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Hedging and Vertical Integration in Electricity Markets

Author

Listed:
  • René Aïd

    () (EDF R&D and Finance for Energy Market Research Centre, F-92141 Clamart Cedex, France)

  • Gilles Chemla

    () (Imperial College Business School, DRM-CNRS, and CEPR, London SW7 2AZ, United Kingdom)

  • Arnaud Porchet

    () (Global Markets Structuring, Deutsche Bank, and Finance for Energy Market Research Centre, University of Paris-Dauphine, 75775 Paris Cedex 16, France)

  • Nizar Touzi

    () (Centre de Mathématiques Appliquées, Ecole Polytechnique, 91128 Palaiseau Cedex, France)

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. This paper was accepted by Wei Xiong, finance.

Suggested Citation

  • René Aïd & Gilles Chemla & Arnaud Porchet & Nizar Touzi, 2011. "Hedging and Vertical Integration in Electricity Markets," Management Science, INFORMS, vol. 57(8), pages 1438-1452, August.
  • Handle: RePEc:inm:ormnsc:v:57:y:2011:i:8:p:1438-1452
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    File URL: http://dx.doi.org/10.1287/mnsc.1110.1357
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    References listed on IDEAS

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    2. Boroumand, Raphaël Homayoun & Goutte, Stéphane & Porcher, Simon & Porcher, Thomas, 2015. "Hedging strategies in energy markets: The case of electricity retailers," Energy Economics, Elsevier, pages 503-509.
    3. Karsten Neuhoff & Sophia Rüster & Sebastian Schwenen, 2015. "Power Market Design beyond 2020: Time to Revisit Key Elements?," Discussion Papers of DIW Berlin 1456, DIW Berlin, German Institute for Economic Research.
    4. Guy Meunier, 2014. "Risk Aversion and Technology Portfolios," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 44(4), pages 347-365, June.
    5. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2015. "Electricity derivatives pricing with forward-looking information," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 34-57.
    6. Ren'e Aid & Luciano Campi & Delphine Lautier, 2015. "A note on the spot-forward no-arbitrage relations in a trading-production model for commodities," Papers 1501.00273, arXiv.org, revised Apr 2015.
    7. repec:eee:eneeco:v:67:y:2017:i:c:p:355-365 is not listed on IDEAS
    8. Meunier, Guy, 2013. "Risk aversion and technology mix in an electricity market," Energy Economics, Elsevier, vol. 40(C), pages 866-874.
    9. Downward, Anthony & Young, David & Zakeri, Golbon, 2016. "Electricity retail contracting under risk-aversion," European Journal of Operational Research, Elsevier, vol. 251(3), pages 846-859.
    10. repec:eco:journ2:2017-03-31 is not listed on IDEAS
    11. Gibson, Rajna & Habib, Michel A. & Ziegler, Alexandre, 2014. "Reinsurance or securitization: The case of natural catastrophe risk," Journal of Mathematical Economics, Elsevier, vol. 53(C), pages 79-100.
    12. repec:kap:revind:v:52:y:2018:i:1:d:10.1007_s11151-017-9580-1 is not listed on IDEAS
    13. Bunn, Derek W. & Oliveira, Fernando S., 2016. "Dynamic capacity planning using strategic slack valuation," European Journal of Operational Research, Elsevier, vol. 253(1), pages 40-50.
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