Operation, Valuation and Electricity Sourcing for a Generic Aluminium Smelter

Abstract

Electricity prices vary across different geographic locations and affect the relative cost position of individual aluminium producers. Understanding the scope of electricity price risk is thus of high importance to industry players. We propose a sequential valuation and optimisation approach for investigating the relationship between operating policy, electricity sourcing and smelter value. The hybrid optimisation approach determines a heuristic operating policy with the least squares Monte Carlo (LSM) method and uses portfolio optimisation to find a corresponding electricity procurement scheme. We find that the resulting procurement scheme reduces the risk of shutdowns without compromising smelter value. In addition, the procurement scheme obtained when using demand derived from the heuristic operating policy outperforms the one found when treating demand as constant. Our findings show that there is substantial value in operational flexibility and suggest that decisions on electricity sourcing should be coupled with the operating policy. This could motivate the industry to adapt a valuation approach that captures the full value of operational flexibility and yields a corresponding operating policy.