Dynamic Hedging for a Norwegian Hydropower Producer - Electricity prices, inflow and currency risk
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This master's thesis consists of two articles. In the first article, we present a global, dynamic model for hedging of hydropower production. We include stochastic processes for spot and futures prices, reservoir inflow and currency exchange rate. We present a sequential approach, obtaining optimal production and hedging decisions separately. To manage the risk, we allow for trading in currency forwards and power futures contracts. Risk preferences are modelled using conditional risk mapping. The risk-reduction effect of currency hedging is found to be moderate - currency hedging increases the 5 % CVaR of the terminal discounted cash flows by 2.4 %. We also find that including monthly power futures in the hedging strategy allows for precision hedging that can contribute to substantial reductions in risk. In the second paper, we propose a medium-term scheduling model for hydropower production. We use a multi-factor price process in which the price of futures contracts is used to forecast future spot prices. Further, we include a short-term correlation between prices and local inflow. Our main contribution is a comparison of the performance of our scheduling model to a model in which price and local inflow are assumed to be independent and a model in which price movements are described using only one factor. We quantify the loss in expected revenues of using the latter two models compared to the case where price movements are in fact driven by multiple factors and correlated with local inflow. In both situations, we find the loss to be approximately 2-3 %.