Valuation of renewable energy assets – Electricity markets

Valuation of renewable energy assets – Electricity markets

An electricity market is basically the connecting link between the renewable energy asset and the real economy – and also the connecting link between your investment and the topline of your profit and loss statement. To comprehend the monetization potential of the asset you want to invest in, you need to understand the particular market design and how exactly the electricity is being sold on the market.

You want to invest in a renewable energy asset (for example in a wind farm) – therefore you (or your advisers) need to have a solid understanding regarding

  1. Profile risk (sometimes labelled as cannibalization)
  2. Balancing risk (risk caused by the deviations between day ahead feed-in forecast and the actual production)

Regarding profile risk – this is caused by the correlation between renewables feed-in and market prices – simply when it is windy, the electricity market prices are lower – and vice versa (it is driven by the price building mechanics and the steepness of the merit order curve). This is a fundamental issue – this can really hurt your topline if not mitigated properly in the PPA. There are ways how to hedge this risk and how to make it more manageable – you just need to know exactly how.

In term of the balancing risk – it is caused by the inaccuracy of day-ahead production forecast. Bulk of the electricity is normally sold in the day-ahead spot market. However, this becomes tricky for renewable energy generation which is characteristic for its stochastic production. The deviations between the forecasts and the actual production can become quite costly – some electricity markets impose significant penalties for such inaccuracies.

To understand the electricity market design – especially regarding the profile and the balancing risks is crucial for a proper investment valuation (and also for ongoing management of the corresponding risks). In the following articles we will provide more clarity on each of these two risks and what the best way for hedging is.