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risk management in
the energy market
UCY ENERGY is one of
the major player on the European energy wholesale marketand provides a variety
of services for power and other commodities
Financial risk management is often a high
priority for participants in deregulated electricity markets due to the
substantial price and volume risks that the markets can exhibit. A consequence
of the complexity of a wholesale electricity market can be extremely high price
volatility at times of peak demand and supply shortages. The particular
characteristics of this price risk are highly dependent on the physical
fundamentals of the market such as the mix of types of generation plant and
relationship between demand and weather patterns. Price risk can be manifest by
price "spikes" which are hard to predict and price "steps" when the underlying
fuel or plant position changes for long periods.
"Volume risk" is often used to denote the phenomenon whereby electricity market
participants have uncertain volumes or quantities of consumption or production.
For example, a retailer is unable to accurately predict consumer demand for any
particular hour more than a few days into the future and a producer is unable to
predict the precise time that they will have plant outage or shortages of fuel.
A compounding factor is also the common correlation between extreme price and
volume events. For example, price spikes frequently occur when some producers
have plant outages or when some consumers are in a period of peak consumption.
The introduction of substantial amounts of intermittent power sources such as
wind energy may have an impact on market prices.
Electricity retailers, who in aggregate buy from the wholesale market, and
generators who in aggregate sell to the wholesale market, are exposed to these
price and volume effects and to protect themselves from volatility, they will
enter into "hedge contracts" with each other. The structure of these contracts
varies by regional market due to different conventions and market structures.
However, the two simplest and most common forms are simple fixed price forward
contracts for physical delivery and contracts for differences where the parties
agree a strike price for defined time periods. In the case of a contract for
difference, if a resulting wholesale price index (as referenced in the contract)
in any time period is higher than the "strike" price, the generator will refund
the difference between the "strike" price and the actual price for that period.
Similarly a retailer will refund the difference to the generator when the actual
price is less than the "strike price". The actual price index is sometimes
referred to as the "spot" or "pool" price, depending on the market.
Many other hedging arrangements, such as swing contracts, Virtual Bidding,
Financial Transmission Rights, call options and put options are traded in
sophisticated electricity markets. In general they are designed to transfer
financial risks between participants.
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