Chapter 12 - Risk Management in a Competitive Electricity Market

Abstract

This chapter provides an overall framework of risk management for Gencos' trading in a competitive electricity market. At first, a Genco's objective and trading constraints are identified. Then the identified objective and constraints are translated into a reasonable and feasible risk-control strategy under which a specific trading schedule could be made. A risk-control strategy varies with different trading objectives and constraints. A more conservative Genco prefers to control risk through diversification, i.e. trading energy between spot and contract markets. A less conservative Genco tends to trade physical energy in spot markets only and hedge spot-price risk with options. The risk-management process of a Genco with normal conservative objectives was demonstrated based on the historical data of electricity prices in the PJM market. Simulation results confirmed that diversification, i.e. trading among multiple physical approaches, is helpful to reduce the complete trading risk, and VaR provides a useful approach to judge whether the formed trading portfolio is acceptable. The proposed framework of risk management provides a clear hierarchy of the risk management process, which should help a Genco to identify its objective and achieve an optimal trading portfolio in markets involving risks. It is also applicable to other market participants, such as energy purchasers, with little modification.