Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability
AbstractOne 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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Date of creation: Sep 2006
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Other versions of this item:
- Severin Borenstein, 2007. "Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 111-130.
- L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
- L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-09-30 (All new papers)
- NEP-ENE-2006-09-30 (Energy Economics)
- NEP-FMK-2006-09-30 (Financial Markets)
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