Commodity risk hedging of a power producer: Case study of the Czech power market

Every power producer is facing the risk of an adverse price movement of commodities used for the power production and power itself in the meantime between cash flow planning and the actual power production. This study analyzes process of hedging the commodity market risk with usage of derivatives with financial settlement as an alternative to physical ones. For this purpose a hypothetical power producer operating a gas power unit was selected. Based on the real Czech power market data of 2019 this paper simulates expected cash flow, assesses potential risk for the producer and compares real cash flow of an unhedged position with a position hedged via futures contracts and spread options with financial settlement. For the risk evaluation Monte Carlo simulation and value at risk methods are used. As the most effective way to hedge the market risk of 2019 proved itself the futures hedge with monthly hedging tenor with an alternative in a short call option position. Practical implications: The study is written in a practical approach to the market risk man- agement process so that could be applicable in any company active in the power market facing the risk of commodity price movements regardless the input commodity used for the electric- ity production. Using the data of the Czech power market of 2019 the paper presents the case of a real power market participant.