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Invest in Power
Arie KapulkinActive Power Investments LLC
Niagara Falls, ON19 September 2012
2
Outline
• Overview of Energy Trading
• Development of Nodal Power Markets
• Financial trading in Nodal Power Markets
• Risk Management
• Opportunities for investors
• Conclusions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
3
What is Energy Trading?
• A purchase or sale of energy, paper or physical, for consumption or resale
• Purchase or sale for consumption or resale in the very short time frame refers to spot energy trading; energy trading in the future refers to futures/forwards
• Why Trade? Energy Trading results in realization of gains from trade – there is no different from other trading of commodities or goods
• Examples include: oil, gas, power, coal, emissions, weather, etc.; all these commodities can be traded
• We can trade products and their derivatives; derivatives are instruments that derive their value from the underlying product
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
4
Traded Products: Temporal Dimension
• Spot (cash) market is same hour/day (Example: Real-Time (RT)) for immediate production or consumption
• Day Ahead (DA) is a type of the short-term hourly or block-based forward market for the next day
• Futures or forward market is trading for some remote time period
• Examples: balance of the month, prompt month, 3 to 5 years out Henry Hub on NYMEX
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
5
Traded Products: Spatial Dimension
• Energy is traded worldwide
• Oil is traded on major energy exchanges: NY Harbor, WTI – Cushing, Gulf Coast, North Sea, Singapore
• Gas is traded at Henry Hub in LA and AECO in Alberta and a number of secondary gas hubs; Ze Brugge terminal in Europe, etc.
• Electricity is traded at great many locations due to its local production and consumption nature: All over the world (Example: Electricity Hubs in the US)
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
6Copyright © 2012 by Active Power Investments LLC All Rights Reserved
7
Where is Energy Traded?
• One-to-one: individual bilateral deals
• Many-to-one: marketers • Model pioneered by Enron
• Requires the company to actively match buyers and sellers
• Many-to-many: ICE, Nodal Exchange, Futures Markets• Platform to enable clearing b/w multiple participants
• Organized power markets• New ways to transact: central clearing of locational bids by system
operators (ISOs and RTOs)
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
8
Outline
• Overview of Energy Trading
• Development of Nodal Power Markets
• Financial trading in Nodal Power Markets
• Risk Management
• Opportunities for investors
• Conclusions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
9
generation
customerservice
distribution
transmission
IPP self-generation
CUSTOMERSTheory
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
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generation
customerservice
distribution
transmission
IPPself-generation
CUSTOMERS PracticeCopyright © 2012 by Active Power Investments LLC
All Rights Reserved
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
11
power exchangegeneration
customerservice
distribution
transmissiongeneration
customerservice
distribution
transmission
ISO
marketing
trading
ancillary srvcs
Transition
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Power Marketing and Energy Trading Explosion
• Utilities, financial houses, marketers, brokers, generating entities, and speculators are buying, selling, and swapping power/energy on an ever-increasing scale
• The total volume of trade is multiples of the value of the underlying commodity
• Power marketing / brokering has grown tremendously since the start of deregulation
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
13
North American Regional Transmission Organizations
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
14
Move from the Zonal To FNM – Nodal Market
• No intra-zonal constraints enforced • Internal Congestion Zones – Constraints enforced between zones
• Full Network Model (All constraints enforced) • Locational Marginal Pricing at each node
NP15
SP15
ZP26
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
15
Why Nodal?
• Efficiency: minimization of production cost– System-wide, incentive-compatible
• Advanced locational signal for buyers and sellers to match next day needs and supplies
• Economic signal (LMP) to Gens and Demand Response while protecting load
• Congestion risk management (CRR/FTR/TCC) and transmission planning
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
16
Locational Marginal Prices in Nodal Markets
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
17
Outline
• Overview of Energy Trading
• Development of Nodal Power Markets
• Financial trading in Nodal Power Markets
• Risk Management
• Opportunities for investors
• Conclusions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
18
Financial Instruments
• Virtual Trading: trade DAM vs. RTM– Virtual Supply (Financial Generator): sell DA buy
RT– Virtual Demand (Financial Load): buy DA sell RT
• Congestion Revenue Rights (aka FTR or TCC)– Buy or sell congestion between two nodes– Buy in monthly/seasonal, settle in DAM
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
19
Virtuals as Purely Financial Instruments
• Used to capture the price difference between DAM and RTM at a location
• If the location price in DAM is expected to be greater than RTM, then an Inc at that location would be the correct tool
• If the location price in DAM is expected to be less than RTM, then a Dec at that location would be the correct tool
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
20
Incs and Decs as Financial Instruments
Inc Payoff ($)
RT LMP ($)DA• RT2
RT1
P1
P2
Dec Payoff ($)
RT LMP ($)DA
•RT2
RT1
P1
P2
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
21
FTR/CRR/TCC: Traffic Power
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
22
Regular Congestion
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
23
Extreme Congestion
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
24
FTR Properties
• Financial settlement, no physical delivery• Can be acquired centrally or from another
participant • Can be bought or sold b/w any two pricing
locations (aka injection and withdrawal points, or source and sink) defining a path
• Can cover on-peak or off-peak• FTR payoff can be either positive or negative
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
25
Financial Perspective
• Hedgers: offset the expected congestions• Speculators: look for most profitable paths• Look at FTRs as a stand-alone financial
instrument• Purchase Forward Contract for congestion
difference at a set price• Delivery is based upon DAM price differences
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
26
Financial Perspective cont.
• Goal of FTR spec bids: Buy the FTR in the auction at less than the total amount of the congestion revenue which will be paid to the FTR holder throughout the auction period
• These financial instruments could be thought of as investments that get future “earnings”
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
27
Outline
• Overview of Energy Trading
• Development of Nodal Power Markets
• Financial trading in Nodal Power Markets
• Risk Management
• Opportunities for investors
• Conclusions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
28
FTR Holder Risks
• FTR Holder purchased an FTR with anticipation of congestion happening in one direction
• Actual system conditions can change from auction assumptions
• System conditions and DA market clearing can be different than holder’s assumptions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
29
VaR: Portfolio Mapping
West Portfolio
East Portfolio
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VaR and Electricity
• Market Prices have relatively short histories compared to financial indexes
• Price distribution: Fat tails, Outliers, Price Jumps in spot prices
• High Volatilities, Unstable Correlations
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
31
Oil & Gas Impact
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
32
Stress Testing
• Focus on potential sources of risk that– Impact the portfolio seriously– Have not occurred in the recent past
• No standard/scientific way to reliably measure risk– Scenarios tailored to the portfolio
• Stress testing looks for the worst outcome in contrast to VaR which looks at extreme movements in price distribution
• Stress testing is more effective when the portfolio has fewer sources of risk
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
33
Outline
• Overview of Energy Trading
• Development of Nodal Power Markets
• Financial trading in Nodal Power Markets
• Risk Management
• Opportunities for investors
• Conclusions
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
34
Recent and future developments
• CA• TX (ERCOT)• SPP
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Why invest in power nodal markets?
• New less efficient markets, higher spreads• Higher barriers to entry (talent, data, analysis,
process, ISO / regulatory compliance)• Uncorrelated with equity, debt, FX, real estate• No to very low correlation with other energy
commodities such as oil or NG• Multiple independent power markets –
diversification of opportunities
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
36
0
50
100
150
200
250
300
350
400
450
500
0
1
2
3
4
5
6
$/M
Wh
$/M
MBt
uDaily Price Comparison NG - Power
Carthage HUB_North
Correlation: 0.0516(Pearson linear correlation coefficient)
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
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-6
-4
-2
0
2
4
6
8
-60
-40
-20
0
20
40
60
1/1/2010 2/1/2010 3/1/2010 4/1/2010 5/1/2010 6/1/2010 7/1/2010 8/1/2010 9/1/2010 10/1/2010 11/1/2010 12/1/2010 $/M
Wh
$
S&P 500 vs SP15 MCC - NP15 MCC
S&P 500 MCC Spread
Correlation: 0.004
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Key Points and Conclusions
• Virtual Offers/Bids– Prediction of RT price with some degree of
accuracy is a must to achieve the goal– Diversification across pricing points is a key factor– Offers financial participants risk premiums when
arbitraging DA – RT price differences
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
39
Key Points and Conclusions
• FTR –Congestion patterns change over time– Short-term congestion is harder to predict
(month-to-month, day-to-day)– Long-term congestion may be more predictable
but does change based on new generation/transmission construction (or retirements)
– FTRs are a tool that can provide profitable opportunities for financial participants
Copyright © 2012 by Active Power Investments LLC All Rights Reserved
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Questions?
Copyright © 2012 by Active Power Investments LLC All Rights Reserved