To hedge or not to hedge, that is the question. Whether it is nobler in the wallet to suffer the slings and arrows of outrageous price volatility, or to take up hedges against them and by doing so, confuse your investors. (I've actually found some use for learning Shakespeare; my high school English teacher would be so proud.)

Anyway, I'm trying to say that there are two ways to go about the business of selling wholesale electricity -- the hedge-heavy path taken by the likes of NRG Energy (NYSE:NRG), or the more freewheeling approach of a company like Dynegy (NYSE:DYN). Like most things in business, it's a calculated gamble. It's great to be locked into contracts when prices are falling, but not so much fun when market prices rise above the levels specified in the deals.

Judging by Dynegy's third-quarter report, higher electricity prices do seem to be the order of the day. Reported revenue rose 15%, while operating income was flat and reported net income declined. Although there are all manner of charges, gains, and discontinued ops between the two periods, EBITDA tied to power generation does seem to have risen slightly in the third quarter.

Looking at somewhat more intelligible data, trends in the base power business look encouraging. Overall net generated volume increased 21%, and prices were strong across the board. Average on-peak prices in New York markets were up more than 90%, while pricing in the Midwest was up more than 80%. While a power agreement with Ameren (NYSE:AEE) prevented Dynegy from seeing the full benefit of that strong Midwest market, that deal expires at the end of 2006.

Overall, Dynegy has some interesting trends that should work in its favor. Those Midwest non-peak assets are largely coal-fired, and the company has favorable coal and rail prices locked into long-term deals. Assuming that Midwest power prices stay firm after next year, Dynegy should be looking at some high-price/low-cost leverage, particularly if the gap between coal and gas prices increases.

Operations seem to be improving at Dynegy, and the company is looking for positive free cash flow next year. The company is also in decent shape regarding balance sheet liquidity and flexibility. It could be positioned to pursue potentially accretive deals like the recent NRG Energy-Texas Genco transaction. This is not the safest investment around, and wholesale power can be tricky (just ask Calpine (NYSE:CPN) or Duke Energy (NYSE:DUK)). But if prices stay strong, Dynegy could sparkle.

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Duke Energy is a Motley Fool Income Investor recommendation.

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).