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Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability

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  • Severin Borenstein

Abstract

One of the most critical concerns that customers have voiced in the debate over real-time retail electricity pricing is that they would be exposed to risk from fluctuations in their electricity cost. The concern seems to be that a customer could find itself consuming a large quantity of power on the day that prices skyrocket, resulting in a high monthly bill. I analyze the magnitude of this risk, using demand data from 1142 large industrial customers, and then ask how much of this risk can be eliminated through various straightforward financial instruments. I find that very simple hedging strategiesÑforward purchase contracts that are already used with many RTP programsÑcan eliminate more than 80% of the bill volatility that would otherwise occur. I then show that a slightly more sophisticated application of these forward power purchases can significantly enhance their effect on reducing bill volatility.

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Bibliographic Info

Article provided by International Association for Energy Economics in its journal The Energy Journal.

Volume (Year): Volume 28 (2007)
Issue (Month): Number 2 ()
Pages: 111-130

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Handle: RePEc:aen:journl:2007v28-02-a05

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References

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  1. Borenstein, Severin & Bushnell, James & Knittel, Chris & Wolfram, Catherine, 2008. "Inefficiencies and Market Power in Financial Arbitrage: A Study of California's Electricity Markets," Staff General Research Papers 13133, Iowa State University, Department of Economics.
  2. Gregory W. Brown & Klaus Bjerre Toft, 2002. "How Firms Should Hedge," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1283-1324.
  3. Severin Borenstein & Stephen P. Holland, 2003. "On the Efficiency of Competitive Electricity Markets With Time-Invariant Retail Prices," NBER Working Papers 9922, National Bureau of Economic Research, Inc.
  4. Severin Borenstein, 2007. "Wealth Transfers Among Large Customers from Implementing Real-Time Retail Electricity Pricing," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 131-150.
  5. Ronald I. McKinnon, 1967. "Futures Markets, Buffer Stocks, and Income Stability for Primary Producers," Journal of Political Economy, University of Chicago Press, vol. 75, pages 844.
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Cited by:
  1. S. Borenstein, 2013. "Effective and Equitable Adoption of Opt-In Residential Dynamic Electricity Pricing," Review of Industrial Organization, Springer, vol. 42(2), pages 127-160, March.
  2. Paul L. Joskow, 2012. "Creating a Smarter U.S. Electricity Grid," Journal of Economic Perspectives, American Economic Association, vol. 26(1), pages 29-48, Winter.
  3. Willems, Bert & Morbee, Joris, 2010. "Market completeness: How options affect hedging and investments in the electricity sector," Energy Economics, Elsevier, vol. 32(4), pages 786-795, July.
  4. James Cochell & Peter Schwarz & Thomas Taylor, 2012. "Using real-time electricity data to estimate response to time-of-use and flat rates: an application to emissions," Journal of Regulatory Economics, Springer, vol. 42(2), pages 135-158, October.
  5. Kopsakangas Savolainen, Maria & Svento, Rauli, 2012. "Real-Time Pricing in the Nordic Power markets," Energy Economics, Elsevier, vol. 34(4), pages 1131-1142.
  6. Fred Schroyen & Adekola Oyenuga, 2011. "Optimal pricing and capacity choice for a public service under risk of interruption," Journal of Regulatory Economics, Springer, vol. 39(3), pages 252-272, June.

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