DERIVATIVE FINANCIAL INSTRUMENTS ON THE ELECTRICITY MARKET AND THEIR SIGNIFICANCE FOR INSURANCE CORPORATIONS

Abstract

In the last thirty years, the main motive concerning reforms in the electricity industry around the world is to increase efficiency in the production, transmission, distribution and supply of electricity to final consumers. The reforms of electric power systems consist of production restructuring, improvement of competition, deregulation and ownership transformation. Restructuring included the separation of production, transmission, distribution and supply of electricity. Market competition meant the development of the wholesale electricity market and the growth of competition in retail. Deregulation represented the process of establishing independent regulatory bodies, as well as free access of third parties to the network infrastructure. Finally, the process of ownership transformation enabled the privatization of the existing state-owned power companies.
It can be stated that in this century, in the largest number of world economies, there has been a strong development of the electricity market, which is significantly different from other markets in terms of its characteristics. The main reason for this is the fact that there is no possibility of storage on the electricity market, that is, simultaneous production and consumption is not possible. However, supply and demand in a given electrical network must always be in balance. The imbalance between the supply and demand of electricity causes the frequency in the system to deviate from the standard frequency.
Electricity prices, in the period before the latest reform activities in the power sector, were regulated and therefore stable and predictable. However, deregulation and market liberalization have led to increased price volatility and increased risk. One of the most significant challenges in risk management in electricity markets is maintaining the energy balance. Deviation of production from consumption leads to disturbances that can lead to interruption of electricity supply and have severe financial consequences. In order to keep the system in balance, transmission system operators are obliged to organize a balanced energy market. The balanced electricity market is essentially a spot market for a very short period of time.
Derived financial instruments are more present on the electricity market and the following stand out due to their importance: forward, futures, option and swap contracts. These instruments are efficient in reducing the risk in the electricity market. It is especially important to keep in mind the fact that derivative instruments can be used based on the principle of hedging operations.
The devastating importance of derivative instruments in the trading of electricity and many other goods can be judged by the investment portfolios of insurance corporations. The expansion of the use of derivatives in the insurance industry is connected with the elimination of the shortcomings of the corresponding indices, as well as the presence of the possibility of multi-year coverage.