A Steady Hand for Wobbly Steps : Why New Electricity Markets Need Vesting Contracts

Overview & Synopsis

New electricity markets carry inherent risks of volatility and market power abuse - teething troubles that can derail reform. Vesting contracts are transitional financial hedges imposed before privatization to stabilize generator revenues and protect retailers - and, ultimately, consumers - from price shocks. By mimicking the natural hedge of a vertically integrated utility, or the hedging portfolio of a mature, liquid market, these contracts provide a steadying hand during the shift to competition. Their successful implementation, however, requires precise modeling of price and volume to discipline market behavior without sacrificing short-term economic efficiency or stifling long-term investment.