A model for hedging load and price risk in the Texas electricity market

- We present a structural model for electricity spot prices in the ERCOT market.
- Relationships between power price and factors such as load and gas price are studied.
- Seasonal patterns and load-dependent spikes are shown to be well captured.
- Closed-form results for prices of forwards, options and spread options are derived.
- We demonstrate the effectiveness of hedging power demand with forwards and options.

Energy companies with commitments to meet customers' daily electricity demands face the problem of hedging load and price risk. We propose a joint model for load and price dynamics, which is motivated by the goal of facilitating optimal hedging decisions, while also intuitively capturing the key features of the electricity market. Driven by three stochastic factors including the load process, our power price model allows for the calculation of closed-form pricing formulas for forwards and some options, products often used for hedging purposes. Making use of these results, we illustrate in a simple example the hedging benefit of these instruments, while also evaluating the performance of the model when fitted to the Texas electricity market.