The Optimal Choice of the Strike Price for Energy Swing Options

Peter Gross*, Raimund Kovacevic and Georg Pflug

Energy swing options are supply contracts, where the holder is free to specify the amounts to be delivered on short notice, paying a fixed price per unit delivered. Due to special characteristics of energy markets, risk elimination by replication of these contracts at energy markets is not possible. As a consequence, when selling delivery contracts, an electricity producer has to explicitly consider the risk emanating from fluctuations in supply cost and demand. The impact of these risk factors can be influenced by the contract seller to a certain extent: Supply cost and fluctuations can be absorbed by the own generation portfolio whereas demand fluctuations can be influenced by the choice of the strike price, implicitly changing the consumers behavior. Considering this, the determination of the optimal strike price can be formulated as a stochastic bilevel problem where the optimal decision of one player (price setting and production) has to consider the optimal decision of a second player (consumption depending on the price). We illustrate the problem and its specific difficulties, present a tailored solution algorithm and provide computational results.

Mathematics Subject Classification: 97M40 90C15 91A65

Keywords: stochastic bilevel program, swing option pricing

Minisymposion: Stochastic Models for Optimization of Electric Power Systems