Powering up profits - Integrating Power Purchase Agreements and Battery Systems for Nordic Power Futures

Abstract

This master’s thesis aims to assess the profitability and the factors impacting the profitability of entering a short position in financial derivative contracts on the Nordic power market while procuring electricity through a pay-as-produced power purchase contract and on the day-ahead (DA) market, simultaneously the strategy utilizes a battery storage system to mitigate the effects of price spikes. The research adopted a mixed-method approach by combining quantitative analysis with qualitative findings. First, a qualitative pre-study was conducted, followed by the development of a mathematical model to simulate the strategy's energy and cash flows to quantify the investment's financial viability. The qualitative pre-study provided additional context and understanding of the simulation model results.
Results from multiple scenarios were generated by varying input parameters within the mathematical model to assess the impact on profitability. The findings highlighted key factors impacting the profitability of the examined strategy, including the price levels of power purchase agreements that emerged as a critical determinant, along with the risk premium associated with financial futures contracts and the investment costs of battery storage systems. These factors were found to have the most substantial influence on the financial outcomes of the implemented strategy.
Several limitations exist regarding how the system was simulated, such as inherent biases in the chosen input parameters. Therefore, future research should address these gaps in understanding by developing the accuracy of the simulation, as well as by conducting more in- depth simulations specifically focused on the battery storage component and delving into the exploration of future market behaviors such as volatility and cannibalization. Such research efforts will contribute to a more robust understanding of the profitability and viability of short positions in financial derivative contracts in conjunction with power purchase agreements and BESS, ultimately aiding in informed decision-making within the energy market.

Abstract (Swedish)

Denna masteruppstats ämnar utröna lönsamheten och de faktorer som påverkar lönsamheten vid ingåendet av en kort position i finansiella derivat på den nordiska elmarknaden samtidigt som motsvarade position anskaffas genom handel på Nord Pools day-ahead (DA) marknad och via så kallade pay-as-produce Power Purchase Agreements (PPA), samt genom tillämpandet av batterilager för att mitigera effekterna av prisstegringar på DA-marknaden. Studien har applicerat en mixad metod genom att kombinera kvantitativ analys med kvalitativa iakttagelser. Först genomfördes en kvalitativ förstudie, följt av konstruerandet av en matematisk modell för att simulera handelsstrategins energi- och kassaflöden samt kvantifiera strategins ekonomiska genomförbarhet. Den kvalitativa förstudien bidrog med ytterligare sammanhang och förståelse för resultaten från simulationsmodellen.
Resultat för flera scenarier genererades genom att variera inputparametrar inom den matematiska modellen för att bedöma påverkan på lönsamheten. Resultaten påvisade vilka nyckelfaktorer som påverkade lönsamheten för den undersökta strategin. Prisnivåerna för PPA visade sig vara en avgörande faktor, tillsammans med riskpremien för finansiella derivat samt investeringskostnaderna för batterilager. Dessa faktorer visade sig ha störst inflytande på de finansiella resultaten för den implementerade handelsstrategin.
Det finns dock flertalet begränsningar i hur modellen simulerades samt eventuella avvikelser i valda inputparametrarna. Framtida studier inom området bör avse förbättra noggrannheten i simulationen och genomföra mer djupgående simuleringar som specifikt fokuserar på batterilagringskomponenten samt utforskar framtida marknadsbeteenden som volatilitet och kannibalisering. Dessa insatser skulle vidare kunna bidra till en mer robust förståelse av lönsamheten och genomförbarheten av att ingå en kort position i finansiella derivat i kombination med PPA och batterilager, vilket i slutändan kan komma att underlätta för informerade beslut inom energimarknaden.

Popular Abstract

The profitability puzzle – finding profit in the energy transition

This popular science article is derived from the master thesis: “Powering up profits – Integrating Power Purchase Agreements and Battery Systems for Nordic Power Futures” written by Ellen Jinglöv and William Thorwaldson (2023)

The Swedish electricity sector faces a complex puzzle: changes such as more intermittent renewable energy production, electrification, an expected surge in demand and fluctuating electricity prices are jumbling the pieces of the puzzle. As we strive for a green and reliable electricity system, laying these puzzle pieces in their rightful places becomes a significant challenge.

In the transformation of our energy system, the energy industry actors must navigate the changes while ensuring profitability and bankability for implementing green technologies like renewables and storage assets. This makes exploring new business models, and innovative revenue generation approaches that support this transformation more crucial than ever. This includes aligning and combining different trading methods and electricity management to achieve financial viability.

Long-term contracts for trading electricity, both in financial markets and bilaterally, have played vital roles in managing price risks and enabling hedging against market uncertainties. Bilateral power purchase agreements (PPAs) have been game-changers for Nordic wind park developers over the past decade. They have provided a means to secure the revenue necessary for financing the construction and operation of wind parks.

Battery storage systems are key pieces in the energy puzzle, assisting in balancing the supply and demand of electricity, smoothing out the fluctuations
associated with renewable energy sources and contributing to grid stability. Traditionally, these systems have found profitability in balancing markets, where support services are traded in real-time. However, as more participants enter the market, it may become saturated, resembling an overcrowded room where growing space becomes challenging. Exploring less saturated and deep markets, such as the day-ahead market, could present further opportunities in the future.

However, in the trading of electricity, different risks and challenges arise. When entering into long-term contracts, the price levels set of the contracts are crucial for profitability since they determine revenue and project viability. Strategic pricing mitigates risks and fosters a favorable investment environment for long-term profitability. Battery storage also allows for risk mitigation, however, results have shown that their profitability is currently limited in day-ahead markets. This could, however, change if investment costs decrease or market conditions change.

As the energy sector continues to transform, the puzzle of profitability offers an opportunity for actors to integrate trading and energy solutions for revenue stacking in order to support the deployment of green technologies, and in many ways depending on risk appetite. By assembling these puzzle pieces, we take significant steps toward reaching our climate goals and building a sustainable future for future generations.

• author: Thorwaldson, William and Jinglöv, Ellen
• supervisor: Martin Andersson
• organization: Department of Energy Sciences
• course: MVKM01 20231
• year: 2023
• type: H2 - Master's Degree (Two Years)
• subject: Technology and Engineering
• keywords: Power Purchase Agreements, Financial Power Trading, Battery Energy Storage Systems, Power Futures
• report number: LUTMDN/TMHP-23/5544-SE
• ISSN: 0282-1990
• language: English
• id: 9127208
• date added to LUP: 2023-06-20 11:27:35
• date last changed: 2023-06-20 11:27:35