Michael Giberson
Recently Southwestern Public Service (SPS), a local utility affiliated with Xcel Energy, issued two RFPs seeking wind power and dispatchable power resources.
Among the language in both RFPs, an assertion that in evaluating the proposals “SPS seeks to diversify and minimize the development risk in its selected portfolio.” But, ideally, they should aim beyond minimizing development risk, and seek to maximize the value of the portfolio of resources they hold given the level of risk acceptable to the company.
“The concept of fuel mix diversity as applied to electricity generation is intuitively appealing, but remains ill-defined,” writes Fabien Roques in a post at the EU Energy Policy Blog, “Learning from financial methods to optimize power generation portfolios.” Roques explains how portfolio theory and other insights from financial economics can help turn the ill-defined concept of fuel mix diversity into a practical tool for managing long-term plans.
As the financial crisis makes headlines around the world, it might seem to say the least a bit provocative to assert that the energy industry could learn anything from the financial sector in terms of risk management. We argue that some analytical methods borrowed from the financial literature (Portfolio Theory and Real Options) can be successfully applied to the energy sector to gain insights on the value of fuel mix diversification as a hedge against a wide range of risks….
Portfolio theory is highly suited to the problem of planning and evaluating electricity portfolios and strategies because energy planning is not unlike investing in financial securities where financial portfolios are widely used by investors to manage risk and to maximize performance under a variety of unpredictable outcomes. Similarly, it is important to conceive of electricity generation not in terms of the return of a particular technology today, but in terms of its contribution to a utility or a country generation portfolio return. At any given time, some alternatives in the portfolio may have a low return on investment while others have a higher return costs, yet over time, an astute combination of alternatives can serve to maximize the overall generation portfolio return relative to the risk.
Coincidently, just this morning I started reading Roques article appearing in the latest Utilities Policy, “Technology choices for new entrants in liberalized markets: The value of operating flexibility and contractual arrangements.”