From The Power Game substack, May 12:
Architectures for risk hedging incentives: standard sizing or tailored fit?
Hedging and risk-management has received much-needed focus in recent market design discussion papers, but multiple options exist for completing markets for risk.
Hedging is core to commodity risk management. The earliest organized futures markets, the Dojima Rice Exchange, was formed in 1730 to allow trade rice futures, via a contract-for-difference and margin scheme known as “Shikigin”. In the electricity sector, hedge markets developed co-incidentally with the structural reform and liberalization. NYMEX issued the first electricity futures contracts in 1996, the COB and Palo Verde electricity futures.
Much of the historical dialogue on resource adequacy has centred upon ‘missing money’; yet the inadequacies of this framing for both diagnosis and solution seem to fall short (see Biggar 2025, Hogan 2022).1 A better framing of the fundamental challenge of resource adequacy and indeed resilience in electricity markets is through the lens of hedging. In that vein it is pleasing to see a renewed focus upon the role of hedging in managing price risk; PJM’s recent market design paper devotes significant attention to the disparities between spot markets and hedge markets.
1. Diagnosing markets for risk
The theoretical model is as such. Full strength price formation (including the prospect of extreme prices) should create strong short-term signals but also strong long-term signals. The moniker is: “Price volatility is a feature, not a bug of electricity market design”.
Retailers/consumers and generators/storage resources that are risk-averse can contract to reduce their risk exposures. Such contracts can facilitate financing and build of new resources and retirement of old… guided by the spot price (the optimal ‘locational marginal price’ signal)....
....MUCH MORE
If interested in a related diversion see also:
"Japan ends 300 years of trading rice futures" + "The Greatest Hedge Fund Manager of All Time"