The set of tradable "benchmarks" has never been able to adequately span the set of risks sustained by participants in energy markets. Locational price exposures in natural gas markets can number in the dozens. For power markets under the now standard LMP paradigm the number can be in the thousands. The market structure is ostensibly designed to incentivize development of assets where they are needed. The drawback, however, is that valuation and hedging has always been challenging, and residual risks are all too often inventoried in the hope of "graceful" amortization.
Changes in the regulatory landscape and concurrent dealer exodus have resulted in a marked drop in liquidity in the last few years, and the mismatch between available hedges and actual risks has never been greater. This affects everyone from natural shorts serving load to project finance lenders.
In this talk we will discuss forward price inference, optimal hedge construction and a hedge rating framework for project finance in the context of this low liquidity environment.
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