Electricity customers’ financial and reliability risk protection utilizing insurance mechanism

Abstract

Due to the electricity market risks and lack of various purchasing options, electricity customers are reluctant to participate in the electricity market. On the other hand, due to the electricity grid conditions and the absence of enough information about customers’ preferences, most utilities do not differentiate electricity services at the customer level. To provide various service options, this paper proposes the utility company provides financial and outage insurance mechanisms (FIM and OIM). In the FIM, electrical energy is sold via the real-time pricing (RTP) method. Each of the electricity customers selects a strike price, as an insurance deductible, based on his/her preferences. When the electricity market price exceeds the deductible, the utility company pays the difference between the deductible and the market price. In the OIM, a customer receives outage reimbursement based on his/her outage value. In this paper, the concept of the utility function is utilized to identify the customer’s and insurer’s behavior against different insurance contracts. Results illustrate the proposed FIM reduces the electricity market fluctuations and the average of the customers’ costs. According to the OIM, the outage is divided differently between the customers based on their outage value.

Introduction

These days, electricity consumers have become active players in the modern power system. Hence, it is essential to provide a mechanism that enables the customers to participate in the power market [1]. One of the effective structures that enable electricity customers to participate appropriately in the electricity market is real-time pricing (RTP) [2], [3]. Through the RTP, customers, even the end-used one, are presented with a ‘price signal’ that more accurately conveys the actual costs of electricity generation and supply-side [4]. The price signal incentivizes the customers to reduce or shift electricity usage from the peak to the off-peak periods [5]. Electricity market price volatility reduction is the most notable advantage of RTP [6]. However, some rigid barriers restrict customers’ participation in RTP [7]. The most important of these barriers are:

• Complexity of market participation and lack of experience.

• Measurement and communication costs.

• Economic risks and volatilities of the market prices.

These barriers motivate the customers to purchase their electricity energy via the flat-rate pricing method or use a protection mechanism against the market price risks. A well-designed risk hedging mechanism would help relieve the customers’ concern by preserving them against the market risks [8]. Risk hedging contract enables the customers to manage their electricity cost by sharing electricity market risks with the risk hedger [9]. Flat-rate pricing and real-time pricing methods can be interpreted through the risk hedging concept. In flat-rate pricing, the risks of the market price fluctuations are covered completely. Therefore, the customers pay only the average price of the market as the premium. In RTP, customers select self-risk hedging by paying the variable market price for the electricity energy [10].

Electricity consumers’ risks not only involve the market price but also furthermore include the quality and reliability of the delivery service. In the current regulatory schemes to improve electricity customers’ reliability, the average of the service is employed as the criterion to incentivize or penalize the utility company [11], [12]. Although these schemes can improve the reliability, they do not consider the customer’s personal preferences. To consider the customers’ preferences, some studies, [13], [14], propose reliability improvement schemes in which electricity customers can choose their desired service level. The inflexibility of the electrical grid remains another challenge limiting the provision of electricity services based on the customers’ preferences. For example, regardless of their preferences, all of the customers in a grid receive the same service quality. Insurance is an efficient risk hedging mechanism that can overcome the challenges mentioned above by providing various electricity services and purchasing options.

Several aspects of insurance and its application in the power system have been studied so far. Refs.​ [15] and [16] have studied the insurance mechanism to protect generation units against forced outage risks. A novel insurance protection has been provided by independent system operator for electricity bilateral contract in [17]. Insurance mechanisms can also be used to cover renewable resources risks. In [18], an insurance mechanism has been designed to cover wind generation trading risks in the electricity market. Ref. [19] has provided insurance support for small hydropower sector investors. The paper has created a trade-off to divide the project costs risks between the insurance company and the investors.

Some other studies have investigated reliability insurance for electricity sectors. In [20], the reserve market has been considered as an insurance mechanism in which generation units collect the premium from who purchases the insurance and provide a reliable power supply in return. In [21], the distribution company has provided different electricity services via different insurance contracts. The distribution company uses the collected insurance premiums to improve electricity service or pay reimbursement. Another reliability insurance scheme has been introduced in [22], which allows the consumers to determine their value for reliability based on their preferences. The utility company has to reimburse the consumers according to their outage value when the electricity outage occurs. In addition to selling commoditized kilowatt-hours (kWh), Ref. [23] has suggested the electricity firms sell reliability insurance. The proposed insurance can reduce both the price and volume risks of firms by receiving a stable revenue. Ref. [24] has introduced a reliability insurance scheme overlay on energy electricity markets, in which financial protection is provided to the consumers against electricity outages. From the proposed insurance scheme, the collected premiums are used to invest in electricity generation or pay the reimbursement. Also, Ref. [25] has proposed distributed generation (DG) provides the reliability insurance mechanism.

Although different insurance mechanisms have been investigated for different electricity sectors, utilizing financial insurance to protect electricity customers’ risks is neglected. Moreover, the existing reliability insurance mechanisms include some weakness to provide electricity service based on the customers’ preferences. In this paper, a novel insurance mechanism based on the concept of the utility function is designed to protect the electricity customers’ concerns. From economics, the function that can explain people’s behavior against risk hedging mechanism is utility function [26]. Therefore, this paper utilizes the utility function to identify electricity customers’ viewpoints and design financial and outage insurances mechanisms (FIM and OIM). In the FIM, each customer selects a strike price, which represents the maximum price that the customer is ready to purchase from the market. When the market price is lower than the strike price, the customer pays the market price for electricity energy consumption. Otherwise, the insurer is responsible for paying the difference between the market price and predetermined strike price. Selected strike prices can be interpreted as the insurance deductibles. In the insurance literature, deductible represents the part of the claim that the policyholder takes by himself/herself. By selecting different deductibles, all customers can take part in the electricity market based on their preferences. Moreover, OIM is used to cover electricity outage risks, where each customer selects his/her outage value and pays a premium to prevent the risk. To reduce the reimbursement, the insurer can manage the outage by applying different outage levels to the customers based on their outage values. Through the OIM, the customers can select various electricity services based on their preferences. The main contributions of this paper are summarized as follows:

• The utility function is employed to measure the electricity customers’ preferences considering different risk aversion behaviors.

• A new load model is designed based on the customers’ risk aversion behavior.

• Customer welfare is modeled only as a function of electricity price and the customers’ risk aversion coefficient.

• The risk aversion coefficients are estimated via price-elasticity of electricity demand.

• A novel insurance mechanism is designed to cover electricity customers’ concerns due to electricity market price and electricity outage risks.

• Maximum tolerable (minimum acceptable) insurance premium is determined based on the customers’ (insurer) viewpoint considering different utility functions.

The rest of this paper is organized as follows: Section 2 discusses the utility theory. In this section,​ electricity customers’ behavior is modeled via different utility functions. Sections 3 Financial Insurance Mechanism (FIM), 4 Outage Insurance Mechanism (OIM) describe financial and outage insurance mechanisms. The numerical results are addressed in Section 5. Finally, the paper is concluded in Section 6.