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1 Case Assignment 4 C ASE : “C ONTRACTUAL I NNOVATION IN THE U.K. E NERGY M ARKETS I NSTRUCTIONS : Work in groups of 3. Hand in typewritten solutions with no more than 3 pages. Question 1- 4 is each worth 5 points, while Question 5 and 6 are each worth 40 points. 1. Why does Eastern want more generating capacity? 2. What prevented Eastern from increasing its own electricity generation capacity? 3. What were the main reasons for Enron to enter into the agreement with Eastern to receive gas and supply the value of electricity rather than operate simply as an independent power plant (IPP). 4. Despite using Sutton as a hedge for its commitment to Eastern, what residual operating risk would Enron be taking? 5. Using information in the case, estimate the value of Eastern’s option to purchase 700 MWH (mega watts per hour) of electricity from Enron for a typical (seasonally adjusted) half an hour interval in 1996. Use estimated daily volatilities in the case and assume a correlation coefficient of 0.1 between gas and electricity prices and assume a heat rate of 7.0MMBtu/MWh. First estimate the value of the half and hour option without any additional costs, and then build in the additional costs: (a) Variable charge for plant operating = L357.5 per half hour. NOTE: The letter L is used to denote British Pounds. (b) Gas transportation and plant startup/shutdown costs of 10% of total gas costs. Also provide the total expected profit for a full year after additionally considering fixed costs of L69m for the year. Please provide all your assumptions and a justification for them. In addition, please provide a print version of your spreadsheet for grading.

2 6. Consider a variation to the Enron case. Assume that a 2000 MWh power plant can bid for supplying power each hourly interval the following day. Suppose that 1/3 of the hours are peak hours and 2/3 are off-peak. The following

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