The energy transition, the market for hedges, and the implications for the Default Tariff Cap (DTC)

Magnus Martinsen

NERA Economic Consulting, UK

In Great Britain, the incentives for retailers to purchase hedges, as set out by the Default Tariff Cap (DTC) are not tied to customers’ willingness to pay for hedging products.  As the energy transition results in increased penetration of intermittent renewables, the availability of hedges may worsen and the cost of hedging rise to the detriment of customers.  To estimate the cost to customers of purchasing hedges according to the profile set out by the DTC, we developed a novel approach that uses energy market modelling and a bottom-up model of generators’ risk to estimate the remuneration (i.e., cost of hedging) that generators require to supply hedges in the British market from 2023 and 2035.   We find that the average risk premia will rise significantly, creating concerns for both the affordability of electricity for customers and the tenability of the DTC in the future