From Stream Flows to Cash Flows: Leveraging Evolutionary Multi-Objective
Direct Policy Search to Manage Hydrologic Financial Risks
Abstract
Hydrologic variability can present severe financial challenges for
organizations that rely on water for the provision of services, such as
water utilities and hydropower producers. While recent decades have seen
rapid growth in decision-support innovations aimed at helping utilities
manage hydrologic uncertainty for multiple objectives, support for
managing the related financial risks remains limited. However, the
mathematical similarities between multi-objective reservoir control and
financial risk management suggest that the two problems can be
approached in a similar manner. This paper demonstrates the utility of
Evolutionary Multi-Objective Direct Policy Search (EMODPS) for
developing adaptive policies for managing the drought-related financial
risk faced by a hydropower producer. These policies dynamically balance
a portfolio, consisting of snowpack-based financial hedging contracts,
cash reserves, and debt, based on evolving system conditions.
Performance is quantified based on four conflicting objectives,
representing the classic tradeoff between “risk” and “return” in
addition to decision-makers’ unique preferences towards different risk
management instruments. The dynamic policies identified here
significantly outperform static management formulations that are more
typically employed for financial risk applications in the water
resources literature. Additionally, this paper combines visual analytics
and information theoretic sensitivity analysis to help decision-makers
better understand how different candidate policies achieve their
comparative advantages through differences in how they adapt to
real-time information. The methodology developed in this paper should be
applicable to any organization subject to financial risk stemming from
hydrology or other environmental variables (e.g., wind speed,
insolation), including electric utilities, water utilities, agricultural
producers, and renewable energy developers.