Whether you are a buyer, or seller, of power, an effective hedging program will save you from a ton of headaches, and questions.\u00a0 \u00a0Power markets are the most volatile commodity given their dependence on various other commodities, the instantaneous nature of power, and the very limited ability for power to be stored in significant volumes.\u00a0 The primary purpose of hedging is to create a more predictable set of cash flow in order to run your business more effectively.\u00a0\u00a0 An effective hedging program doesn\u2019t leave significant money on the table, nor does it make significant money.\u00a0 If you really think you can make money from hedging, than you are trading, not hedging.\u00a0\u00a0 Trading can be an effective business proposition, but it requires a lot more than hedging in terms of governance, infrastructure, and analytics.<\/p>\n
Hedging can be relatively simple given that the goal is to assure more predictable cash flows, and not to make money.\u00a0\u00a0 In hedging, the governance requirements are about monitoring and making sure a methodology is employed which has demonstrated the ability to be an accurate predictor in the past.\u00a0\u00a0 Any significant variations in the past analysis should be flagged and addressed in the analytics.\u00a0 The infrastructure for hedging can be quite simple by employing a product such as Power Market Analysis (PMA) from All Energy Consulting.\u00a0\u00a0 PMA can be used to create the timing signals and levels at which to purchase, or sell, power.<\/p>\n
The analytics piece is the beginning, and the end, of developing an effective hedging program.\u00a0\u00a0 The purpose of analytics is to develop an effective system to signal purchases, or sales, and execution volumes over time.\u00a0 The system should not try to guess, or time, the optimum purchase time, but scale into the hedge volume based upon signals.\u00a0\u00a0 Initially it will take several iterations of back casting to the past to produce an effective methodology to achieve intended goals while meeting an \u00a0\u00a0organization\u2019s stated requirements (risk tolerance, budget, etc.).<\/p>\n
A simple mathematical approach of developing a hedge typically doesn\u2019t take into account weather-based fundamental market movements and the resulting commodity price changes.\u00a0\u00a0 PMA increases the robustness of any hedge process by producing a unique set of outcomes that show the risk and reward potential of locking in prices ahead of time.\u00a0\u00a0 A simple concept of integrating PMA is to execute a hedge when the risk and reward profiles are asymmetrical.\u00a0 PMA, in its non-customized form, runs a relatively high power, and a low power price, scenario for all power markets in North America.\u00a0 The PMA model output provides the low, and high, expectations of power prices in the future.\u00a0 The model does not predict commodity prices, but uses forward markets for the implied forecast of the future.\u00a0 Given that you use the forwards markets to execute your hedges, it is only appropriate to use the commodity prices from these same markets.<\/p>\n
In the table below, we present actual results published May 8th<\/sup> 2014. \u00a0The results are due to the gas and coal forwards of May 7th<\/sup>.\u00a0\u00a0 The table shows that the forward curve on May 7th for NEPOOL On-Peak trading is above $60\/MWh for most of the summer months.\u00a0\u00a0 The PMA model runs indicate a much lower price outlook, with only July and September possibly being higher (in the high power price case) as compared to the forward curve.\u00a0 Even if July were to achieve the high case, an increase of $6.89\/MWh is being risked for a potential drop of $13.08\/MWh.\u00a0 This is an asymmetrical risk-reward profile which should signal some volume of hedging, if one was a seller of power (owner of a generation asset).\u00a0 If one was a consumer of power, this would indicate to limit the hedge volume.\u00a0 In the end, this summer has been extremely mild. \u00a0Buyers of the forward curve have had an agonizing summer, losing nearly $20\/MWh for the summer.\u00a0 Sellers are somewhat relieved.\u00a0 PMA does not predict weather, but the low and high cases do represent extreme weather events impact on price levels.\u00a0\u00a0 The model does not predict that it was going to be a mild summer, but it does show the forward curve has a significant premium relative to the potential outcomes.\u00a0\u00a0 In this simple example, the May 8th<\/sup> report indicated a signal to lock in some of the power for the summer if you were a plant owner.\u00a0 If you were a power consumer, it signals to minimize, or not purchase, summer power as the exposure to higher prices is limited.<\/p>\n
![\"\"](\"https:\/\/allenergyconsulting.com\/blog\/wp-content\/uploads\/2014\/08\/PowerHedge.jpg\" "\\"PowerHedge\\"")
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