WIND DERIVATIVES – A BET OR A HEDGE?
Feb 15, 2017
Recently EEX has launched wind power futures for Germany and Austria to help wind power producers or asset owners manage volume risks and wind induced market price risks. The purpose of this post is to share some thoughts on the applicability of this and similar products for hedging, as well as some issues one might have when calibrating and applying a hedge on own asset(s). The topic will definitely be open to further discussion and exchange of experience, especially when the products actively used for risk management and liquidity start to build up (or not).
With the growing market penetration of renewables across Europe, hedging power from renewables becomes an important issue. Asset owners are understandably looking to reduce the uncertainty of energy output, despite subsidy scheme or wholesale marketing. The number of market participants whose revenues are dependent on the supply of renewable energy is growing as well. To meet these needs, products such as insurances and futures are being developed. However, given the heterogeneity of wind producing sites and the specifics of each asset park or class, a lot of issues arise around the applicability of a single (standard) product as a hedge. Potentially significant basis risk might cause both cashflow implications and inadmissibility of the hedge for accounting treatment purposes.
According to specifications, the underlying is represented by an average wind load factor per period, creating a “baseload” of sorts, based on meteorological data provided by the German Weather Service and turbine database updated on monthly basis. Here is a list of some sources of risk:
• Risk profile and calibration
Difficulties for hedging might arise from wind conditions at a site not matching the wind speeds collected by the meteorological data. Furthermore, the load profile or curve used to transform wind speed data (m/s) into electrical output (MWh) might significantly differ from the turbine type specific curve or the dispatch by the operators. As a result, the hedge instrument might result in a payoff from the buyer (hedger) to the seller (dealer, exchange) not compensated by higher revenues from high wind output. A related issue is how to calibrate onshore met data to offshore wind conditions, as these might differ significantly.
• Availability of assets
Further issue is the technical availability of assets. While turbine manufacturers guarantee a certain technical availability, any unexpected outages not covered by the insurance might trigger payments for the derivative while not generating actual revenues or compensations.
• Price levels
Different subsidy levels and mechanisms are also key in determining how much revenue an asset owner is losing when the asset does not generate. While insurances usually provide individually tailored notional compensations per MWh (based on asset owners’ expected revenues), this is not the case for the broadly defined wind power index. Hedging a renewable asset with a fixed remuneration per MWh based on average load data only (where 1 % equals 1 €/h according to EEX) would hardly compensate for the risk of losing the subsidy, nor the cost to rebalance the portfolio due to over- or under-generation (imbalance cost).
• Intermittency costs
When using an average (baseload) price to mitigate revenues, an issue arises with the so-called profile cost and seasonal uplift of a particular asset or portfolio (majority of renewable production usually during lower priced hours due to the merit order effect). As the load factor is the main determinant of the Wind Power Index, the latter will be unsuitable to mitigate this kind of market price risk. In this case, the best hedge would be to pick a location which best matches the wind output profile on a country level.
Based on the contract details outlined by EEX, wind futures will probably be more suitable for market participants who are not wind asset owners, but are somehow impacted by the wind generation (be it price or volume effects). The latter won’t be confronted with the operational issues described above and the determination of the sensitivity of their portfolios to changes in wind profiles is expected to be more straightforward.
Taking the complexity of calibrating futures to serve hedging purposes into account, a logical question arises whether entering into such contracts constitutes a well-informed bet rather than a hedge for future cash flows? The answer certainly depends on the analytical abilities and specifics of each business. Or maybe sometimes purely on luck?