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Volumetric Hedging in Electricity Procurement



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Volumetric Hedging in Electricity Procurement Yumi Oum Department of Industrial Engineering and Operations Research University of California Berkeley CA 94720 1777 Email yumioum berkeley edu Shmuel Oren Department of Industrial Engineering and Operations Research University of California Berkeley CA 94720 1777 Email oren ieor berkeley edu Abstract Load serving entities LSE providing electricity service at regulated prices in restructured electricity markets face price and quantity risk We address the hedging problem of such a risk averse LSE Exploiting the correlation between consumption quantities and spot prices we developed an optimal zero cost hedging function characterized by payoff as function of spot price We then show how such a hedging strategy can be implemented through a portfolio of call and put options I I NTRODUCTION The introduction of competitive wholesale markets in the electricity industry has put high price risk on market participants particularly on load serving entities LSEs The unique non storable nature of electricity as a commodity eliminates the buffering effect associated with holding inventory and makes the possibility of sudden large price changes more likely Significant market risks that are faced by LSEs are not related to price alone Volumetric risk or quantity risk caused by uncertainty in the electricity load is also an important exposure for LSEs since they are obligated to serve the varying demand of their customers at fixed regulated prices Electricity volume directly affects the company s net earnings and more importantly the spot price itself Hence hedging strategies that only concern price risks for a fixed amount of volume cannot fully hedge market risks faced by LSEs The price and volumetric risks are especially severe to LSEs because supply and demand conditions usually shift adversely together as demonstrated by the California electricity crisis in 2000 and 2001 which led three large LSEs in California to bankruptcy or near



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