Cross Hedging Strategies for Solar Energy Production using Weather Derivatives
29 Pages Posted: 15 Aug 2015 Last revised: 27 Apr 2016
Date Written: April 26, 2016
Weather elements such as temperature and solar radiation play a crucial role in renewable power production as well as in power consumption. Consequently, these weather factors impact the profitability of such renewable energy producers. In this research, we identify the core risk exposures of a solar energy producer at different times of the year owing to variability in weather elements and energy consumption patterns. We investigate the extent of natural hedge embedded in the dependence of power production using solar energy and power consumption on risk of variations in weather elements. We further develop a framework to construct explicit cross hedging strategies for mitigation of the identified weather risk using temperature-based weather derivatives. In this framework, we analyze the extent of risk reduction possible at different times of the year through a variety of temperature derivative contracts. We find that there is significant benefit of natural hedge in certain months of the year, while in others explicit hedges put in place can effectively modify risk exposure. Our study finds that temperature derivatives based hedges are more effective for summer versus winter months.
Keywords: Solar energy, risk management, natural hedge, cross hedge, weather derivatives, locational basis risk
JEL Classification: G32, Q47
Suggested Citation: Suggested Citation