Hedging households against extreme electricity prices

Dynamic electricity prices expose households to the risk of extremely high electricity bills during scarcity events. To protect households from high scarcity prices, I explore how to combine dynamic electricity prices with forward hedging. I derive household-specific optimal forward hedge shares by applying a utility maximization model to 2,159 UK households exposed to dynamic prices. The average optimal hedge share is 59% of households’ baseline consumption. Hedge shares are higher for electric heating and electric vehicle owners and lower for solar PV and battery storage owners. My key theoretical finding is that an increase in households’ price elasticity of demand raises optimal hedge shares if households face positive correlation between electricity prices and their weather-related desire to consume electricity. Forward hedging effectively reduces electricity bill volatility by 18% for price-inelastic households. When exposing households to scarcity events, hedging achieves sizable welfare gains equivalent to a 19% reduction in average electricity prices.