Retailers' risk management and vertical arrangements in electricity markets

The failure of the asset-light retailer's organizational model is indicative of the incapacity of this organizational structure to manage efficiently the combination of sourcing and market risks in the current market environment. Because of the structural dimensions of electricity's market risks, a retailer's level of risk exposure is unknown ex ante and will only be revealed ex post when consumption is known. In contrast to the “textbook model” of electricity reforms, the paper demonstrates through numerical simulations that in the current market context pure portfolios of contracts are incomplete risk management instruments compared to physical hedging. The latter is critical to overcome the asset-light retailer's curse.

► The paper analyses the risks faced by electricity retailers.
► We study the limits of contractual hedging.
► Through numerical simulations, we compare the risk profiles of different portfolios of hedging.
► We demonstrate the superior efficiency of physical hedging.