Internal transfer price optimisation for integrated energy firms

By selecting appropriate levels for the internal transfer prices of commodities and risk, an energy company can influence the alignment of its overall risk-return profile with its strategic objectives. Here, Henrik Specht, Sergey Zykov, Tilman Huhne and Magnus Wobben present an analytical framework to demonstrate that, under real-world conditions, the optimal internal pricing will deviate from the ‘arm’s length principle’ as it is commonly adopted by the energy industry

The focus of the model is to understand the impact of ITPs as incentive-setters

Internal transfer prices (ITPs) are widely used to transfer positions in commodities and, implicitly, the risks attached to those positions. In an energy company, these  transactions happen between divisions, such as the generation, sales and trading divisions.

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