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Interruptible Electricity Contracts from an Electricity Retailer's Point of View: Valuation and Optimal Interruption

Department of Electrical and Computer Engineering, University of Texas at Austin, Austin, Texas 78712
Institute for Computational Engineering and Sciences, University of Texas at Austin, Austin, Texas 78712
Department of Information, Risk and Operations Management, McCombs School of Business, University of Texas at Austin, Austin, Texas 78712
ross.baldick{at}engr.utexas.edu
skolos{at}mail.utexas.edu
stathis.tompaidis{at}mccombs.utexas.edu

We consider interruptible electricity contracts issued by an electricity retailer that allow for interruptions to electric service in exchange for either an overall reduction in the price of electricity delivered or for financial compensation at the time of interruption. We provide a structural model to determine electricity prices based on stochastic models of supply and demand. We use stochastic dynamic programming to value interruptible contracts from the point of view of an electricity retailer, and describe the optimal interruption strategy. We also demonstrate that structural models can be used to value contracts in competitive markets. Our numerical results indicate that, in a deregulated market, interruptible contracts can help alleviate supply problems associated with spikes of price and demand and that competition between retailers results in lower value and less frequent interruption.

Subject classifications: natural resources: energy, interruptible electricity; dynamic programming/optimal control.
History: Received December 2003; revision received June 2004; accepted June 2005.

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