Imbalance at Risk: A Key Tool in Managing Power Market Imbalances
Value at Risk (VaR) is a well known and commonly used metric for measuring the financial risk in an asset position in market based industries. The power markets are no different, and VaR is well established in the electricity sector as a measure of risk in financial and physical portfolios. In these markets VaR has traditionally focused on the day-ahead market exposure - largely because this is where most market exposure is located. But as power producers and retailers become more exposed to the imbalance markets, there is an increasing need to both measure and manage imbalance risk.
Imbalance at Risk
At Optimeering, we use the concept of Imbalance at Risk (IaR) to do this. Simply put, IaR measures the your risk to losses in the imbalance market, arising from your physical portfolio imbalances. In the past, this risk has been small and largely ignored - especially since over time imbalance losses have often later been compensated for by imbalance gains. However with increasing volatility in the imbalance markets, ignoring this risk is getting, well, increasingly risky.
IaR allows you to quickly quantify imbalance loss exposure. We start by choosing a level of statistical certainty (e.g. 5%). The IaR is then the imbalance loss or cost that you have a 5% chance of exceeding over the time period in question. So, for example, we could calculate the IaR for a wind portfolio for tomorrow. If this came out at €25000, you would expect to have a 5% chance that your imbalance costs for tomorrow would exceed €25000.
IaR can be calculated in a number of ways. Perhaps the simplest is to base the calculation on historical imbalance price movements and distributions. However, this has a number of weaknesses, not least the fact that imbalance prices and volatilities we have experienced over the past year or two are substantially different than historical levels. Also, it fails to take account of market information we can use to set our expectations around the near-term distribution of imbalance prices. Using such information - for example from an accurate imbalance price distribution forecast - can provide more insight than a vanilla historical-price-based measure. Forecast IaR (FIaR) can be a powerful tool to manage short term imbalance risk.
What time period should we look at?
A quick answer? Multiple time frames. IaR calculated over the medium term - months or years - can give you an indication of your overall financial exposure, and take account of the fact that your imbalance gains may largely offset your losses over time. This is especially true if your imbalance volumes are not correlated with imbalance prices. However, this is not always the case - we should not expect for example that imbalances in a large wind portfolio in a given price area is not correlated at all with imbalance price levels and volatility in the same area.
Short term time horizons - for example same-day, or next-day - are useful when it comes to active management of these risks. Why? Well, let’s say we are able to measure FIaR for today using a good forecast. By using active management of this exposure in those days and hours where IaR is large enough, we can minimise losses without (hopefully) impacting gains, with the consequence improvement in bottom-line portfolio return.
Example FIaR visualisation
Using IaR to manage imbalances
One example strategy is to use short-term IaR to select hours or periods to use the intraday market to close out an expected imbalance. For example, if IaR in a given hour exceeds a threshold, the intraday market could be used to close out or reduce the size of the imbalance position. An extension to this is to look at IaR over a number of hours (e.g. the front 12 hours). If IaR again exceeds a threshold, the intraday market over the coming 12 hours could be actively used to reduce IaR. This approach could involve for example intraday trades in hours where imbalance exposure is low, but that overall result in a reduction in IaR over the whole period.
Using IaR in this way can be an effective method for managing imbalance risk, by focusing trading or mitigation activity on those hours and periods where exposure is highest. It lends itself to both manual trading workflows (as you only need to focus on a few hours or periods) as well as automated imbalance management workflows.
Imbalance risk is getting real. More and more power market actors are experiencing periods where imbalance costs have hurt - and that is bottom line pain that everyone wants to avoid. IaR, as an extension of the familiar VaR methodology, is a simple yet effective way of measuring and managing imbalance risks, that lends itself to both manual and automatic imbalance management workflows. If you are interested in finding out more about forecasting imbalance markets, calculating IaR and FIaR, and using them to manage your imbalance risk, contact us at Optimeering.