Working Paper: NBER ID: w12524
Authors: Severin Borenstein
Abstract: One of the most critical concerns that customers have voiced in the debate over real-time retail electricity pricing is that they would be exposed to risk from fluctuations in their electricity cost. The concern seems to be that a customer could find itself consuming a large quantity of power on the day that prices skyrocket and thus receive a monthly bill far larger than it had budgeted for. I analyze the magnitude of this risk, using demand data from 1142 large industrial customers, and then ask how much of this risk can be eliminated through various straightforward financial instruments. I find that very simple hedging strategies can eliminate more than 80% of the bill volatility that would otherwise occur. Far from being complex, mystifying financial instruments that only a Wall Street analyst could love, these are simple forward power purchase contracts, and are already offered to retail customers by a number of fully-regulated utilities that operate real-time pricing programs. I then show that a slightly more sophisticated application of these forward power purchases can significantly enhance their effect on reducing bill volatility.
Keywords: real-time pricing; bill volatility; hedging; electricity market
JEL Codes: L51; L94
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real-time retail electricity pricing (RTP) (L97) | bill volatility (E42) |
| hedging (G41) | bill volatility (E42) |
| real-time retail electricity pricing (RTP) (L97) | average bill volatility (E39) |
| optimal hedging (G13) | bill volatility under RTP (G17) |
| real-time retail electricity pricing (RTP) (L97) | hedging (G41) |