SparkSpreads - Spark-Spread Option Pricing Mike Trobaugh...

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Unformatted text preview: Spark-Spread Option Pricing Mike Trobaugh November 16, 2006 Entegra Power Group LLC Formed in June 2005 Assets owned Gila River Power Station south of Phoenix Union Power Station in El Dorado, Arkansas TransUnion gas pipeline Largest natural gas-fired generation facilities in the U.S. Previously owned by TECO Energy Current ownership group consists of approx 40 hedge funds / private equity entities 150 total employees Corp HQ in Tampa, FL Future Plans Restructuring of the debt and equity stapled together Current debt facility - $1.325 billion (trading at 1.20) Enterprise value - $1.6 billion Refinance debt facility Cash pay debt PIK (payment-in-kind) Cash flows support $400 million of cash pay debt Growth options for merchant generators Asset acquisitions Mergers Energy management services Entegra Hedging Strategies Hedge 75% of plant capacity in the forward markets Forward premium Potential upside in spot market Insurance for operational risk Sell must-take forwards in high demand months (July Sept) Plants are deep in the money Minimal extrinsic value Sell spread options in the low demand months (Jan June & Oct Dec) Minimal intrinsic value Majority of plant value is extrinsic or option value Hedge off-peak and super-peak energy Off-peak = overnight hours & Sundays (utilize forwards and options) Super-peak = 8 hour schedule (highest demand hours during the summer) Hedging Products Power Physical Forwards (firm or unit contingent) Heat rate forwards Heat rate or spread options Financial Swaps (settles against daily power index) Heat rate look-back options Natural Gas Physical Receipt point gas Financial NYMEX futures ICE Henry Hub swaps Basis swaps $ / MWh -10.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00 45.00 50.00 0.00 5.00 -5.00 Jan-05 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 18 month / MA Forwards Forward Premium or Discount? Spot Value $ / MWh 10 15 20 25 30 35 0 2/14/2006 2/28/2006 3/14/2006 3/28/2006 4/11/2006 4/25/2006 5/9/2006 5/23/2006 6/6/2006 6/20/2006 7/4/2006 7/18/2006 8/1/2006 8/15/2006 8/29/2006 9/12/2006 9/26/2006 10/10/2006 10/24/2006 11/7/2006 Spark Spreads Forward Spark Spreads 5 Q3 07 Spark Spreads Spark Spread Options Spark spread formula SparkSprea d j = Market Pr ice - ( HeatRate j * Fuel Pr ice i + VOM j ) Spread option payoff CallOption Value = Max { Market Pr ice - ( HeatRate * Fuel Pr ice + VOM ), K } Pricing components Power Price NYMEX contract price Gas basis Power volatility Gas volatility Correlation Time until delivery Option value Entegra Option Pricing Assumptions Strike price is equal to the power plants' variable production economics Gas volatility = NYMEX ATM monthly implied volatility Power volatility = gas volatility Forward volatility = spot volatility Correlation implied from actual trades and market quotes Utilize off-the-shelf option pricing model (FinTools Excel add-in) Assumptions reviewed and validated by third party consultants $ / MWh 10 15 20 25 30 35 0 5 -5 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Intrinsic vs Extrinsic Value Intrinsic Value Call Option Value Extrinsic Analysis Month Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Strip 11 12 12 13 14 15 17 17 19 20 Extrinsic Value ($/MWh) Forward Spot 2.79 1.14 3.43 2.33 4.11 2.99 3.64 0.30 2.03 0.06 1.29 0.01 0.01 0.67 0.06 1.30 - 1.93 0.69 Synthetic Call Options Sell value If market does not see enough extrinsic value, sell the forward if spreads are above historical spot values If spreads decline closer to generation strike price, sell heat rate put options (equivalent volume as forward position) Total value = Hedged forward spread + Option premium Payout is equivalent to selling a heat rate call option Optimization of Physical Asset Sell what you own Heat rate call option Hedge plan economics and execution aligned with corporate objectives Accurately model generation costs Dispatch power plant to match load curve Standard products do not match load curve Optimize dispatch schedule in daily and hourly markets ...
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