New Model Developed at the Tepper School Seeks to Optimize Market Price Risk in Energy Trading
Novel technique allows traders to achieve greater effectiveness.
New research at the Tepper School of Business is guiding merchant companies toward better decision making by developing a novel, dynamic model that optimizes energy market price risk and trading operations.
The research, which was funded by a grant from the National Science Foundation, is coauthored by Nicola Secomandi, Professor of Operations Management and head of the Tepper School’s Ph.D. Program, as well as Selvaprabu Nadarajah (Ph.D. 2014), now on the faculty at the University of Illinois-Chicago. The paper, Merchant Energy Trading in a Network, appeared in Operations Research.
Energy trading involves managing both the uncertainty of market prices at multiple geographical locations and the operations of networks of storage and transportation assets — trucks, ships, storage tanks, batteries, and power transmission lines. Because the trading relies on access to storage and transportation infrastructure, estimating the market value of these assets is helpful.
The new model supports the decisions of how much energy to buy where and when, where to move it, where to sell it, where to store it, and when to take it out of storage and sell it. As a byproduct, it assigns a market value to the network of assets, says Secomandi, which a merchant company can use to support capital budgeting decisions.
For example, a merchant company trading natural gas would have contracts to lease the capacity of pipelines and storage facilities. That company must decide where and how much gas to buy, how much of it to ship via pipelines or put in storage, and, once it is moved or stored, how much of it to sell or further store. Merchant companies trading electricity in networks of transmission lines and industrial batteries face analogous decisions. The new model helps to drive all of those decisions.
“Trading energy is an important business,” says Secomandi. “It’s difficult to do it effectively,” which is why it makes for a ripe field for his research. Currently, he is exploring issues related to market incompleteness in that context through another NSF grant. In June he co-chaired the Annual Meeting of the Commodity and Energy Markets Association at the Tepper School in Pittsburgh.