Hedging quantity risks with standard power options in a competitive wholesale electricity market

This paper addresses quantity risk in the electricity market and explores several ways of managing such risk. The paper also addresses the hedging problem of a load-serving entity, which provides electricity service at a regulated price in electricity markets with price and quantity risk. Exploiting the correlation between consumption volume and spot price of electricity, an optimal zero-cost hedging function characterized by payoff as a function of spot price is derived. It is then illustrated how such a hedging strategy can be implemented through a portfolio of forward contracts and call and put options. (C) 2006 Wiley Periodicals, Inc.