Impact of Price–Quantity Uncertainties and Risk Aversion on Energy Retailer’s Pricing and Hedging Behaviors

The joint uncertainties of wholesale price and end-user demand quantity often poses huge pricing challenges to energy retailers. However, the literature lacks analysis of such uncertainties’ impacts on retailer pricing behaviors and possible hedging behaviors. To study these impacts, this paper proposes four models: a risk-averse or a risk-neutral retailer deciding retail price with or without forward contract. We present closed-form solutions for these four models on optimal retail price, as well as optimal forward position (if allowed). We propose a novel approach of volatility decomposition to describe the relationship between behaviors and different volatility sources. Comparative statics gives detailed analysis of the pricing and hedging behaviors in both uncertainties, as well as their correlation. We obtain profit distributions using Monte Carlo simulations in the context of the California Electricity Market. Results show that the price and quantity uncertainties and their correlation create significant differences in the retailer’s behaviors, and the determinants of these differences are different. In addition, forward contract increases expected profit and decreases profit volatility for risk-averse retailers simultaneously. These results could serve as a benchmark for analyses of deregulated, imperfect energy markets coupled with contingent financial markets under both price and quantity uncertainties.