Overview of Risk Management in Electricity Markets Using Financial Derivatives

Electricity spot prices are highly volatile under
optimal generation capacity scenarios due to factors such as nonstorability
of electricity, peak demand at certain periods, generator
outages, fuel uncertainty for renewable energy generators, huge
investments and time needed for generation capacity expansion etc.
As a result market participants are exposed to price and volume risk,
which has led to the development of risk management practices. This
paper provides an overview of risk management practices by market
participants in electricity markets using financial derivatives.

• Aparna Viswanath

• Financial Derivatives
• Forward
• Futures
• Options
• Risk Management.

[1] J. Hull, Options, futures and other derivative. 4 th ed. Englewood, NJ:
Prentice-Hall; 2000.
[2] F. Black and M. Scholes, “Pricing of Options and Corporate Liabilities,”
Journal of Political Economy 81:3, pp. 637-654, 1973.
[3] R. Ghaffari and B. Venkatesh, “Options based reserve procurement
strategy for wind generators – using binomial trees,” IEEE Trans. Power
Systems, vol. ED-11, pp. 34–39, Jan. 2012
[4] K.W.Hedman and G. B. Sheble, “ Comparing hedging methods for
Wind Power: Using pumped Storage Hydro Units vs. Options
purchasing,” 9 th International Conference on Probabilistic methods
applied to Power Systems KTH, Stockholm, Sweden – June 11-15,
2006.
[5] G. Sanchez, J. M. Alzate, A. cadena and J. M. Benavides, “Setting up
standard power options to hedge price- quantity risk in a competitive
electricity market: The Colombian Case,” IEEE Trans. Power Systems,
vol. 26, No.3, pp. 1493-1500 Aug. 2011.
[6] Y. Oum, S.S. Oren and S. Deng, "Hedging Quantity Risk with Standard
Power Options in a Competitive Wholesale Electricity Market," Naval
Research Logistics. Vol. 53, (2006) pp. 697-712.
[7] S.J. Deng and S.S. Oren, “Electricity derivatives and risk management”,
Energy, vol. 31, pp. 940–953, 2006.
[8] S.S. Oren, "Combining Financial Double Call Options with real Options
for early Curtailment of Electricity Service," Proceedings of the 32 nd
Hawaii International Conference on System Sciences, 1999. [9] T.W. Gedra, Optional Forward Contracts for electric power service
contracts. PhD Thesis, University of California, Berkeley; 1991.
[10] T.W. Gedra and P.V. Pravin, “Markets and Pricing for interruptible
Electric Power Transactions,” IEEE Trans. Power Systems, vol. 8, No.1,
pp. 122-128, Feb. 1993.
[11] T. Ishikida and P.V. Pravin, “Pricing of Electric Power under
Uncertainty: Information and Efficiency,” IEEE Trans. Power Systems,
vol. 10, No.2, pp. 884-890, May. 1995.
[12] S.S. Oren, "Generation Adequacy via Call Option Obligations: Safe
Passage to the Promised Land," Electricity Journal, November, 2005
[13] M. Pereira, L.A. Barroso and J. Rosenblatt, “Supply adequacy in the
Brazilain power Market,” Proceedings of the IEEE PES General
Meeting, Denver, 2004.
[14] L.A. Barroso, J. Rosenblatt, B. Bezerra, A. Resende, M. Periera, “
Auctions of contracts and Energy Call options to Ensure Supply
Adequacy in the Second Stage of the Brazilian Power sector reform,”
Proceedings of IEEE General Meeting 2006, Montreal.
[15] B. Bezerra, L.A. Barroso, M.V. Periera, S, Granville, A, Guimaraes, A,
Street, “Energy Call Options Auctions for Generation Adequacy in
Brazil,” Proceedings of IEEE General Meeting 2006, Montreal.