Managing Weather Risk in Electricity Markets

Together with N Lange (CBS Copenhagen) and TÅ Myklebust (NHH), FE Benth have developed a framework for valuation and hedging of quanto-option contracts, a new class of energy-derivatives to hedge volume risk. We are the very first to propose a reasonable and efficient framework for valuation of quanto-options. FE Benth has in collaboration with N Detering (Frankfurt Business School), we have solved the hedging problem related to quantos when there are trading limitations. FE Benth has co-authored with JS Benth (Ahus, UIO) a monograph on stochastic modeling and pricing in weather markets, published in 2013 by World Scientific. Ambit fields is a class of stochastic processes in time and space that efficiently can model weather phenomena like temperature and wind, as well as forward prices in energy markets. We have developed a stochastic integration theory for these processes that can serve as a tool for further analysis and modelling using these fields. This has been done by FE Benth in collaboration with A Veraart (Imperial College, London), O Barndorff-Nielsen, J Pedersen (Århus) and A Suess (Barcelona). This work serves as the core in a scientific monograph on "Ambit Stochastics" with FE Benth, O Barndorff-Nielsen and A Veraart that is in its finalizing stage autumn 2015. Here developments of FE Benth and H Eyjolfsson (Bergen) on numerical simulation of ambit fields will also be discussed. FE Benth with B Ruediger (Wuppertal) and A Suess (Barcelona) have proposed a novel random field model for forward prices with stochastic volatility. C Kluppelberg (Technical University of Munich) presented a two-day intensive course on advanced stochastic modelling of electricity markets and wind fields in September 2012. In September 2013, R Aid (EDF) presented at two-day intensive course on energy market modelling and optimization. The two courses attracted all together 50 participants, with 20 representatives from industry (Thomson Reuters PointCarbon, Norwegian Computing Center, Statkraft, SKM Energy). R Kiesel (Universitat Duisburg-Essen) gave an intensive course with the title "Fundamental challenges in the European electricity markets" in October 2014. The course was an integrated part of a workshop for the industry with the title "Stochastics and Risk for the Energy Markets", organized in collaboration with the Center of Advanced Study (CAS). It attracted more than 40 participants from academia and industry, listening to speakers from Verbund Energy (Austria), EDF (France), Statkraft. T Meyer-Brandis (LMU Munchen) lectured on the intensive course in October 2015, where the topics were systemic risk and information in the energy markets. Industry participants included Stakraft and E-Co. P Kruhner has worked with FE Benth on developing the theory for pricing of the futures markets. New results on representations of the price curves using advanced theory has been found. In particular, explicit connections between typical energy spot price factor models and infinite dimensional models have been derived along with definitions of Levy processes in function spaces. Kruhner finished his post doc in August 2014, and has moved on to a 6 year post doc position at the Technical University of Vienna, Austria. PhD student H Zdanowicz submitted her thesis in September 2015. The committee has approved her thesis, and the defence will take place February 12, 2016. She has worked out new approximative formulas for the pricing of spread options, as well as new models for temperature forward price smoothing. Noteworthy is her last paper on empirical analysis and solar power generation in collaboration with A Veraart. This paper presents new insights into the stochastics of photovolatiac power production. I Taib defended succesfully his PhD thesis in June 2013. He held a scholarship from the Malaysian state, and was associated to the MAWREM project. The personell has been active on conferences, in particular participated on the thematic program at the Fields Institute in Toronto in August 2013 on climate and energy finance. Moreover, FE Benth is co-organizer of a thematic year at the Wolfgang Pauli Institute in Vienna on energy, finance and environment, lasting since 2012. The academic year 2014/15 FE Benth co-organized with Giulia Di Nunno a Center for Advanced Study at the Academy in Oslo, named Stochastics of Financial and Environmental Economics. In October 2013 we organized with R Kiesel in Essen the annual Energy & Finance Conference. It attracted more than 140 participants from Europe and the US, where 1/3 came from industry. Both FE Benth and P Kruhner gave talks at the conference. FE Benth has given invited presentation for the industry at the "Cutting Edge 2013" meeting at the University of Oslo in the fall 2013. In addition, he has given intensive two-day industry courses in London and Stockholm targetting the European energy industry. Finally, he held the MAWREM industry day on December 7th.

With renewable sources of energy becoming more dominant in the production of power, the energy markets will become (even) more dependent on variations in weather. In this project we will model and analyse weather risk in energy markets, and investigate ho w actors on the market can manage this risk. We focus on two power markets, namely NordPool and EEX, and investigate how weather factors like temperature, precipitation and wind impact prices. We want to quantify this using stochastic models which are tr actable for further analysis. The challenge is to develop models which appropriately include the relationships between weather factors and prices. Another challenge that we aim at solving is to correctly model the dependencies between different energy mar kets that are connected, through weather factors on one had, but also through interconnectors and fuels on the other. We focus on multivariate stochastic models for the market price dynamics, and sought to include related markets like the ones for emissio ns and temperatures. As an application of our advanced multivariate price models, we will analyse risk management using derivatives. Such derivatives include plain vanilla options on energy, temperature and emissions, but also more exotic spread and quan to options. The latter two classes of derivatives depend on the covariation between two or more prices and risk factors. Questions like pricing and hedging of these contracts will be investigated. The outcomes of this project will make the foundation for the power industry to face the risk challenges from a growing impact of weather coming from renewable energy like for example wind power and trading with emission permits. This is important aspects for energy markets in transition from coal and gas fuele d power production towards more "green" generation of electricity.