Electricity Tariff Volatility Mitigation Using Uncertainty-Diminution and Hedge Contracts along with Risk Management Policies

Abstract

After the advent of restructured power systems and the transition from traditional grid management into deregulated management, which procures higher levels of intelligence, observability, agility, controllability, the importance of quantitative risk assessment and risk mitigation has been grown. In recent years, many market players have experienced long-term planning problems, which incur staggering costs to the grids. Investing in the electricity industry is a long-term investment and the investor will suffer heavy losses in the case of inappropriate forecasting and lack of elaborated management. Hence, the investors should be so encouraged through incentives and tariff determination policies that a convincing level of reliability is achieved. Furthermore, the investment costs and maintenance costs should be recovered by the revenue earned from well-thought-out tariffs. Tariffs also send economic signals to price-elastic loads that help to shape the consumption pattern of end-users and change the demand curve, particularly for peak clipping and valley filling. In a restructured environment, the electricity tariffs have hourly or intra-hour volatilities. These variations are triggered by various uncertainties. The uncertainty in tariffs is not desired by the customers. The improvement in the predictability of tariffs mitigates the risk for market players as well as end-users for profitability and portfolio management. Such improvements and risk mitigations can be maintained by some financial means, known as hedging means, such as call/put option contracts, contract for difference agreements, long-term future or forward contracts, diversification and liquidity improvement in markets, insurance and arbitrage diminution rules, etc. In this paper, a new tariffs volatility reduction technique using risk management approaches and long-term contracts for restructured power systems is proposed. Bilateral long-term contracts will arguably alleviate risk fluctuations in investment and subsequently market prices in the long term. In order to solve this problem and its economic facets, long-term bilateral hedge contracts for the control of long-term uncertainty are integrated into the model. In the proposed method by designing long-term contracts deploying economic financing paradigms and optimal decision-making schemes, the role of long-term hedge contracts in reducing general tariff costs and instability by incorporating GAMS software on the Iran National Grid (ING) has been investigated.