Optimizing Hedging Strategies for Hydropower Producers Using Forwards: Investigating the Effects of Seasonality in the Price-Load Relationship for the Norwegian Electricity Market

Abstract

When there is seasonality in the price or volume of a commodity, risk management strategies ought to be adjusted accordingly. Using the Norwegian electricity market as a case, this thesis examines the gains from implementing seasonal varying hedge ratios. To complement the analysis, relevant risk metrics are evaluated and compared. Using data spanning over a decade, we find that a seasonal trend is apparent in the price-load relationship. A linear relation is confirmed for the winter with a weakening tendency when approaching summer from each side, where it is non-existent. The observed seasonality is explained by the characteristic supply stack and varying demand throughout the year, with the prices being more demand-driven during winter. A strong price-load correlation implies a more sensitive cash flow. This indicates that there is seasonality in the optimal hedging strategy, requiring higher hedge ratios during winter. Performing hedge ratio optimizations, CVaR is found to be the superior risk metric. The optimized hedge ratio exhibits a clear seasonal pattern. As expected, the ratio is highest during winter and lowest during summer, reflecting the trend of the price-load correlation. Our results show that a seasonal varying hedge ratio outperforms a more static strategy, reducing downside risk and simultaneously increasing profit. Consequently, this thesis clearly shows that seasonal varying hedge ratios ought to be implemented as a part of a hydropower producer s hedging strategy.