Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability
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.
|Date of creation:||Sep 2006|
|Date of revision:|
|Publication status:||published as Severin Borenstein, 2007. "Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability," The Energy Journal, International Association for Energy Economics, vol. 28(2), pages 111-130.|
|Note:||IO AP EEE|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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- Ronald I. McKinnon, 1967. "Futures Markets, Buffer Stocks, and Income Stability for Primary Producers," Journal of Political Economy, University of Chicago Press, vol. 75, pages 844.
- Borenstein, Severin & Bushnell, James & Knittel, Chris & Wolfram, Catherine, 2008.
"Inefficiencies and Market Power in Financial Arbitrage: A Study of California's Electricity Markets,"
Staff General Research Papers Archive
13133, Iowa State University, Department of Economics.
- Christopher Knittel & Catherine Wolfram & James Bushnell & Severin Borenstein, 2006. "Inefficiencies and Market Power in Financial Arbitrage: A Study of California?s Electricity Markets," Working Papers 630, University of California, Davis, Department of Economics.
- Severin Borenstein & Stephen P. Holland, 2003.
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NBER Working Papers
9922, National Bureau of Economic Research, Inc.
- Severin Borenstein & Stephen Holland, 2005. "On the Efficiency of Competitive Electricity Markets with Time-Invariant Retail Prices," RAND Journal of Economics, The RAND Corporation, vol. 36(3), pages 469-493, Autumn.
- Gregory W. Brown & Klaus Bjerre Toft, 2002. "How Firms Should Hedge," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1283-1324.
- Severin Borenstein, 2007. "Wealth Transfers Among Large Customers from Implementing Real-Time Retail Electricity Pricing," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 131-150.
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