CSEM WP 155 Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability

One of the most critical concerns that customers have voiced in the debate over real-time retail electricity pricing is that they would be exposed to risk from fluctuations in their electricity cost. The concern seems to be that a customer could find itself consuming a large quantity of power on the day that prices skyrocket and thus receive a monthly bill far larger than it had budgeted for. I analyze the magnitude of this risk, using demand data from 1142 large industrial customers, and then ask how much of this risk can be eliminated through various straightforward financial instruments. I find that very simple hedging strategies can eliminate more than 80% of the bill volatility that would otherwise occur. Far from being complex, mystifying financial instruments that only a Wall Street analyst could love, these are simple forward power purchase contracts, and are already offered to retail customers by a number of fully-regulated utilities that operate real-time pricing programs. I then show that a slightly more sophisticated application of these forward power purchases can significantly enhance their effect on reducing bill volatility. 1 Director of the University of California Energy Institute (www.ucei.org) and E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business, U.C. Berkeley (www.haas.berkeley.edu). Email: [email protected]. My thanks to David Hungerford at the California Energy Commission and Susan McNicoll at Pacific Gas & Electric for helping me obtain access to data. For helpful comments and discussions, I thank Meredith Fowlie, Rob Letzler, Frank Wolak and seminar participants in U.C. Berkeley’s Department of Agricultural and Resource Economics.