Long-Term Electricity Contract Valuation Using Rollover Hedging

1
Apr

René Aïd, François Barjon, Christine Vialas

This paper proposes a market-based method to provide a selling price for long-term contract on electricity market. In market-based approaches, one searches to fulfil a given long-term commitment only by selling and buying available futures contracts on the market. The price of the contract is then given by the cost of the best available hedging strategy. Here, the hedging strategy is based on rolling futures of the longest maturity, i.e. successively selling and buying back the futures with the same maturity. To implement this rollover strategy, we extend a two-factor model of the forward curve to be able to model prices for newly quoted contracts. Prices for new maturities are generated with a random process. Since this whole modelling process results in an incomplete market, the price for the long-term contract is defined by a risk criterion. The standard Value at Risk measure is used. The efficiency of this methodology is assessed both using Monte-Carlo simulations and a real life experiment of what would have occurred if this method had been applied in the past. We show that, in standard market conditions, a mid-term contract between five to ten years maturity base load contract can be sold at a 95% risk level with a premium not exceeding 5% of the current price of the longest futures maturity. We also show that liquidity constraints do not increase signficantly this risk premium.

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