Water as a commodity in hydropower generation

Speaker: Prof. Eduardo Schwartz, Beedie School of Business, Simon Fraser Univ.

Abstract: The increased impact of extreme weather events and draughts has prompted the rapid growth of the water market. This paper analyzes the optimal operation of a reservoir that generates electricity and manages the water by trading water rights. We extend the framework introduced in a recent paper by Figuerola-Ferretti, Schwartz, and Segarra (2024) to include the water price process in a model that accounts for water inventory and the electricity price as two independent price processes. The model is implemented under the stochastic optimal control approach and calibrated using monthly data for a reservoir in the estate of California. The water price process and the dynamics of inflow into the reservoir include their dependence on the California Drought Severity Index. Results show that the underlying water and electricity price dynamics exhibit a high degree of uncertainty and seasonality. They also demonstrate that, under the calibrated model parameters on average for the parameters used, around 25% of the revenue generated by the reservoir arises from the revenue obtained from selling water rights. The water contribution to revenue generation would increase under enhanced severity of climate change.