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Hedging and Vertical Integration in Electricity Markets

28 Pages Posted: 19 Feb 2009 Last revised: 2 Feb 2011

René Aïd

Université Paris-Dauphine

Gilles Chemla

Imperial College Business School; French National Center for Scientific Research (CNRS)

Arnaud Porchet

Citibank, N.A.

Nizar Touzi

Ecole Polytechnique, Paris

Multiple version iconThere are 2 versions of this paper

Date Written: February 11, 2009

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 that enables us to 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 are imperfect substitutes as to 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 while linear forward contracts do not. Vertical integration is superior to forward hedging in presence of highly risk averse retailers. We illustrate our analysis with data from the French electricity market.

Keywords: hedging, forward, wholesale spot price, retail, vertical integration

JEL Classification: g13, g34, l22

Suggested Citation

Aïd, René and Chemla, Gilles and Porchet, Arnaud and Touzi, Nizar, Hedging and Vertical Integration in Electricity Markets (February 11, 2009). EFA 2009 Bergen Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1342874 or http://dx.doi.org/10.2139/ssrn.1342874

Rene Aid

Université Paris-Dauphine ( email )

Place du Maréchal de Lattre de Tassigny
Paris, 75016
France

Gilles Chemla (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom
+44 207 594 9161 (Phone)
+44 207 594 9210 (Fax)

French National Center for Scientific Research (CNRS)

Dauphine Recherches en Management
Place du Marechal de Lattre de Tassigny
75775 Paris cedex 16, 75016
France

Arnaud Porchet

Citibank, N.A. ( email )

399 Park Ave., 11th Floor
New York, NY 10043
United States

Nizar Touzi

Ecole Polytechnique, Paris ( email )

1 rue Descartes
Paris, 75005
France

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