Risk Management in Country's Electricity Industry: Requirements and Instruments

Financial derivatives do not represent ownership rights in any asset but, rather, derive their value from the value of some other underlying commodity or other asset. They are claimed to be efficient and effective tools for hedging against risk exposure. In many countries, use of derivatives in electricity industry has come about with electricity price deregulation. In electricity market, risk of price fluctuations threatens electricity consumers and producers. While, varying prices encouraged consumers to find ways to reduce their costs, and producers looked for ways to stabilize cash flow, derivative contracts were introduced to transfer price risk, to those who are able to bear it. Price risk management in electricity industry is relatively a new phenomen. However, electricity derivative contracts have grown rapidly. In this article, we will introduce various kinds of financial derivatives (such as Forwards, Futures, Options, and Multiple-Trigger Derivatives), commodity characteristics of electricity and price risk management methods with derivatives in the electricity industry.