Analysis of fixed volume swaps for hedging financial risk at large-scale wind projects

Highlights: • Large scale wind power projects are increasingly seeking financial hedging contracts to mitigate exposure to price risk. • Fixed volume price swaps pose significant liabilities for wind power producers in the form of "shape risk" and "basis risk". • We identify alternative contract designs that are more effective at hedging at a lower cost than conventional fixed volume swaps. Large scale wind power projects are increasingly selling power directly into wholesale electricity markets without the benefits of stable (fixed price) off-take agreements. As a result, many wind power producers seek financial hedging contracts to mitigate exposure to price risk. One particular hedging contract - the "fixed volume price swap" - has gained widespread use, but it poses several liabilities for wind power producers that reduce its effectiveness. In this paper, we examine problems associated with fixed volume swaps and explore possibilities for improving their performance. Using a hypothetical wind power project in the Southwest Power Pool (SPP) market as a case study, we first look at how "shape risk" (an imbalance between actual wind power production and hourly production targets specified by contract terms) negatively impacts contract performance and whether this could be remedied through improved contract design. Using a multi-objective optimization algorithm, we find examples of alternative contract parameters (hourly wind power production targets) that are more effective at increasing revenues during low performing months and do so at a lower cost than conventional fixed volume swaps. Then we examine how "basis risk" (a discrepancy in market prices between the "node" where the wind project injects power into the grid, and the regional hub price) can negatively impact contract performance. Overall, our results suggest that wind power producers would be better served hedging substantially lower volumes of wind power production, and in certain months should not be hedging at all. Another key finding is that contract performance improves with modest reductions in basis risk. This indicates that eliminating transmission congestion issues across the grid may not be necessary to improve contract performance.