Talking pennies: Optimal Electricity Demand-Response Contracting

We formulate the problem of demand-response contract in electricity markets as a Principal-Agent problem with moral hazard. The Principal is a risk--averse producer subject to energy generation cost and to variation of... [ view full abstract ]

We formulate the problem of demand-response contract in electricity markets as a Principal-Agent problem with moral hazard. The Principal is a risk--averse producer subject to energy generation cost and to variation of generation costs due to limited flexibility.
The Principal aims at finding the contract inducing the optimal reduction both of the consumption and of its volatility. We interpret
the reduction of the consumption volatility as an increase of the consumer's responsiveness. We provide closed--form expression for the optimal contract that maximises the utility of the principal in the case of linear energy valuation. We show that optimal contracting
allows the system to bear more risk as the volatility may increase. By calibrating the model with publicly available data, we drive
conclusion on the potential improvement of consumers' responsiveness induced by optimal contracting.