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A tutorial on portfolio-based control algorithms for merchant energy trading operations

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  • Secomandi, Nicola

Abstract

Merchant energy trading companies operate energy conversion facilities and infrastructure via direct or contractual ownership. Portfolio-based control algorithms are a real option approach that practitioners use to manage these assets. To avoid potential model error, this approach represents the operations of these assets as portfolios of traded financial instruments on energy commodities. Optimization of the portfolio composition subject to the asset operational constraints yields a market-value, an operating policy, and a financial hedge for the asset. We provide a tutorial on this methodology, focusing on examples of natural gas transport and storage assets. We frame the presentation within the typical organizational structure of merchant energy trading companies. We also discuss limitations of this approach and their possible remedies.

Suggested Citation

  • Secomandi, Nicola, 2016. "A tutorial on portfolio-based control algorithms for merchant energy trading operations," Journal of Commodity Markets, Elsevier, vol. 4(1), pages 1-13.
    • Handle: RePEc:eee:jocoma:v:4:y:2016:i:1:p:1-13
    DOI: 10.1016/j.jcomm.2016.10.003
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    References listed on IDEAS

    as
    1. Swindle,Glen, 2014. "Valuation and Risk Management in Energy Markets," Cambridge Books, Cambridge University Press, number 9781107036840.
    2. Nicola Secomandi, 2010. "On the Pricing of Natural Gas Pipeline Capacity," Manufacturing & Service Operations Management, INFORMS, vol. 12(3), pages 393-408, October.
    3. Thompson, Matt, 2016. "Natural gas storage valuation, optimization, market and credit risk management," Journal of Commodity Markets, Elsevier, vol. 2(1), pages 26-44.
    4. Nicola Secomandi, 2015. "Merchant Commodity Storage Practice Revisited," Operations Research, INFORMS, vol. 63(5), pages 1131-1143, October.
    5. Mihaela Manoliu, 2004. "Storage Options Valuation Using Multilevel Trees And Calendar Spreads," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 7(04), pages 425-464.
    6. repec:dau:papers:123456789/607 is not listed on IDEAS
    7. Petter Bjerksund & Gunnar Stensland & Frank Vagstad, 2011. "Gas Storage Valuation: Price Modelling v. Optimization Methods," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 203-228.
    8. Nicola Secomandi & Mulan X. Wang, 2012. "A Computational Approach to the Real Option Management of Network Contracts for Natural Gas Pipeline Transport Capacity," Manufacturing & Service Operations Management, INFORMS, vol. 14(3), pages 441-454, July.
    9. Secomandi, Nicola & Seppi, Duane J., 2014. "Real Options and Merchant Operations of Energy and Other Commodities," Foundations and Trends(R) in Technology, Information and Operations Management, now publishers, vol. 6(3-4), pages 161-331, July.
    10. Nicola Secomandi, 2010. "Optimal Commodity Trading with a Capacitated Storage Asset," Management Science, INFORMS, vol. 56(3), pages 449-467, March.
    11. Nadarajah, Selvaprabu & Margot, François & Secomandi, Nicola, 2017. "Comparison of least squares Monte Carlo methods with applications to energy real options," European Journal of Operational Research, Elsevier, vol. 256(1), pages 196-204.
    12. Nicola Secomandi, 2008. "An Analysis of the Control-Algorithm Re-solving Issue in Inventory and Revenue Management," Manufacturing & Service Operations Management, INFORMS, vol. 10(3), pages 468-483, December.
    13. Nicola Secomandi & Guoming Lai & François Margot & Alan Scheller-Wolf & Duane J. Seppi, 2015. "Merchant Commodity Storage and Term-Structure Model Error," Manufacturing & Service Operations Management, INFORMS, vol. 17(3), pages 302-320, July.
    14. Helyette Geman, 2005. "Commodities and Commodity Derivatives. Modeling and Pricing for Agriculturals, Metals and Energy," Post-Print halshs-00144182, HAL.
    15. James E. Smith, 2005. "Alternative Approaches for Solving Real-Options Problems," Decision Analysis, INFORMS, vol. 2(2), pages 89-102, June.
    16. Guoming Lai & François Margot & Nicola Secomandi, 2010. "An Approximate Dynamic Programming Approach to Benchmark Practice-Based Heuristics for Natural Gas Storage Valuation," Operations Research, INFORMS, vol. 58(3), pages 564-582, June.
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    2. Mayer, Klaus & Trück, Stefan, 2018. "Electricity markets around the world," Journal of Commodity Markets, Elsevier, vol. 9(C), pages 77-100.

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