Risk Management and Optimal Hedging in Electricity Forward Markets coupled with a balancing mechanism

The balancing arrangement is the last module of the sequence of electricity markets and is the base of all other (forward/hedging) markets. The design of the balancing arrangement determines the way as market participants act in forward markets looking an optimal hedging position. Balancing mechanisms that penalize real-time energy imbalance are common in Europe. This paper focuses on the consequences of penalizing imbalance prices. Our modeling approach is a simple two-stage market-equilibrium with generators and retailers. Using numerical examples we find four main consequences: Forward price distortion, market participants´ utility asymmetrical changes, TSO utility increase, and inefficiency