Publication: Spot price modeling and the valuation of electricity forward contracts : the role of demand and capacity
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2007-12-16
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Abstract
We propose a model where wholesale electricity prices are explained by
two state variables: demand and capacity. We derive analytical expressions to
price forward contracts and to calculate the forward premium. We apply our
model to the PJM, England and Wales, and Nord Pool markets. Our empirical
findings indicate that volatility of demand is seasonal and that the market price
of demand risk is also seasonal and positive, both of which exert an upward
(seasonal) pressure on the price of forward contracts. We assume that both
volatility of capacity and the market price of capacity risk are constant and
find that, depending on the market and period under study, it could either
exert an upward or downward pressure on forward prices. In all markets we
find that the forward premium exhibits a seasonal pattern. During the months
of high volatility of demand, forward contracts trade at a premium. During
months of low volatility of demand, forwards can either trade at a relatively
small premium or, even in some cases, at a discount, i.e. they exhibit a negative
forward premium
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Keywords
Power prices, Demand, Capacity, Forward premium, Forward bias, Market price of capacity risk, Market price of demand risk, PJM, England and Wales, Nord Pool