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Hedging and Vertical Integration in Electricity Markets

Author

Listed:
  • René Aïd

    (EDF R&D and Finance for Energy Market Research Centre, F-92141 Clamart Cedex, France)

  • Gilles Chemla

    (Imperial College Business School, DRM-CNRS, and CEPR, London SW7 2AZ, United Kingdom)

  • Arnaud Porchet

    (Global Markets Structuring, Deutsche Bank, and Finance for Energy Market Research Centre, University of Paris-Dauphine, 75775 Paris Cedex 16, France)

  • Nizar Touzi

    (Centre de Mathématiques Appliquées, Ecole Polytechnique, 91128 Palaiseau Cedex, France)

Abstract

This paper analyzes the interactions between competitive (wholesale) spot, retail, and forward markets and vertical integration in electricity markets. We develop an equilibrium model with producers, retailers, and traders to study and quantify the impact of forward markets and vertical integration on prices, risk premia, and retail market shares. We point out that forward hedging and vertical integration are two separate mechanisms for demand and spot price risk diversification that both reduce the retail price and increase retail market shares. We show that they differ in their impact on prices and firms' utility because of the asymmetry between production and retail segments. Vertical integration restores the symmetry between producers' and retailers' exposure to demand risk, whereas linear forward contracts do not. Vertical integration is superior to forward hedging when retailers are highly risk averse. We illustrate our analysis with data from the French electricity market. This paper was accepted by Wei Xiong, finance.

Suggested Citation

  • René Aïd & Gilles Chemla & Arnaud Porchet & Nizar Touzi, 2011. "Hedging and Vertical Integration in Electricity Markets," Management Science, INFORMS, vol. 57(8), pages 1438-1452, August.
    • Handle: RePEc:inm:ormnsc:v:57:y:2011:i:8:p:1438-1452
    DOI: 10.1287/mnsc.1110.1357
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    References listed on IDEAS

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