A stochastic model for hedging electricity portfolio for an hydro-energy producer

A stochastic multi-stage portfolio model for a hydropower producer operating in a competitive electricity market is proposed. The portfolio includes its own production, a set of power contracts for delivery or purchase including contracts of financial nature as forwards to be able to hedge against risks. The goal of using such a model is to maximise the profit of the producer and reduce the economic risks connected to the fact that energy spot and forward prices are highly volatile. Our results show that, forward contracts can be used for hedging purposes if we assume that their price can be derived by the spot dynamics. In incomplete markets the relationship between spot and forward price is non uniquely determinate. If we explicitly model the spot and the forward dynamicss we can obtain consistent scenarios which allow for speculative behaviour. Beyond financial gains, the convenience of using financial contracts is a more efficient use of the hydroplant, taking advantage of the possibility of pumping water and ending up with a higher final value of the reservoir.