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Hedging and Vertical Integration in Electricity Markets

Author

Listed:
  • René Aïd

    (LEDa - Laboratoire d'Economie de Dauphine - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres)

  • Gilles Chemla

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

  • Arnaud Porchet
  • Nizar Touzi

    (CMAP - Centre de Mathématiques Appliquées de l'Ecole polytechnique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique)

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.

Suggested Citation

  • René Aïd & Gilles Chemla & Arnaud Porchet & Nizar Touzi, 2011. "Hedging and Vertical Integration in Electricity Markets," Post-Print hal-02304220, HAL.
    • Handle: RePEc:hal:journl:hal-02304220
    DOI: 10.1287/mnsc.1110.1357
    as

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