Risk Capital Requirements for Energy Commodities – Analysis on the Impact on Power Plant Values
In the aftermath of the recent financial crisis in the banking sector from 2007–2009, credit risk mitigation has gained significant importance in the markets. As billions of Euros have had to be raised to save several banks from bankruptcy by countries all over the world, institutions like the European Commission are calling for a stronger general control, especially over derivative markets, via the application of centralized clearing mechanisms. These regulations will heavily influence European utilities, as the majority of their trades are still conducted in over-the-counter (OTC) markets without clearing. These additional clearing cash requirements will increase the working capital requirements for utility companies, independently of the hedging strategies and the traded volumes.
In our analysis we characterize and describe the impacts of margining on power plants, clustered by different fuel types. Our study is particularly focused on power plant valuation, portfolio optimization and portfolio selection problems for power plants, given liquidity constraints. We give a deeper understanding of the effects of margining on the cash flow of power plants, and the resulting risk capital needs (FCN Working Paper No. 1/2010).
A sub-study explores the impact of margining on financial costs in comparison to direct management and intentional acceptance of credit risk. For this purpose we evaluated the losses due to defaulting business partners given the interest requirements of the cash reserve cushion for an assumed margining account. We compare a scenario that assumes 100% margining with a scenario in which none of the credit risk is collateralized. We test the robustness of our model by evaluating sensitivity with respect to commodity prices, partner structure of sales/purchase portfolios, and the underlying fuel mix (FCN Working Paper No. 13/2010, revised May 2011).
In another strand of our analysis, we look into the interaction of market-, credit- and margining risk, using the expected shortfall of the cumulated gross margin as an indicator of the necessary economic capital of a given power plant portfolio. Comparing a classical linear risk aggregation to the results of an integrated approach using copulas in cash restricted environments, we assess the impact of an integrated risk assessment on the trading policy of a German utility (FCN Working Paper No. 11/2010).
Lang J., Madlener R. (2010). Relevance of Risk Capital and Margining for the Valuation of Power Plants: Cash Requirements for Credit Risk Mitigation, FCN Working Paper No. 1/2010, Institute for Future Energy Consumer Needs and Behavior, RWTH Aachen University, February.
Lang J., Madlener R. (2010). Portfolio Optimization for Power Plants: The Impact of Credit Risk Mitigation and Margining, FCN Working Paper No. 11/2010, Institute for Future Energy Consumer Needs and Behavior, RWTH Aachen University, September.
Bellmann E., Lang J., Madlener R. (2010). Cost Evaluation of Credit Risk Securitization in the Electricity Industry: Credit Default Acceptance vs. Margining Costs, FCN Working Paper No. 13/2010, Institute for Future Energy Consumer Needs and Behavior, RWTH Aachen University, September (revised May 2011).