Efficient frontiers for electricity procurement by a local distribution company with multiple purchase options

In meeting its retail sales obligations, management of a local distribution company (LDC) must determine the extent to which it should rely on spot markets, forward contracts, and the increasingly popular long-term tolling agreements under which it pays a fee to reserve generator capacity. We address these issues by solving a mathematical programming model to derive the efficient frontier that summarizes the optimal tradeoffs available to the LDC between procurement risk and expected cost. To illustrate the approach, we estimate the expected procurement costs and associated variances that proxy for risk through a spot-price regression for the spot-purchase alternative and a variable-cost regression for the tolling-agreement alternative. The estimated regressions yield the estimates required to determine the efficient frontier. We develop several such frontiers under alternative assumptions as to the forward-contract price and the tolling agreement's capacity payment, and discuss the implications of our results for LDC management.