Working Paper: CEPR ID: DP8313
Authors: Ren AD; Gilles Chemla; Arnaud Porchet; Nizar Touzi
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 due to 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 when retailers are highly risk averse. We illustrate our analysis with data from the French electricity market.
Keywords: electricity markets; forward hedging; producers; retailers; spot; vertical integration
JEL Codes: D21; G13; G32; G34; I11; I51; I94
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Vertical Integration (L22) | Reduced Retail Prices (L42) |
| Forward Hedging (G13) | Reduced Retail Prices (L42) |
| Vertical Integration (L22) | Increased Retail Market Shares (L81) |
| Forward Hedging (G13) | Increased Retail Market Shares (L81) |
| Vertical Integration (L22) | Restored Risk Symmetry (D81) |
| Forward Contracts (G13) | Asymmetry in Risk Exposure (D81) |
| Integrated Firms (L22) | Lower Retail Prices (D49) |
| Vertical Integration is Superior to Forward Hedging (L22) | Effective Risk Management (H12) |