The Economics of Electricity Markets

13Managing Intertemporal Price Risks

Participants in wholesale electricity markets face volatile wholesale prices. This chapter discusses the standard tools for managing those risks, and some of the ways those tools can be combined to obtain the insurance that participants in the market desire. In this chapter, we focus on the case where there is a single wholesale spot price (network constraints are ignored). This allows us to focus on the question of managing intertemporal price risk. In Chapter 14, we focus on the question of managing differences in prices across different locations on the network (interlocational price risk).

13.1 Introduction to Forward Markets and Standard Hedge Contracts

Wholesale electricity markets are known to be highly volatile. The wholesale spot price may vary by multiples of hundreds or even thousands over the course of the day.

This volatility exposes market participants to risk. Where market participants are risk averse, exposure to risk reduces short-run economic welfare. Exposure to risk can also dampen incentives to make valuable sunk investments, reducing long-run economic welfare.

Participants in wholesale electricity markets will typically seek to minimise their exposure to price volatility. Market participants can reduce their exposure to this volatility by participating in the forward markets.

A trade in the forward market can be an agreement to take physical delivery of the good or service at a given time in the future at a fixed price. ...