Optimal retail contracts with contractible uncertainty

Darryl R. Biggar and Mohammad Reza Hesamzadeh

Energy Economics, 2024, vol. 136, issue C

Abstract: Around the world policymakers and regulators are struggling with the question of how to design retail electricity tariffs in the face of increasing penetration of local generation (e.g., solar PV), smart appliances, local storage, and electric vehicles. There is a widespread recognition that retail tariffs should vary dynamically across time and space, reflecting the changing conditions (congestion and losses) on the underlying networks. But, at the same time, there is recognition that such tariffs potentially expose retail customers to substantial risk. Risk averse retail customers desire protection against price spikes and volatile wholesale spot prices. This paper seeks to derive the optimal retail contract in the special case in which the uncertainty in the market is contractible (in the sense defined here). We show that the optimal retail contract exposes the prosumer to the wholesale spot price at the margin, but also perfectly insulates the customer from risk, achieving the first-best outcome. We show how the hedge component of this retail contract can be constructed from standard-form hedge contracts. We draw out several lessons for policymakers.

Keywords: Retail market; Optimal retail contract; Hedge contract (search for similar items in EconPapers)
JEL-codes: D47 D53 D61 D81 D86 L11 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:136:y:2024:i:c:s0140988324004778

DOI: 10.1016/j.eneco.2024.107769

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