Valuing risk-reduction: Three applications in the electricity industry

This dissertation is motivated by the belief that it is possible for regulators to attenuate some of the uncertainties that surround the operation of electricity markets, and therefore understanding the sources, implications and costs of these uncertainties can help shape policies in the field. At least in some cases, the quantification of the effects of uncertainty can serve as an incentive for industry participants and regulators to make a common front against unnecessary costs.; Options theory and the method of risk-neutral valuation provide a framework to quantify the value of hedging against uncertainty. By incorporating options theory---widely used in the financial world---this thesis contributes a framework to quantify the risks and value accordingly the instruments or strategies that provide hedging. Having an idea of what the fair cost of hedging is, we will have better tools to identify inefficiencies and opportunities for regulation improvement.; This dissertation looks at three cases of uncertainty in the electricity industry, related to generation, transmission and ancillary services, and proposes a method to quantify the cost of this uncertainty and use this value to inform policy making. In the three cases, there is a strategy or contract that can be seen as a hedging instrument and valued as such. In the ambit of electricity transmission, Financial Transmission Rights (FTRs) can be seen as hedging instruments that provide protection against highly volatile transmission congestion costs. An FTR is essentially a contract that allows (or obligates) the holder to get the monetary difference between the marginal price of electricity at the point where it is withdrawn to the marginal price electricity at its source. In the ambit of electricity generation, the investment in environmental-control-devices or cleaner generation technologies can be seen as protection against the risk of not being able to comply with potential stringent air-emission regulations. In the ambit of ancillary services, the provision of reliability-support resources can be seen as reduction of the risk of not being able to deal with contingencies that treat the instantaneous balance between supply and demand.