Hydropower production planning and hedging under inflow and forward uncertainty

We consider longand medium-term production planning and hedging in a hydropower system under price and inflow uncertainty. The price uncertainty is modeled with a multidimensional forward curve model that considers time dependant spot volatility, the volatility curve’s maturity effect, and the forward curve’s correlation structure. We give a simple and intuitive parameterization for the optimal production strategy of a profit maximizing producer. The parameterization leads to a simple production hedging policy. The accuracy of the parameterization is analyzed by comparing its expected cash flows to an upper bound of expected cash flows. In our bench marking case the parameterization gives profits that are less than 2.6% from the optimal profits. Our bench marking illustrates that during winters 1997-2003 our method would have increased the profits of an actual hydropower producer by 4.2%.