Hedging Strategies for Load-Serving Entities in Wholesale Electricity Markets
For load-serving entities facing price and quantity risks in wholesale electricity markets, this work provides a comparative analysis of financial vs. demand-side hedging strategies.
This paper develops profit-maximizing hedging strategies for load-serving entities using forward contracts and call options, and compares them to Demand Response. Using California smart meter data, it finds conditions where Demand Response outperforms financial hedging.
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.