ENERBIZ Il: Strategy and Risk Management in Electricity Trading
Franco, C. J.*, Vargas, B.*, Arango, S. **, Bedoya, L. **, Ochoa, P., ** Dyner, I.**
*Interconexion Eléctrica E.S.P., S.A.
**Universidad Nacional de Colombia
cjfranco@ isa.com.co
idyner@ perseus.unalmed.edu.co
ABSTRACT
The electricity market in Colombia has been immersed in a competitive environment in
which trading is a high-risk activity involving a large number of agents. Those agents
should have specialised knowledge on the market to develop strategies and manage the risk.
ISA, the Colombian Grid Company, and the National University of Colombia developed a
workshop for energy trading in Colombia supported by a microworld named ENERBIZ. In
the first version of the microworld, the user assumes the role of a trader under different
hydrology scenarios and learns about the market before confronting his task under real-life
situations.
The second stage of this workshop, named ENERBIZ II, is intended to the learning of
strategy and risk management tools. The strategy approach seeks to develop competitive
advantage skills. With the risk management module, the user leans the more important
concepts of risk, efficient portfolio and measure of the risk associated to electricity trade.
Presentation
The Colombian electricity agents are facing several problems derived from their poor
knowledge of the market rules and the decision making process. Small utilities and
generators are mainly affected by the lack of analysis tools in this environment. ENERBIZ
I was intended to provide tools for dealing with the market uncertainty and dynamism.
Trading means buying electricity for sale to both final users and/or other market agents.
Purchases and sales can be performed in two different ways: using bilateral contracts, and
in the electricity pool. ENERBIZ I was made for trading because it involves almost all
agents in the market and has a high potential number of users.
The activity of trading has the same problems of several organizations: individuals and
groups need adequate training in topics related to both risk analysis and corporate strategy,
in order to take advantage of market opportunities in a competitive environment.
ENERBIZ | is a helpful analysis tool to support training programs. It has been used in
several workshops with traders, regulators, generators, etc. of the Colombian Electricity
Market to explain the dynamics associated and the role of a trader buying and selling
electricity, using different types of contract.
Among other microworlds that inspired the creation of ENERBIZ I, are: The Beer Game
[1], People Express [1], Oil Producers [1] and Beefeater Restaurants [2], see Langley and
Larsen [3] for a brief description of most of them.
ENERBIZ I was the first approach to the learning of the basis of strategy and risk
management. There is a need for tools to take advance of the market, and ENERBIZ II is
focused on strategy concepts in electricity trading and risk analysis and management. This
paper present ENERBIZ II, as a microworld built to support the training of traders in the
Colombian electricity market, but focusing on strategy and risk management. In the
following sections we briefly present the system dynamics model, some of its most
important features, the added modules, and the application of new concepts.
Model
ENERBIZ II is a new version of the microworld and is supported in a system dynamics
model. The general structure of ENERBIZ I remains unchanged, but some new concepts
and modules were added. The general system representation of the trading business is
shown in Figure 1.
In Figure 1, energy traders have to take into account the pool price, contract market, and
regulation. Both pool market and contract market are constrained by regulation policies.
Moreover, energy availability has an effect on pool and contract prices. Finally, we have to
include in the model two customer markets: large users with free-market access and small,
regulated users. The microworld includes the trading business, competitors and final users
in order to represent the Colombian electricity market.
Thermical
Plants
Figure 1. General Structure of the System: model to support the Microworld
Simulated
Company
Small
(Regulated)
Large
Customers
(Free)
The interface of ENERBIZ permits several options to make decisions and to see a lot of
graphic and tabular reports (Dyner 2000). The interface tries to give a pleasing and modern
environment where the trainee can develop skills on contract electricity. The figure 2
shows the decision- window in ENERBIZ I, while figure 3 shows some standard reports.
Compras Ventas jPrecios del Mercado |
Pague lo Contratado || Pague lo Contratado Pague lo Contratado
Cantidad Cantidad Precio sewn
(oan) an) On) 3Meses 6262
3meses [ 10-24 ameses [ i004 [454 ore ome
12Meses [20-4 42meses [4ST SOL 36Meses [83.37
36Meses [5044 geMeses [ 0=4[ 0-4) | Pague lo Demandado
sawn
Pague lo ee Paque lo ore _ 5 me
‘ope ‘ope recio
ay (Min, ny ‘12 Meses 62.50
SMeses [30-44 Shess | 1004, at Flys! 63.36
taveces [Tis] || tamesee [mad [re | Preciode Bolsa
Precio de Bol.
S6Meses [5544 meses [ rss{f 35st Asch rieso | m7
Exposici6n a Bolsa | Mercadeo
Compras: ("| Inversion en Mercadeo: p 4
Ventas. [aay (Porcentaje de las Ventas) =
I ‘Ubique el puntero del mouse sobre alguno de los objetos de este cuadro para consultar su definicion
Figure 2. Windows decision of ENERBIZ I
Customerss
Transocciones en E
r
Pagos por Garariias.
Demands Requads
‘Clircatre Actaror)
Figure 3. Graphics report of ENERBIZ I.
ENERBIZ II is intended to teach basic concepts about corporate strategy and risk
management applied to electricity market. Some theoretical issues are explained and
practised through workshops that make use of the microworld.
The new version of the model has a deeper representation of the company, and the trainee
can make many more decisions than in ENERBIZ I. The model is now more detailed in the
representation of the market, in aspects such as investments and contracting options.
ENERBIZ II allows energy risk management by using portfolio theory and value and risk.
The new concepts developed in ENERBIZ II are explained below.
Strategy
ENERBIZ II can be used as support to business-strategy teaching. ENERBIZ II also
intends to ease the practice and learning of tough concepts through the interaction with its
Microworld. In ENERBIZ, a company achieves sustainable competitive advantage through
a good resource management, using three different kinds of investment decisions:
Innovation and Technology, Human Resources, and Marketing and Customer Service.
An adequate share of investment on the items mentioned before is essential to achieve both
a sustainable growth of the company, and the goals of the managers. If a company invests
all the capital in innovation and technology, without investing in human resources or
customer service, will probably get no benefit.
When you invest only in human resources you can get a short-run growth because the
market changes quickly and the company becomes obsolete. The same situation happens if
you only invest in marketing and customer service.
Risk - trade electricity
Trade of electricity faces new risks and offers opportunities. Thus, management and
valuation of risk have become important for power markets. In Colombia, hydrology plays
an important role in the volatility of electricity prices. Because of this, the management
and valuing of risk are necessary tools for trading electricity in Colombia.
ENERBIZ II intends to teach some concepts about management and valuing risk through
double-loop learning (Argirys, 1977). The main concepts explained in the microworld are
portfolio theory to manage risk and value at risk, both in the electricity markets.
Portfolio theory was initially developed for Markowitz in 1952; now it is a standard tool
applied to manage risk in financial markets. Portfolio theory intends to take advantage of
different features of assets in the market for minimising the inversion risk with a given
retum (Elton and Gruber, 1995). The main concept used in portfolio theory is
diversification, which is to choose a group of assets that do not have similar retum by
balancing assets, with high and low risks and returns (Brealey and Meyers, 1996).
On the other hand, Value at risk is an important measure to which a given
portfolio is subject to different kinds of risk present in financial markets.
Considerable amount of research has been dedicated in recent years to the
development of acceptable methods for evaluation of this risk measure (Fusaro,
1995). Value at Risk (VAR) is an important measure of exposure of a given
portfolio of assets to different kinds of risk inherent in financial environment. By
now, it has become a tool for risk management and part of industrial regulatory
mechanisms.
Portfolio’s VAR is the minimum expected lost in a period of time with a given
confidence level which is expressed in reference currency (Blanco and Garman,
1999). For example if the VAR for a day of a portfolio is 10 millions of pesos with 95% of
confidence level, there is a probability of 5% for losing 10 millions of pesos in the next 24
hours.
The microworld is intended to give the concepts that allow the trainees to learn basic
concepts about portfolio theory to manage risk in volatile markets and Value at Risk to
quantify this risk. This knowledge allows them to improve their performance in the
electricity market in Colombia.
For leaming to manage and value risk by using the microworld there are six steps, which
are shown in the Figure 3, and explained below.
* Market analysis: It pretends to analyse the available assets (risk and retum) and trainee
risk position (Value at Risk).
* Stating scenarios: According to market analysis, the trainee defines some scenarios that
he wants to test by using the microworld.
* Stating strategies and objectives: The trainee defines his objectives and strategies, based
on the chosen scenario, and his mental models about the risk in the market.
* Making decisions: By using the microworld, the trainee makes decisions. According to
his defined strategies, he creates a portfolio and has decides to take a risk, which is valued
by VAR.
¢ Performance analysis: The simulated market shows the trainee performance, which
must be analysed by comparing the stated and achieved objectives.
* Feedback and development of strategies and objectives: By asking and answering
questions about the performance, and under the guidance of experts, the trainee reinforces
or restructures the mental models about management and valuing risk. Then the trainee
may state a new scenario and repeat the double-loop learning shown in Figure 1.
Decisions
Strategies y YY
Objectives Simulated
Market
(Microworld)
Scenarios
Information
Mental Models — Risk - Return
Value at Risk
Figure 3. Management and valuing of risk at the Microworld.
Final comments
ENERBIZ II has been applied in a workshop where the concepts of trading, strategy and
risk management for the Colombian electricity market are included. Its risk-management
module allows not only that the user understands the market structure and dynamics, but
also that he acquires the specific skills to manage uncertainty and risk in the energy market.
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