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Hedging and vertical integration in electricity markets

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  • Chemla, Gilles
  • Porchet, Arnaud
  • Aïd, René
  • Touzi, Nizar
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    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

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    File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/11029/2/CEPR-DP8313.pdf
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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/11029.

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    Date of creation: 2011
    Date of revision:
    Publication status: Published in Management Science, 2011, Vol. 57, no. 8. pp. 1438-1452.Length: 14 pages
    Handle: RePEc:dau:papers:123456789/11029

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    Related research

    Keywords: Spot and vertical integration; Retailers; Producers; Hedging; Electricity markets;

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    References

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    1. Hung-po Chao & Shmuel Oren & Robert Wilson, 2005. "Restructured Electricity Markets: A Risk Management Approach," Levine's Bibliography 784828000000000232, UCLA Department of Economics.
    2. Khalid Sekkat, 2006. "Vertical relationships and the firm in the global economy," ULB Institutional Repository 2013/7312, ULB -- Universite Libre de Bruxelles.
    3. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249, December.
    4. Allaz, Blaise, 1992. "Oligopoly, uncertainty and strategic forward transactions," International Journal of Industrial Organization, Elsevier, vol. 10(2), pages 297-308, June.
    5. Evens SALIES & Catherine WADDAMS, 2004. "Charges, costs and market power in the deregulated UK electricity retail market," Industrial Organization 0406003, EconWPA.
    6. Chemla, Gilles, 2003. "Downstream Competition, Foreclosure, and Vertical Integration," Economics Papers from University Paris Dauphine 123456789/6313, Paris Dauphine University.
    7. Justine S. Hastings & Richard J. Gilbert, 2005. "MARKET POWER, VERTICAL INTEGRATION AND THE WHOLESALE PRICE OF GASOLINE -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 53(4), pages 469-492, December.
    8. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
    9. Ordover, Janusz A & Saloner, Garth & Salop, Steven C, 1990. "Equilibrium Vertical Foreclosure," American Economic Review, American Economic Association, vol. 80(1), pages 127-42, March.
    10. G. Chemla, 1999. "Downstream competition, foreclosure, and vertical integration," THEMA Working Papers 99-18, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    11. Evens Salies and Catherine Waddams Price, 2004. "Charges, Costs and Market Power: the Deregulated UK Electricity Retail Market," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 19-36.
    12. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
    13. Nils-Henrik M. von der Fehr & Petter Vegard Hansen, 2010. "Electricity Retailing in Norway," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 25-46.
    14. Hung-po Chao & Shmuel Oren & Robert Wilson, 2005. "Restructured Electricity Markets: Reevaluation of Vertical Integration and Unbundling," Levine's Bibliography 784828000000000238, UCLA Department of Economics.
    15. Joskow, Paul L, 1985. "Vertical Integration and Long-term Contracts: The Case of Coal-burning Electric Generating Plants," Journal of Law, Economics and Organization, Oxford University Press, vol. 1(1), pages 33-80, Spring.
    16. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
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    19. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    20. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
    21. Chemla, Gilles & Porchet, Arnaud & Touzi, Nizar & Aïd, René, 2009. "Forward Hedging and Vertical Integration in Electricity Markets," Economics Papers from University Paris Dauphine 123456789/6395, Paris Dauphine University.
    22. Williamson, Oliver E, 1971. "The Vertical Integration of Production: Market Failure Considerations," American Economic Review, American Economic Association, vol. 61(2), pages 112-23, May.
    23. Kenneth J. Arrow, 1975. "Vertical Integration and Communication," Bell Journal of Economics, The RAND Corporation, vol. 6(1), pages 173-183, Spring.
    24. D. W. Carlton, 1976. "Vertical Integration in Competitive Markets Under Uncertainty," Working papers 174, Massachusetts Institute of Technology (MIT), Department of Economics.
    25. Klein, Benjamin, 1988. "Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 199-213, Spring.
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    Cited by:
    1. Guy Meunier, 2012. "Risk aversion and technology portfolios," Working Papers hal-00763358, HAL.
    2. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2013. "Electricity Derivatives Pricing with Forward-Looking Information," Working Papers on Finance 1317, University of St. Gallen, School of Finance.
    3. Guy Meunier, 2013. "Risk aversion and technology mix in an electricity market," Working Papers hal-00906944, HAL.

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