Stochastic programming models for replication of electricity forward contracts for industry

Forward contracts for electricity are valuable to consumers (suppliers) that wish to obtain (sell) power at prices that are more stable than those typically seen in electricity markets. Only a limited variety of forward contracts are available on the market so the need is for a “custom” contract that meets a specific profile of electricity requirements (usually uncertain) over time. This paper develops stochastic programming models that can be used by the supplier of a custom contract to design a procurement strategy that minimizes its expected costs of supply in meeting contract obligations. The procurement strategy will consist of a mix of forwards available in the market, and, in each period, blending its own generation with spot purchases of power. The model also integrates spot selling of power. We consider that expected spot prices and forward prices may disagree since electricity is not storable, creating apparent arbitrage opportunities. We bound the transaction amounts to limit effects of apparent arbitrage and for consistency with the assumption of constant variable generation costs and market prices. For sample cases we compute the optimal procurement strategy, demonstrate the magnitude of the saving, and illustrate the sensitivity of this saving to the magnitude of the upper bounds on the allowed forward positions (a proxy for risk). © 2006 Wiley Periodicals, Inc. Naval Research Logistics, 2006