TY - JOUR

T1 - Hedging local volume risk using forward markets: Nordic case

AU - Ernstsen, Rune Ramsdal

AU - Boomsma, Trine Krogh

AU - Tegner, Martin

AU - Skajaa, Anders

PY - 2017/10

Y1 - 2017/10

N2 - With focus on the Nordic electricity market, this paper develops hedging strategies for an electricity distributorwho manages price and volume risk from fixed price agreements on stochastic electricity load. Whereasthe distributor trades in the spot market at area prices, the financial contracts used for hedging are settledagainst 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 systemprice and the load, accounting for correlations, and we suggest various strategies for hedging in the presenceof 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, weshow 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 performanceimprovement is mainly driven by the choice of risk measure.

AB - With focus on the Nordic electricity market, this paper develops hedging strategies for an electricity distributorwho manages price and volume risk from fixed price agreements on stochastic electricity load. Whereasthe distributor trades in the spot market at area prices, the financial contracts used for hedging are settledagainst 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 systemprice and the load, accounting for correlations, and we suggest various strategies for hedging in the presenceof 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, weshow 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 performanceimprovement is mainly driven by the choice of risk measure.

KW - Electricity markets

KW - Fixed price contracts

KW - Volume risk

KW - Hedging

U2 - 10.1016/j.eneco.2017.10.017

DO - 10.1016/j.eneco.2017.10.017

M3 - Journal article

VL - 68

SP - 490

EP - 514

JO - Energy Economics

JF - Energy Economics

SN - 0140-9883

ER -