Natural gas-fired power plants valuation and optimisation under Levy copulas and regime-switching

TL;DR

This paper develops a stochastic control framework for valuing and optimizing natural gas-fired power plants, incorporating complex market dynamics like regime-switching and Levy copulas to model price jumps and dependencies.

Contribution

It introduces a Levy regime-switching model with skewed Levy copulas for more accurate energy market risk modeling and solves the resulting HJB PIDE using an explicit finite difference method.

Findings

Numerical solutions provide plant value and optimal strategies under complex market conditions.

The model captures demand-supply fluctuations and economic disruptions effectively.

Control surfaces and contract values are demonstrated through a specific example.

Abstract

In this work we analyse a stochastic control problem for the valuation of a natural gas power station while taking into account operating characteristics. Both electricity and gas spot price processes exhibit mean-reverting spikes and Markov regime-switches. The Levy regime-switching model incorporates the effects of demand-supply fluctuations in energy markets and abrupt economic disruptions or business cycles. We make use of skewed Levy copulas to model the dependence risk of electricity and gas jumps. The corresponding HJB equation is the non-linear PIDE which is solved by an explicit finite difference method. The numerical approach gives us both the value of the plant and its optimal operating strategy depending on the gas and electricity prices, current temperature of the boiler and time. The surfaces of control strategies and contract values are obtained by implementing the numerical method for a particular example.