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 and thus receive a monthly bill far larger than it had budgeted for. 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 strategies can eliminate more than 80% of the bill volatility that would otherwise occur. Far from being complex, mystifying financial instruments that only a Wall Street analyst could love, these are simple forward power purchase contracts, and are already offered to retail customers by a number of fully-regulated utilities that operate real-time pricing programs. 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12524.
Length: Date of creation: Sep 2006 Date of revision: Handle: RePEc:nbr:nberwo:12524
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Find related papers by JEL classification: L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
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