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Hedging local volume risk using forward markets: Nordic case

Rune Ramsdal Ernstsen, Trine Krogh Boomsma, Martin Tegnér and Anders Skajaa

Energy Economics, 2017, vol. 68, issue C, 490-514

Abstract: With focus on the Nordic electricity market, this paper develops hedging strategies for an electricity distributor who manages price and volume risk from fixed price agreements on stochastic electricity load. Whereas the distributor trades in the spot market at area prices, the financial contracts used for hedging are settled against the system price. Area and system prices are correlated with electricity load, as are price differences. In practice, however, this is often disregarded. Here, we develop a joint model for the area price, the system price and the load, accounting for correlations, and we suggest various strategies for hedging in the presence of local volume risk. We benchmark against a strategy that ignores correlation and hedges at expected load, as is common practice in the industry. Using data from 2013 and 2014 for two Danish bidding areas, we show that our best hedging strategy reduces gross loss by 5.8% and 13.6% and increases gross profit by 3.8% and 9.5%, respectively. Although this is partly due to the inclusion of correlation, we show that performance improvement is mainly driven by the choice of risk measure.

Keywords: Electricity markets; Fixed price contracts; Volume risk; Hedging (search for similar items in EconPapers)
JEL-codes: C50 G00 G10 G11 G17 G32 Q02 Q40 Q41 Q47 (search for similar items in EconPapers)
Date: 2017
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Energy Economics is currently edited by R. S. J. Tol, Beng Ang, Lance Bachmeier, Perry Sadorsky, Ugur Soytas and J. P. Weyant

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