Portfolio risk management and carbon emissions valuation in electric power

The context is an electric power company with regulated load obligations and a spot market for energy sales and purchases, as well as liabilities incurred by carbon emissions from generation units or power contracts controlled by the company. Against the backdrop of the existing carbon cap and trade system in the European Union, this paper develops a framework for integrating energy portfolio risk management with liabilities associated with the company’s carbon emissions. The multi-period VaR-constrained portfolio approach of Kleindorfer and Li (Energy J 26(1): 1–26, 2005) is first extended to cover the implied liabilities arising from carbon emissions. This entails some changes to account for the fact that dispatch/bidding/execution decisions will be affected by carbon liabilities for some generation units and contracts. The paper then develops a dynamic programming framework for optimizing the timing of carbon trades (i.e., the timing of the acquisition of the required carbon certificates to cover carbon emissions liabilities of the company), given banked credits or allocations of carbon credits at the start of the planning period and the emissions liabilities resulting from the company’s joint energy and carbon portfolio optimization problem.