Valuation of structured retail electricity contracts with market models

Kevin Metka and Reik Borger

Journal of Energy Markets

Abstract: ABSTRACT We show how financial models can be used to price certain contracts in the electricity market in an analogous way to interest rate products. Such contracts are delivery contracts with retail or institutional customers. In fact, many features of electricity products exist almost identically in structured LIBOR products and some models have already been adapted to the world of commodities. However, we are the first to show how they can be applied in order to value such structures in the retail market. Although the market in consideration is far from being driven by rational participants only, we show how to quantify features such as call rights for customers, how to hedge analysis for utilities and how to monetize laziness (ie, the irrational behavior of customers) based merely on public information.

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