Optimization of hydro power on the Nordic electricity exchange using financial derivatives

Abstract: Since the deregulation of the Nordic electricity market in 1996, electricity has become one of the most traded commodities in the Nordic region. The electricity price is characterized by large fluctuations as the supply and demand of electricity are seasonally dependent. The main interest of the hydro power producers is to assure that they can sell their hydro power at an attractive rate over time. This means that there is a demand for hedging against these fluctuations which in turn creates trading opportunities for third party actors that offer solutions between consumers and producers. Telge Krafthandel is one of these actors interested in predicting the future supply of hydro power, and consequently the resulting price of electricity. Several existing models employ the assumption of perfect foresight regarding the weather in the future. In this thesis, the authors develop new models for hydro power optimization that take hydrological uncertainty into account by implementing a variation of multi-stage optimization in order to maximize the income of the hydro power producers. The optimization is performed with respect to prices of financial derivatives on electricity. This gives insights into the expected supply of hydro power in the future which in turn can be used as an indicator of the price of electricity. The thesis also discusses, among other things, different methods for modeling stochastic inflow to the reservoirs and scenario construction. This practice will result in different methods that are suitable for various key players in the industry.