Hedging strategies for solar power businesses in electricity market using weather derivatives

The large-scale introduction of natural energy being promoted worldwide in recent years leads to an increased impact of weather fluctuations on wholesale electricity prices. In markets where the introduction of solar power generation is rapidly progressing worldwide including Japan, hedging needs for revenue fluctuations in the solar power business have been expanding year by year. Therefore, this study proposes hedging strategies for the revenue of power generation companies that trade generated solar power through the wholesale electricity market, using a portfolio of derivatives whose underlying assets consist of fuel price, solar radiation, and temperature. We specifically propose a multilateral hedging method that applies multiple non-parametric regression methods such as tensor product spline function, ANOVA decomposition, and spline function with cross variable, and demonstrate the hedging effect using empirical data from the Japan Electric Power Exchange (JEPX).