We consider the problem of an electric-power marketer offering a fixed-price forward contract to provide electricity that it purchases from a potentially volatile and unpredictable fledgling spot energy market. One option for the risk-averse marketer who wants to hedge against the spot-price volatility is to engage in cross hedging to reduce the contract's profit variance, and to determine the forward-contract price as a risk-adjusted price - the sum of a baseline price and a risk premium. We show how the marketer can estimate the spot-price relationship between two wholesale energy markets for the purpose of cross hedging, as well as the optimal hedge and the forward contract's baseline price and risk premium. Copyright © 2001 Elsevier Science B.V. All rights reserved.
CitationWoo, C.-K., Horowitz, I., & Hoang, K. (2001). Cross hedging and forward-contract pricing of electricity. Energy Economics, 23(1), 1-15. doi: 10.1016/S0140-9883(00)00071-2
- Cross hedging
- Forward-contract pricing