Value of Flexibility for an NGCC When Arbitraging between Physical and Financial Options

Abstract

The standard approach of evaluating flexible power plants in deregulated markets is by modelling the spark spread. While this takes account of the volatility of electricity prices and cost of gas and CO2, it does not take account of technical costs (such as ramping up and down) and it ignores the technical constraints. Ideally the configuration of the plant should be optimized considering both financial and technical aspects including the flexibility. As this is too computer intensive we propose a two step approximation: first technical optimization to select an optimal subset of plants then the final choice by considering flexibility and price uncertainty. Then we evaluate a flexible operating strategy that can only be carried out by the owner of a power plant. The basic strategy consists of buying long-term gas futures and selling long-term electricity futures using the gas to generate the electricity to fulfill the futures contracts. The arbitrage consists of buying the electricity on the day-ahead market and selling the unused gas when this is more profitable after taking all the costs and technical constraints into account. To illustrate how this strategy works, we consider the case of an investor in the French market with a natural gas combined cycle (NGCC) with a capacity of about 400MW that can deliver electricity in 4 hour blocks.

Keywords: flexible operating strategy, trivariate model, gas, electricity, CO2, stochastic volatility, futures contracts, day ahead, two step approximation, technical optimisation, financial optimisation, technical constraints, efficiency, ramp-up

JEL Classification: C32, C63, D81, G13