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My firm generates electricity from wind. Accordingly, most of my generation takes place at night, when prices are low -- and, due to congestion / oversupply, often sharply negative -- so much so that the spread between daytime and nighttime (or, more generally, "peak" and "off-peak") prices itself is often negative.

While my first instinct was to hedge this spread with derivatives (either an spread option using Kirk's approximation or using a bear vertical spread), I noticed that the spread between the daytime and nighttime period is random across days and across months in futures as well as real-time markets, so I'm wondering if such an approach is workable. Alternatively, I am considering an extreme-value theory approach, whereby I would create an insurance product based on the probabilities and expected shortfalls of negative spreads -- akin to a CDS.

Could someone please weigh in on this situation? I don't want to abandon a market-based approach -- but, in what appears to be an either highly inefficient or highly unstable market, it seems the derivatives approach is unusable.

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In my experience this is not easily hedgeable.

Expected volume can be hedged using baseload futures, or, if you are in a very liquid market (Germany) a combination of baseload and peak. You will still be exposed to the intraday shape, and, in the long term (you can hedge the first months and quarters but at some point you need to resort to calendar products) to the intrayear shape. The best way of dealing with that risk is adding the right assets to your portfolio if your company can do such a thing (the right combination of wind and solar becomes almost baseload).

Then there is also the volume/price correlation risk: prices are generally going to be lower when your wind farm produces more wind. The only way I know of hedging that is by weather derivatives, and, in general, the margin on those is too high so most generators carry the risk.

There is also the imbalance risk, related to the forecast error in your plant. Again, the only way I know of hedging that is by using physical assets, as CCGTs, batteries or hydro power that allows to profit from the imbalance market while you make losses with your wind farm.

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