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Valuing virtual production capacities on flow commodities

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  • Juri Hinz

Abstract

As a result of storability restrictions, the price risk management of flow commodities (such as natural gas, oil, and electrical power) is by no means a trivial matter.To protect price spikes, consumers purchase diverse swing-type contracts, whereas contract writers try to hedge themselves by appropriate physical assets, for instance, using storage utilities, through transmission and/or production capacities. However, the correct valuation of such contacts and their physical counterparts is still under lively debate. In this approach, an axiomatic setting to discuss price dynamics for flow commodity contracts is suggested. By means of a minimal set of reasonable assumptions we suggest a framework where the standard change-of-numeraire transformation converts a flow commodity market into a market consisting of zero bonds and some additional risky asset. Utilizing this structure, we apply the toolkit of interest rate theory to price the availability of production capacity on a flow commodity. Copyright Springer-Verlag 2006

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  • Juri Hinz, 2006. "Valuing virtual production capacities on flow commodities," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 64(2), pages 187-209, October.
    • Handle: RePEc:spr:mathme:v:64:y:2006:i:2:p:187-209
    DOI: 10.1007/s00186-006-0087-z
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    References listed on IDEAS

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    1. Eugene F. Fama & Kenneth R. French, 2015. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums, and the Theory of Storage," World Scientific Book Chapters, in: Anastasios G Malliaris & William T Ziemba (ed.), THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 4, pages 79-102, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Doege, Jörg & Fehr, Max & Hinz, Juri & Lüthi, Hans-Jakob & Wilhelm, Martina, 2009. "Risk management in power markets: The Hedging value of production flexibility," European Journal of Operational Research, Elsevier, vol. 199(3), pages 936-943, December.
    2. Fanelli, Viviana & Maddalena, Lucia & Musti, Silvana, 2016. "Modelling electricity futures prices using seasonal path-dependent volatility," Applied Energy, Elsevier, vol. 173(C), pages 92-102.
    3. Nadarajah, Selvaprabu & Secomandi, Nicola, 2023. "A review of the operations literature on real options in energy," European Journal of Operational Research, Elsevier, vol. 309(2), pages 469-487.

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