Co-movements between forward prices and resource availability in hydro-dominated electricity markets

Abstract

Hydropower producers estimate the opportunity value of their water, known as a water value, by comparing current prices to future opportunities. When hydropower dominates the energy mix, the system’s hydrological state predominantly governs supply and thus prices. Despite this intuitive relationship, industry practice is to assume that inflow to reservoirs and prices are independent when they establish operational policies 1–2 years ahead. To investigate the impact of this assumption, we formulate the hydropower scheduling problem as a Markov decision process and develop a novel price model that considers the joint dynamics of forward prices and inflows. We find that producers underestimate their water value when they ignore co-movements between price and inflow. The dependency makes producers more willing to postpone generation and tolerate slightly higher spillage risk. This is because high inflow periods tend to observe low prices and the reservoir capacity is limited. Nevertheless, a case study of a hydropower plant with industry data suggests modest economic losses in practice. Our numerical results suggest a potential gain of 0.17% in expected revenue and approximately unchanged revenue variance if producers consider the co-movements when establishing an operational policy.