Risk is the hazard to which we are exposed because of uncertainty. Risk is also associated with decisions. Where there are no uncertainties and no alternatives, there is no risk. Decisions that we make can affect these uncertainties and can reduce hazards. Under regulated markets there were fewer uncertainties and risks because tariffs were almost fixed. With deregulation, electric power markets are volatile, prices change within a short time, and risks can be serious. In the deregulated market of electric power, electricity is a commodity and consumers have choices, correspondingly generators are competing among each other. This has created opportunities mainly for consumers and risks for producers, which need to be hedged. Trading refers to transactions that take place directly between two parties or through an organised exchange. Although commodities trading in agricultural products have been established since the middle of the 19th century, it was only in 1996 that electricity future started to be traded in the New Year Mercantile Exchange in the US. It is believed that the California electricity crises of 2000-2001 and its serious financial and economic consequences were due to inadequate proper hedging through long-term supply contracts. The last two or three decades of electricity market reforms have shifted most of the financial risks from consumers to producers. Such restructured electricity market can pose large financial risks to producers. Therefore, to limit these risks regulatory mechanisms were introduced, such as price caps and various capacity market mechanisms, through balancing risks between consumers and producers, limiting price volatility and ensuring investments recovery to producers.

Chapter Contents:

• 16.1 Introduction
• 16.2 Qualifying and managing financial risks
• 16.3 Quantifying and managing risk
• 16.3.1 Forward contracts
• 16.3.2 Futures contract
• 16.3.3 Options
• 16.3.4 Swaps
• 16.3.5 Political risk
• 16.4 Decision making
• 16.4.1 The decision-making process
• References

Inspec keywords: power markets; risk management; contracts; pricing; hazards; tariffs

Other keywords: New Year Mercantile Exchange; decision making; California electricity crises; economic consequences; tariffs; electricity markets; deregulated electric power market; capacity market mechanisms; risk balancing; financial consequences; risk management; long-term supply contracts; price caps; hazard reduction; price volatility limitation; risk regulatory mechanisms

Subjects: Power system management, operation and economics; Electrical contracting and installation