Tolling deals are designed to hedge power generators that convert a fuel to electricity. We first encountered tolls in Chapter 9 in the context of monthly exercise spread options between power and natural gas. Analysis was based on the Margrabe valuation framework. Tolls with daily or intraday optionality are by far the more common than those with monthly exercise primarily because the dispatch decisions of physical generation are usually made on the time scale of days and hours. Valuation and hedging daily or intraday tolling structures are considerably more complex than the monthly case.

Although sporadic broker activity may constitute an amusing activity between structured desks to “pick off” their competitors, tolling deals were created and exist to hedge risks inherent in the acquisition or development of generation. Given the billions of dollars invested annually in generation and the associated borrowing requirements, tolls are among the more socially defensible derivatives transactions. Paradoxically, they also have caused some of the greatest damage to commodities desks for reasons that will unfold in what follows.

We will start with standard daily structures in which exercise is into a single standard delivery bucket with a single fuel. These “simple” structures are challenging in their own right while avoiding many of the complexities of physical generation to which we turn to later in this chapter.