Electricity Trading

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My head hurts! Here are some basics if you want to learn how to trade “Australian”:http://www.d-cyphatrade.com.au/products/overview_of_the_australian_el electricity. (“pdf”:http://www.d-cyphatrade.com.au/products/overview_of_the_australian_el/overview_of_australian_electr_2.pdf) Some sites:

* “SFE Initial Margin”:http://www.asx.com.au/professionals/clearing/operations/initial_margin_calculations.htm
* “SFE Corporation Ltd”:http://www.asx.com.au/about/sfe/index.htm is the formal name of the Sydney Futures Exchange and merged with the Australian Stock Exchange 25 July 2006. A funny aside, it started in 1960 as the Sydney “Greasy Wool”:http://www.tis-gdv.de/tis_e/ware/fasern/wolle/wolle.htm Futures Exchange 🙂

What can you trade on the SFE are “futures”:http://www.d-cyphatrade.com.au/products/electricity_futures (“pdf”:http://www.d-cyphatrade.com.au/products/electricity_futures/base_load_futures/futures_options_contract_spec.pdf)

# Base Load futures. 1MW/hour is a single contract. They are dong quarterly for 16-17 quarters out. This is for the entire 24 hour day
# Peak Period futures. 1MW from 0700-2200 Mondy to Friday
# Strip futures. This is where you can buy a consecutive set of quarters like an entire year 2009.
# Base $300 Caps. This is where you are paying for the number of hours where the base load exceeded $300. The settlement price is take the average of all prices that are above $300 (so for instance, over the quarter, say there were 10 hours where the price was above $300 and the average of those prices was $1000). Then on average the price was $70 higher than $300 and that is the settlement price.
# Option for a 1MW of base load
# Option for a strip.
# Caps. If you buy a cap, it means that you will never see a price higher than $300/MwH. So it provide price protection and is insurance. Why would you sell one? If you see the price is high enough that you don’t think this will happen much.
# Swaps. This means that you are saying that if you buy a future, say $55 NSW Q42009 means you are saying that if the price of NSW is above $55, then you make money. That is you are getting a price of $55 in Q4 in NSW. Why would you buy one, if you think the price is headed up and you want to lock in a lower price. You would sell if you think the prices for electricity are going dwon.
# You can buy these for only for off-peak times or for all times.

The hardest concepts are:

* “Value at Risk”:http://en.wikipedia.org/wiki/Value_at_risk which is a standard measure for what the probability of a market loss is. For instance a 5% VaR of $1M means that there is a 5% probability that the portfolio will lose $1M tomorrow. Most commonly you use either 1 or 5% chance and one day or two week horizons. If you actually have this loss, it is called a VaR break. The most important idea is that you can assume 2-3 losses per year that exceed the 1-day 1% VAR. Also, when you have a VAR break, you can’t estimate how big the loss is going to be and it could be huge because VaR excludes catastrophic events when you do the math.

There is a huge list in the bibliography, but I like “Perfect Storms” – Beautiful & True Lies In Risk Management

“Earnings at Risk”:”http://stlouisfed.org/col/director/alco/reviewreports_earningsatrisk.htm” is what you use when you are very close to the close of the futures contract. Now the price is going to rapidly converge to the spot price. So you use a different model. Whereas VaR is statistical over a range of forward distributions, EaR is historical and you simulate what has happened over history and then all the VoLL premium which is the price added because of spikes when you are short.

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