Hedging Aluminum Price Exposures in Power Projects: An Empirical Application of Commodity-indexed Swaps and Arithmetic Asian Options
by
Hernán Alzate
Director, Financial Resources; Interconexión Eléctrica S.A. (ISA)

Power projects face different sorts of market risks, ranging from foreign exchange and interest rate risks to commodities price risk. Although, non-operational exposures to FX and interest rate risks should be mitigated, operational risks due to metal price volatility is, and should be, of paramount importance to companies that undertake large power projects. For instance, Aluminum and Steel price volatility could negatively impact the financial performance of companies that build, operate and maintain high-voltage energy transmission lines (230 and 500 kV). The cost of these raw materials may represent more than 30 percent of the total project costs if the respective exposures are not properly hedged.

Electricity transmitters can hedge Aluminum price risk through either symmetric or asymmetric derivatives instruments. Further, the combination of symmetric and asymmetric instruments is also an excellent hedging tool that should be taken into consideration. This presentation explains how ISA, the largest energy transmitter company in LatAm, mitigates its Aluminum price exposure through a combined hedging strategy composed of commodity-indexed swaps and arithmetic Asian options.

Date received: December 10, 2006