Impact of Price–Quantity Uncertainties and Risk Aversion on Energy Retailer’s Pricing and Hedging Behaviors

Haitao Xiang, Ying Kong, Wai Kin Victor Chan and Sum Wai Chiang
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Haitao Xiang: Shenzhen Environmental Science and New Energy Technology Engineering Laboratory, Tsinghua-Berkeley Shenzhen Institute, Tsinghua University, Shenzhen 518055, China
Ying Kong: Shenzhen Environmental Science and New Energy Technology Engineering Laboratory, Tsinghua-Berkeley Shenzhen Institute, Tsinghua University, Shenzhen 518055, China
Wai Kin Victor Chan: Shenzhen Environmental Science and New Energy Technology Engineering Laboratory, Tsinghua-Berkeley Shenzhen Institute, Tsinghua University, Shenzhen 518055, China
Sum Wai Chiang: Shenzhen Environmental Science and New Energy Technology Engineering Laboratory, Tsinghua-Berkeley Shenzhen Institute, Tsinghua University, Shenzhen 518055, China

Energies, 2019, vol. 12, issue 17, 1-20

Abstract: The joint uncertainties of wholesale price and end-user demand quantity often poses huge pricing challenges to energy retailers. However, the literature lacks analysis of such uncertainties’ impacts on retailer pricing behaviors and possible hedging behaviors. To study these impacts, this paper proposes four models: a risk-averse or a risk-neutral retailer deciding retail price with or without forward contract. We present closed-form solutions for these four models on optimal retail price, as well as optimal forward position (if allowed). We propose a novel approach of volatility decomposition to describe the relationship between behaviors and different volatility sources. Comparative statics gives detailed analysis of the pricing and hedging behaviors in both uncertainties, as well as their correlation. We obtain profit distributions using Monte Carlo simulations in the context of the California Electricity Market. Results show that the price and quantity uncertainties and their correlation create significant differences in the retailer’s behaviors, and the determinants of these differences are different. In addition, forward contract increases expected profit and decreases profit volatility for risk-averse retailers simultaneously. These results could serve as a benchmark for analyses of deregulated, imperfect energy markets coupled with contingent financial markets under both price and quantity uncertainties.

Keywords: pricing; price-quantity uncertainties; risk-aversion; risk-neutral; forward contract (search for similar items in EconPapers)
JEL-codes: Q Q0 Q4 Q40 Q41 Q42 Q43 Q47 Q48 Q49 (search for similar items in EconPapers)
Date: 2019
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