This paper presents a methodology for the valuation, optimization, market, margin and credit risk management of gas-fired power plants and associated tolling contracts. Term structure models for the power and gas forward curves are employed to facilitate hedging and risk adjustment and for improved forecasting of short-term prices. The model for the power forward curve is capable of reproducing the important phenomena often observed in power markets, including spot price spikes and spike clustering, negative prices, and the empirically observed volatility term structures of power and gas forward prices as well as the correlation term structure between these forward curves. The method solves the stochastic dynamic optimization problem that arises from the inclusion of the various operational constraints of gas-fired power plants including minimum uptime and downtime requirements, ramp rate restrictions and costs, variable output and efficiency rates, and minimum generation levels. The model involves the solution of a system of partial differential equations (PDEs), which are solved using the radial basis function (RBF) method. At each time step and operational configuration the model produces an analytic function (RBF expansion) for the value of the power plant as a function of the independent risk factors. These functions can be used for determining optimal operating strategies and can be differentiated analytically to obtain the relevant hedging statistics for the dynamic management of market risk. In addition, these value functions facilitate the calculation of the credit value adjustment (CVA) and potential future exposure (PFE) measurement of tolling contracts. The analytic differentiability of these value functions also facilitates the pricing and risk management of commodity contingent revolvers (CCRs), credit vehicles used to manage margin requirements that result from hedging market risk on an exchange.
