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Domestic Customer Portfolio Risk Management

Domestic Customer Portfolio Risk Management. Oliver Rix Mathematics in the Management of Energy Systems Workshop, ICMS. Redpoint Introduction.

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Domestic Customer Portfolio Risk Management

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  1. Domestic Customer Portfolio Risk Management Oliver Rix Mathematics in the Management of Energy Systems Workshop, ICMS

  2. Redpoint Introduction • Redpoint Energy is a specialist energy consultancy, advising clients on investments, strategy and regulation across Europe’s liberalised power and gas markets • Formed in October 2004 by 3 former directors of Caminus in conjunction with Structure Europe • Growing reputation based on depth of experience and innovative approaches for market, risk and asset modelling • Our team • 11 professionals: • 3 directors • 2 senior managers • 5 consultants • 1 associate Our services Trading and risk best practice Strategy formation Investment advisory Energy market policy Model design and development Our clients Vertically integrated utilities Independent generators Producers Lenders Government and regulators Title: Mathematics in the Management of Energy Systems, ICMS

  3. The challenge VIU Generation business Retail business Trading business Domestic customers • What is the risk? • How can we assess a hedging strategy? Title: Mathematics in the Management of Energy Systems, ICMS

  4. GB power price history Title: Mathematics in the Management of Energy Systems, ICMS

  5. Domestic electricity tariff price movements Source: TheEnergyShop.com Title: Mathematics in the Management of Energy Systems, ICMS

  6. Structure • Risk mapping • Risk measure • Commodity price exposures • Market share risk • Risk interactions • Risk quantification Title: Mathematics in the Management of Energy Systems, ICMS

  7. Risk mapping Gross margin Operational Risk Model risk Pricing decisions Hedging decisions Competitor Pricing Risk Volumetric Risk (Weather) Commodity Price Risk Title: Mathematics in the Management of Energy Systems, ICMS

  8. Risk measure Gross margin 95th percentile Mean Frequency Annual gross margin Title: Mathematics in the Management of Energy Systems, ICMS

  9. Retail portfolio exposure Retail price Power Retail price Retail spread Long Wholesale power Spark spread Short Fuel price Title: Mathematics in the Management of Energy Systems, ICMS

  10. Can closely follow wholesale prices Retail prices... Source: Norwegian Water Resources and Energy Directorate Source: Amundsen and Bergman, 2003, NordPool Can remain static (for periods) Can be correlated to fuel prices Source: Ofgem Domestic Competitive Market Review, July 2004, wholesale energy prices Title: Mathematics in the Management of Energy Systems, ICMS

  11. ...and long term exposures Power Fuel Fuel Fuel Power Power Long Short Retail prices move with power prices: no net exposure Retail prices move with fuel prices: short fuel spread Retail prices “static”: short power Title: Mathematics in the Management of Energy Systems, ICMS

  12. Medium term exposures Delivery period Sourcing Time % fixed Title: Mathematics in the Management of Energy Systems, ICMS

  13. Price setting and market share Price differential Price relative to average (incumbent) Loss in market share Customer loss (12 months to March 2007) From: Ofgem Domestic Retail Market Report, June 2007 Title: Mathematics in the Management of Energy Systems, ICMS

  14. Risk interactions Delivery period Sourcing/hedging period Wholesale purchases Retail price uncertainty Liquidity risk Basis risk between purchases and retail price increases the further out sourcing takes place Interaction between pricing and market share Profile risk Market share uncertainty Spark spread hedge Generation Portfolio Fixing fuel exposures Title: Mathematics in the Management of Energy Systems, ICMS

  15. Risk quantification and modelling challenges Temperature simulations and price/demand response Forecast simulations Wholesale power and fuel price simulations Company Sourcing strategy Sourcing costs Balancing costs Relative retail prices Retail pricing strategy Outturn volumes Competitor Annual margin PDF Retail pricing strategy Market share Customer switching model Competitor pricing model (game theory?) Title: Mathematics in the Management of Energy Systems, ICMS

  16. Conclusions • Historically, retail divisions have often been seen as “low risk” • In a competitive market, however, the interplay of competitor and customer behaviour means that domestic portfolios pose a significant risk measurement problem • Exposures depend on retail price behaviour driven by competitor strategies • There is a critical interaction between hedging decisions, pricing and market share • Attempting to quantify this is important for risk capital allocation and to support hedging and pricing decision-making • A range of modelling challenges exist in assembling the tools to achieve this Title: Mathematics in the Management of Energy Systems, ICMS

  17. Questions? Oliver Rix oliver.rix@redpointenergy.com +44 7790 017576 Title: Mathematics in the Management of Energy Systems, ICMS

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