Foundations and Trends® in Technology, Information and Operations Management > Vol 6 > Issue 3–4

Real Options and Merchant Operations of Energy and Other Commodities

Nicola Secomandi, Tepper School of Business, Carnegie Mellon University, USA, ns7@andrew.cmu.edu Duane J. Seppi, Tepper School of Bushiness, Carnegie Mellon University, USA, ds64@andrew.cmu.edu
 
Suggested Citation
Nicola Secomandi and Duane J. Seppi (2014), "Real Options and Merchant Operations of Energy and Other Commodities", Foundations and Trends® in Technology, Information and Operations Management: Vol. 6: No. 3–4, pp 161-331. http://dx.doi.org/10.1561/0200000024

Published: 11 Jul 2014
© 2014 N. Secomandi and D. J. Seppi
 
Subjects
Brownian Models,  Logistics and Supply Chain Applications,  Markov Decision Processes,  Mathematical Finance and Insurance,  Simulation,  Stochastic Optimization,  Operations Research,  Asset pricing,  Derivatives: Financial engineering,  Futures markets and hedging
 
Keywords
G12 Asset PricingG13 Contingent PricingQ41 Energy Prices
Merchant operationsReal optionsEnergyCommoditiesConversion assets
 

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In this article:
1. Aim and Scope
2. Commodity Conversion Assets and Merchant Operations
3. Commodity Option Valuation
4. Modeling Commodity and Energy Prices
5. Modeling Commodity Storage Assets
6. Benchmarking the Practice-based Management of Commodity Storage Assets
7. Modeling Other Commodity Conversion Assets
8. Trends
Acknowledgments
References

Abstract

The value chain for energy and other commodities entails physical conversions through refineries, power plants, storage facilities, and transportation and other capital-intensive infrastructure. When the operation of such commodity conversion assets occurs alongside liquid markets for the input and output commodities, the operating flexibility of conversion assets can be managed as real options on the underlying commodity prices. Merchant operations is an integrated trading and operations approach that (i) buys and sells commodities to support market-value maximizing operating policies and (ii) values conversion assets, for capital budgeting and trading purposes, based on the cash flows such policies produce. This monograph provides a unique integrated finance and operations perspective on the topic of merchant operations. In particular, this monograph introduces the concept of merchant operations; presents the basic principles of option valuation; surveys foundational models of commodity and energy price evolution; analyzes the structure of optimal operating policies for commodity conversions, focusing specifically on inventory and other intertemporal linkages in storage, inventory acquisition and disposal, and swing assets; considers a variety of heuristic storage operating policies; and discusses future trends in this multidisciplinary area of research and business applications.

DOI:10.1561/0200000024
ISBN: 978-1-60198-842-3
174 pp. $99.00
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ISBN: 978-1-60198-843-0
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Table of contents:
1. Aim and Scope
2. Commodity Conversion Assets and Merchant Operations
3. Commodity Option Valuation
4. Modeling Commodity and Energy Prices
5. Modeling Commodity Storage Assets
6. Benchmarking the Practice-based Management of Commodity Storage Assets
7. Modeling Other Commodity Conversion Assets
8. Trends
Acknowledgments
References

Real Options and Merchant Operations of Energy and Other Commodities

Real Options and Merchant Operations of Energy and Other Commodities delivers a distinctive perspective, integrating finance and operations, on the topic of merchant operations–a new term introduced in the monograph to describe the management and valuation of conversion assets from a merchant perspective. The monograph aims to present the basic tenants of merchant operations as being the management of commodity conversion assets as real options on commodity prices, while the scope is based on the foundational principles that underlie that valuation of real options.

Real Options and Merchant Operations of Energy and Other Commodities follows a straightforward approach. Section 2 introduces and explains conversion assets and merchant operations. Section 3 outlines the theory behind the valuation of real options, while Section 4 illustrates a number of widely used models of the evolution of commodity and energy prices. Sections 5 and 6 provide an in-depth explanation of the operational management of commodity storage assets. Section 7 deals with inventory disposal and acquisitions, and swing assets as final considerations, before Section 8 explains future trends in merchant operations research and application.

 
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