T) are the initial values of out-of-the-money puts and calls respectively.
• Interpretation of term within the integral: Second derivative of the payoff function representing the quantity of options bought or sold.
○ R = Fixed revenue rate○ SF = Shaping Factor○ L(S) = MWH, function of S (spot price of power)○ (1+SF)xL(S) = Cost to serve load
0
0,,
0000
F
FrT dKTKCKfdKTKPKfeFfFV
Margin1 SLSSFRSf
SLSFKf
12
37Choosing the Right Energy Supplier for Your Business
Solving for the Estimated Gamma Function
• Select a series of strikes, Ki , and quantities, , to create a portfolio of puts and calls.
• To estimate the gamma function we need to choose the amount of options for each strike, , so as to minimize the distance between the estimated gamma function and the true gamma function.
• Estimated gamma function equals:
• Choose the optimal quantities by minimizing the sum of the squared errors between the true and estimated gamma function over a set of Q prices.
i
i
i
M
iii
N
ii PKMaxKPMaxP
11
0,0,ˆ
2
1
ˆmin
Q
jjj PP