How exactly does a retail energy marketer use the spread as a hedging device?
David A. Foti works at Accenture and is a frequent contributer to Public Utilities Fortnightly. He may be contacted at firstname.lastname@example.org. Martin F. Nellius is vice president, supply acquisition, for Entergy Solutions Supply Ltd. He has worked in the energy industry for 21 years, and is responsible for various retail operations including power procurement, portfolio management, and risk mitigation strategies for Entergy Solutions Supply.
The Bid-Offer spread was suggested above as one of several possible mitigants for many of the listed risks. How exactly does a retail energy marketer use the spread as a hedging device?
Generically, the Bid-Offer spread represents the profit a market-maker or intermediary demands for creating liquidity. This spread is composed of the intermediary's variable cost per deal plus any liquidity risk they may bear. In liquid markets the bulk of the spread will be variable cost-based and in illiquid markets it will be dominated by the liquidity risk factor.
Newly deregulated energy markets are often characterized by a lack of liquidity. A player who wishes to create markets in such a nascent environment has at least three options for spread determination (in ascending order of complexity):