Electricity contracting and policy choices under risk-aversion,” submitted to Operations Research

Much of the literature on electricity markets has been predicated on the assumption that firms are risk neu-tral; that they make decisions based upon maximizing expected profits. In reality, many firms are controlled by shareholders or owners who take a point of view usually no longer than five to ten years hence, and seek to minimize risk. A firm that does not return profits in that time period is likely to be wound up or forced into bankruptcy. Under such an incentive scheme, firms are likely to be risk-averse, with serious implications for policy analysis. We introduce a model of an electricity market where firms can choose to enter the retail market, then enter into retail contracts, and finally purchase electricity in a wholesale market to satisfy their contracts. We explicitly assume that firms are risk-averse in this model, and act to minimize their conditional value-at-risk (while maximizing profit). We demonstrate how firms ’ behaviour changes with risk-aversion, and use the example of an asset-swap policy to demonstrate the importance of risk-aversion in determining policy outcomes. Key words: risk-aversion, game thoery, retail pricing, electricity 1