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Electricity futures prices: time varying sensitivity to fundamentals

  • Stein-Erik Fleten

    ()

    (Norwegian University of Science and Technology)

  • Ronald Huisman

    ()

    (Erasmus School of Economics and IEB)

  • Mehtap Kilic

    ()

    (Erasmus School of Economics)

  • Enrico Pennings

    ()

    (Erasmus School of Economics)

  • Sjur Westgaard

    ()

    (Norwegian University of Science and Technology)

This paper provides insight in the time-varying relation between electricity futures prices and fundamentals in the form of prices of contracts for fossil fuels. As supply curves are not constant and different producers have different marginal costs of production, we argue that the relation between electricity futures prices and futures prices of underlying fundamentals such as natural gas, coal and emission rights are not constant and vary over time. We test this view by applying a model that linearly relates electricity futures prices to the marginal costs of production and calculate the log-likelihood of different time-varying and constant specifications of the coefficients. To do so, we formulate the model in state-space form and apply the Kalman Filter to observe the dynamics of the coefficients. We analyse historical prices of futures contracts with different delivery periods (calendar year and seasons, peak and off-peak) from Germany and the U.K. The results indicate that analysts should choose a time-varying specification to relate the futures price of power to prices of underlying fundamentals.

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Paper provided by Institut d'Economia de Barcelona (IEB) in its series Working Papers with number 2014/21.

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Length: 29 pages
Date of creation: 2014
Date of revision:
Handle: RePEc:ieb:wpaper:2013/6/doc2014-21
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  1. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
  2. Karakatsani, Nektaria V. & Bunn, Derek W., 2008. "Forecasting electricity prices: The impact of fundamentals and time-varying coefficients," International Journal of Forecasting, Elsevier, vol. 24(4), pages 764-785.
  3. Stein-Erik, Fleten & Paraschiv, Florentina & Schürle, Michel, 2013. "Spot-forward Model for Electricity Prices," Working Papers on Finance 1311, University of St. Gallen, School of Finance.
  4. Povh, Martin & Fleten, Stein-Erik, 2009. "Modeling long-term electricity forward prices," MPRA Paper 13162, University Library of Munich, Germany.
  5. Janczura, Joanna & Weron, Rafal, 2010. "An empirical comparison of alternate regime-switching models or electricity spot prices," MPRA Paper 20546, University Library of Munich, Germany.
  6. Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233.
  7. Ronald Huisman & Victoria Stradnic & Sjur Westgaard, 2013. "Renewable energy and electricity prices: indirect empirical evidence from hydro power," Working Papers 2013/24, Institut d'Economia de Barcelona (IEB).
  8. Redl, Christian & Haas, Reinhard & Huber, Claus & Böhm, Bernhard, 2009. "Price formation in electricity forward markets and the relevance of systematic forecast errors," Energy Economics, Elsevier, vol. 31(3), pages 356-364, May.
  9. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
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