Discussion Paper Details

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Title: Hedging and Vertical Integration in Electricity Markets

Author(s): Ren Ad, Gilles Chemla, Arnaud Porchet and Nizar Touzi

Publication Date: April 2011

Keyword(s): electricity markets, forward, hedging, producers, retailers, spot and vertical integration

Programme Area(s): Financial Economics and Industrial Organization

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.

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Bibliographic Reference

Ad, R, Chemla, G, Porchet, A and Touzi, N. 2011. 'Hedging and Vertical Integration in Electricity Markets'. London, Centre for Economic Policy Research.