A tutorial on portfolio-based control algorithms for merchant energy trading operations

Merchant energy trading companies operate energy conversion facilities and infrastructure via direct or contractual ownership. Portfolio-based control algorithms are a real option approach that practitioners use to manage these assets. To avoid potential model error, this approach represents the operations of these assets as portfolios of traded financial instruments on energy commodities. Optimization of the portfolio composition subject to the asset operational constraints yields a market-value, an operating policy, and a financial hedge for the asset. We provide a tutorial on this methodology, focusing on examples of natural gas transport and storage assets. We frame the presentation within the typical organizational structure of merchant energy trading companies. We also discuss limitations of this approach and their possible remedies.