Relevance of Risk Capital and Margining for the Valuation of Power Plants: Cash Requirements for Credit Risk Mitigation

FCN Working Paper No. 1/2010

60 Pages Posted: 4 Jun 2010

See all articles by Joachim Lang

Joachim Lang

RWTH Aachen University

Reinhard Madlener

RWTH Aachen University

Date Written: February 1, 2010

Abstract

In the electricity sector, most of the trades are still done in the OTC market without direct mitigation of credit risk. Newer discussions fuelled by the European Commission (EUCOM 2009a,b) show that there is a political will to enforce a stronger collateralization policy on all European derivatives markets, including the OTC markets. This is meant to secure the markets and prohibit arbitrage on regulatory regimes as a consequence of the financial crisis. However, collateralization does not come for free. In this study, we analyze the capital needs for margining based on commodity prices of 2007- 2009 in conjunction with the clearing rules for margining of the European Commodity Clearing AG (ECC). We apply different hedging scenarios to state-of-the-art coal- and gas-fired power plants, and the sale of outright power in the German market. Based on the set-up of our analysis, we show that in absolute terms especially outright power has quite significant cash needs for trading, whereas coal-and gas-fired power plants have less than half the needs of outright power. In relative terms for the fossil-fired power plants, we find that coal-fired power plants have a relative advantage in comparison to gas-fired plants. The need for risk capital per MWhth of coal-fired power plants is comparably lower. A major reason for this is the standard notation of coal in US-$ per ton: As one ton of coal contains approx. 7 MWh of thermal energy (which is the relevant unit for the calculation of the fuel consumption), the price change for coal in US-$ (or €) per MWh is only approximately one seventh compared to the notation in metric tons. This translates into comparably lower margining needs for the fuel variation margin of a coal-fired power plant vs. a gas-fired power plant, offering a variety of further research questions.

Keywords: Credit Risk Mitigation, Margining, Collateralization, Risk Capital, Power Plant Valuation, Portfolio Optimization

JEL Classification: G12, G32, L94, O16

Suggested Citation

Lang, Joachim and Madlener, Reinhard, Relevance of Risk Capital and Margining for the Valuation of Power Plants: Cash Requirements for Credit Risk Mitigation (February 1, 2010). FCN Working Paper No. 1/2010. Available at SSRN: https://ssrn.com/abstract=1620514 or http://dx.doi.org/10.2139/ssrn.1620514

Joachim Lang (Contact Author)

RWTH Aachen University ( email )

Templergraben 55
52056 Aachen, 52056
Germany

Reinhard Madlener

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustraße 10
Aachen, 52074
Germany
+49 241 80 49 820 (Phone)
+49 241 80 49 829 (Fax)

HOME PAGE: http://www.eonerc.rwth-aachen.de/fcn

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