managing risk in hydro-based portfolios: the brazilian...

Markets, Investments and Risks inHydro vs Thermal-Dominated Systems

The Energy Centre – U of Auckland Business School

Mario [email protected]

Managing Risk in Hydro-BasedPortfolios: the Brazilian Experience

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Topics

• Brazilian system overview• Hydrothermal scheduling• Risks and challenges• Tools for risk management

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Topics


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The big numbers...

Brazil

Argentina

Peru

Colombia

Venezuela

Bolivia

Uruguay

Paraguay

Surface area: 8 million km2

(= continental US + 1/2 Alaska)Population: 185 millionGDP: US$ 800 billionInstalled capacity (2006): 100 GWProduction (2006): 50 GW averagePeak load: 65 GW

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Energy production sources

Hydro (85%): large plants in cascade, in several river basins, with multiple weather patterns

Thermal (15%): natural gas (combined and simple cycle); coal; heavy fuel; diesel; nuclear; sugarcane biomass cogen

CEMIGFURNASAES-TIETÊCESPCDSAConsórciosCOPELTRACTEBEL

ITAIPUBinacional

Rio Grande

Rio Paranaíba

Rio Tietê

Rio Paranapanema

Rio Iguaçu

CEMIGFURNASAES-TIETÊCESPCDSAConsórciosCOPELTRACTEBEL

ITAIPUBinacional

Rio Grande

Rio Paranaíba

Rio Tietê

Rio Paranapanema

Rio Iguaçu

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Transmission network

Country is interconnected by80 000 km of HV lines (>230 kV)

2200 MW interconnection with Argentina

Long transmission lines(> 1 000 km)

15 000 km of new lines added in the past five years

Auctions for the construction of grid reinforcements

Source: ONS, www.ons.org.br

3500

km

2800 km

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G, T and D Sectors• Generation

– 11 major utilities + several smaller companies

– 15% private (energy produced) – Total revenues (2005) : US$ 13 billion

• Transmission– 35 companies (27 private)– Total revenues (2005) : US$ 3 billion

• Distribution– 64 utilities– 80% private (energy consumed)– Total revenues (2005): US$ 27 billion

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Investment needs

• For a GDP growth of 4%, it is necessary to install 3200 MW average of new firm energy per year⇒ US$ 6 billion/year in investments

Main objective: to ensurean efficient capacity increase

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Resources for generation expansion

Northeast (NE):

• offshore natural gas and oil; LNG and coal imports; biomass (sugarcane); wind

Southeast (SE):

• Hydro; Bolivian gas + local offshore gas fields (Campos and Santos); biomass (sugarcane)

South (S):

• Electricity and gas imports from Argentina; local coal; binational hydro plants; LNG

North (N)

• Substantial hydro (170 GW);limited natural gas

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Topics


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System dispatch

• The National System Operator (ONS) controls the production of all hydro and thermal plants

• Hydro plants are dispatched as a portfolio, to take advantage of hydrological diversity (export from “wet” to “dry” basins)

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The Hydrothermal (HT) scheduling problem

• Formulated as a stochastic DP recursion– Objective: minimize the present value of expected operation

cost (fuel cost for thermal plants + penalties for rationing) taking into account inflow uncertainty

– State variables: reservoir storage levels and observed lateral inflows at each reservoir

• For a system with 50 hydro plants and an autoregressive lag-3 model, this results into 200 state variables ⇒ Discrete stochastic DP cannot be used (curse of dimensionality)

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The SDDP scheme

• A stochastic dual dynamic programming algorithm (SDDP) is used to solve the dispatch problem– the future cost function (FCF) is represented by piecewise

linear hyperplanes (Benders cut)• no discretization necessary• The hyperplane coefficients are the dual values of the dispatch

problem (hence the name)

• The SDDP scheme has been applied to more than 40 countries in Latin America, Europe, Eurasia and Oceania

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Spot price

• In addition to energy production schedule, the HT scheduling model calculates the system short-run marginal cost (SRMC)– Related to the opportunity cost of water (water value)

• The SRMC is used as a proxy of spot prices in all wholesale energy market (WEM) transactions

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Zonal prices

Although bus-level LMPs are calculated, a zonal system with 4 regions is used for WEM transactions

The main transmission network has 3500 buses and 5000 circuits

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Topics


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Average energy inflow – Southeast region

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Average storage level – Southeast region

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Average spot price – Southeast region

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Energy inflow scenarios – Southeast region

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Storage scenarios – Southeast region

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Spot price scenarios – Southeast region

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The spot price distribution is skewed

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1 8 15 22 29 36 43 50 57 64 71 78 85 92 99 106 113 120 127 134 141 148 155 162 169 176 183 190 197

US$

/MW

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média

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Low prices for a long time, punctuated by “spikes”

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jan-93 jul-93 jan-94 jul-94 jan-95 jul-95 jan-96 jul-96 jan-97 jul-97

US$/MWh

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Challenges for new capacity

• Because of price volatility, it is very risky for any generator (hydro or thermal) to enter the system as a merchant plant

• The uncertainty is compounded by the variability of load growth

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55

60

65

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2006 2007 2008 2009 2010 2011

GWm

édio

[High - Base]: 2700 MW average

[Base – Low]: 700 MW average

High GDP5%

Base GDP4%

Low GDP3.5%

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Topics

• Brazilian system overview• Hydrothermal scheduling• Volatility of spot prices• Tools for risk management Contract auctions Forward contracts for hydro Call option contracts for thermal plants

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Supply contracts

• All consumers (free and regulated) should be 100% contracted– Verified ex-post, for the cumulative energy

consumption in the previous year• Although contracts are financial instruments

(forward or call options), they must be “backed” by a firm energy “certificate”

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100% contract + firm energy ⇒ expansion

Should be 100% contracted;looks for a genco or a trader

Loadincrease Genco

Newgeneration

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Contract auctions

• Discos contract energy through auctions– Discos are responsible for load forecast; avoids

government planners’ “optimism”– Contracts reduce risks for investors; lower prices

• Free consumers can contract as they wish, as long as they remain 100% covered– Free consumers are 25% of the market– They serve as “checks and balances” for the

regulated sector

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Auction results 2004-2006

• 5 auctions; US$ 50 billion in contracts

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Next auctions are scheduled for May 2007

Wind, 14

Small hydro, 31

Hydro, 11

sugar cane BM, 55Coal, 8

Cogen, 6

Natural Gas, 11

Oil, 69

205 candidate projects; 25 thousand MWs

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Topics


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Risks of forward contracts for hydro plants

• For thermal plants, forward contracts are Ok– Hedge against low spot prices

– If the spot price is high, the plant will dispatch; the worst expense is the fuel cost

• However, significant risks remain for hydro

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Risk 1: variable hydro production

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H1

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H3

The production of individual hydro plants is quite variable; long periods in which the plant may be “short” on the contract

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H3H2H1

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Idea: total hydro production is more stable

Solution: spatial hedging

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Energy credit x physical hydro production

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1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96 101 106

Month

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Physical production Energy credit

The spatial hedging scheme (MRE)• All hydro plants are “shareholders” of a “hedge fund”

called MRE• The total hydro production is assigned to MRE• It is then allocated to each plant as an “energy credit”, in

proportion to the shares, not to the physical production• The energy credits are used for the WEM clearing

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Risk 2: financial exposure in dry periods

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Hydro plants have a two-sided risk:if they contract too little, they will “starve” in wet periods;

if they contract too much, they are “hurt” by high spot prices in dry periods

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Solution 2a: Contract adjustment in a crisis• In case of rationing, the contracted amount of all

plants is reduced in the same % as the load curtailement– Alleviates exposure to very high prices in crisis situations;

risks are transferred to consumers

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Solution 2b: Optimize energy contracted

• For each candidate contract amount, calculate price that ensures the required return on investment– e.g. “Value at Risk” on IRR: Pr [IRR > target] > 95%– Stochastic optimization model (OptFolio)

• Select energy amount that maximizes plant competitiveness in auctions

Preço de Contrato para a contratação máxima (R$/MWh): 121.75Mínimo Preço de Contrato (R$/MWh): 121.00Contratação Ótima (%) do Lastro: 96%

118.0

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Quantidade (% Lastro)

Preç

o

Preço 125.6 124.6 123.6 122.6 121.8 121.1 121.0 121.0 121.1 121.3 121.8

90% 91% 92% 93% 94% 95% 96% 97% 98% 99% 100%

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Topics


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Auctions for “Call option” contracts • “Call option” contract auctions for thermal plants have

been used since 2005– Plants bid both the “premium” (fixed annual revenue) and the

“strike price” (used as the variable operating cost in the HT dispatch)

• Bids are compared with basis on the estimated benefit for consumers– [low premium, high strike] x [high premium, low strike]

• Objective: transfer benefits (and risks) of hydrothermal optimization to consumers

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Conclusions• Load growth uncertainty and spot price volatility

create important risks for generation investors, in particular for hydro plants

• These risks can be handled by a set of technical, regulatory and financial instruments:– Stochastic optimization for hydrothermal dispatch– “Competition for the market” (long-term contract

auctions)• Discos are responsible for load forecasts

– “Spatial hedging” and forward contract optimization for hydro plants

– Call option contracts for thermal plants

managing risk in hydro-based portfolios: the brazilian...

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