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Real Options and Merchant Operations of Energy and Other Commodities

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  • Secomandi, Nicola
  • Seppi, Duane J.

Abstract

The value chain for energy and other commodities entails physical conversions through refineries, power plants, storage facilities, and transportation and other capital-intensive infrastructure. When the operation of such commodity conversion assets occurs alongside liquid markets for the input and output commodities, the operating flexibility of conversion assets can be managed as real options on the underlying commodity prices. Merchant operations is an integrated trading and operations approach that (i) buys and sells commodities to support market-value maximizing operating policies and (ii) values conversion assets, for capital budgeting and trading purposes, based on the cash flows such policies produce. This monograph provides a unique integrated finance and operations perspective on the topic of merchant operations. In particular, this monograph introduces the concept of merchant operations; presents the basic principles of option valuation; surveys foundational models of commodity and energy price evolution; analyzes the structure of optimal operating policies for commodity conversions, focusing specifically on inventory and other intertemporal linkages in storage, inventory acquisition and disposal, and swing assets; considers a variety of heuristic storage operating policies; and discusses future trends in this multidisciplinary area of research and business applications.

Suggested Citation

  • 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.
  • Handle: RePEc:now:fnttom:0200000024
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    File URL: http://dx.doi.org/10.1561/0200000024
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    Citations

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    Cited by:

    1. 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.
    2. Yangfang (Helen) Zhou & Alan Scheller-Wolf & Nicola Secomandi & Stephen Smith, 2016. "Electricity Trading and Negative Prices: Storage vs. Disposal," Management Science, INFORMS, vol. 62(3), pages 880-898, March.
    3. 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.
    4. 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.
    5. Nicola Secomandi, 2015. "Merchant Commodity Storage Practice Revisited," Operations Research, INFORMS, vol. 63(5), pages 1131-1143, October.
    6. Benth, Fred Espen & Koekebakker, Steen, 2015. "Pricing of forwards and other derivatives in cointegrated commodity markets," Energy Economics, Elsevier, vol. 52(PA), pages 104-117.

    More about this item

    Keywords

    Merchant operations; Real options; Energy; Commodities; Conversion assets;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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