Optimal Static Hedging of Volumetric Risk in a Competitive Wholesale Electricity Market

In competitive wholesale electricity markets, regulated load serving entities (LSEs) and marketers with default service contracts have obligations to serve fluctuating load at predetermined fixed prices while meeting their obligation through combinations of long-term contracts, wholesale purchases and self-generation that are subject to volatile prices or opportunity cost. Hence, their net profits are exposed to joint price and quantity risk both of which are correlated with weather variations. In this paper we develop a static hedging strategy for the LSE (or marketer) whose objective is to minimize a mean-variance utility function over net profit, subject to a self-financing constraint. Since quantity risk is non-traded, the hedge consists of a portfolio of price-based financial energy instruments, including a bond, forward contract and a spectrum of European call and put options with various strike prices. The optimal hedging strategy is jointly optimized with respect to contractin...

• Type: Journal
• Year: 2010
• Where: DA
• Authors: Yumi Oum, Shmuel S. Oren
• Keywords: DA 2010, Hedging Strategy, Net Profit, Quantity Risk