Hedging Strategies for Load-Serving Entities in Wholesale Electricity Markets

TL;DR

This paper explores hedging strategies for load-serving entities in wholesale electricity markets, comparing financial instruments and demand response to manage price and quantity risks effectively.

Contribution

It introduces a method to compute profit-maximizing portfolios of forward contracts and call options based on demand uncertainty, and compares these with demand response strategies.

Findings

Demand response can outperform financial hedging under certain conditions.

Optimal portfolios depend on demand variability and market conditions.

Smart meter data enables realistic simulation of hedging strategies.

Abstract

Load-serving entities which procure electricity from the wholesale electricity market to service end-users face significant quantity and price risks due to the volatile nature of electricity demand and quasi-fixed residential tariffs at which electricity is sold. This paper investigates strategies for load serving entities to hedge against such price risks. Specifically, we compute profit-maximizing portfolios of forward contract and call options as a function of the uncertain aggregate user demand. We compare the profit to the case of Demand Response, where users are offered monetary incentives to temporarily reduce their consumption during periods of supply shortages. Using smart meter data of residential customers in California, we simulate optimal portfolios and derive conditions under which Demand Response outperforms call options and forward contracts.