Valuating risk from sales contract offer maturity in electricity market

The electricity retail business has always been exposed to a significant risk due to a very volatile nature of the wholesale electricity market. Recently, this trend has been accelerating, as electricity-forward price can rise or fall during one day by an amount comparable to the retailer's margin. As a result, the risk that arises from sales contract offer maturity can significantly reduce or even neutralize the retailer's profit. To develop a mitigation strategy for this risk, a retailer clearly needs a model for a detailed risk analysis. Many attempts have been made to analyze several risk issues of an electricity retail company, but so far none has explored and evaluated the sales contract offer maturity risk. This paper presents a fundamental model for evaluating this risk and a methodology for its use, and compares its analytical Performance with traditional techniques obtained from the option-pricing theory. A realistic example illustrates the use and the benefits of the proposed model in risk analysis of the electricity retail business. (C) 2009 Elsevier Ltd. All rights reserved.