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Hedging spark spread risk with futures

Author

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  • Beatriz Martínez Martínez

    (Dpto. Finanzas Empresariales)

  • Hipolit Torro Enguix

    (Universitat de València)

Abstract

This is the first paper to discuss the spark spread risk management using electricity and natural gas futures. We focus on three European markets in which the natural gas share in the fuel mix varies considerably: Germany, the United Kingdom, and the Netherlands. We find that spark spread returns are partially predictable, and consequently, the Ederington and Salas (2008) minimum variance hedging approach should be applied. Hedging the spark spread is more difficult than hedging electricity and natural gas price risks with individual futures contracts. Whereas spark spread risk reduction for monthly periods produces values of between 20.05 and 48.90 per cent, electricity and natural gas individual hedges attain reductions ranging from 31.22 to 69.06 per cent. Results should be of interest for agents in those markets in which natural gas is part of the fuel mix in the power generation system. En este documento se aborda por primera vez en la doctrina la gestión del riesgo del spark spread utilizando futuros sobre la electricidad y el gas natural. Se ha focalizado la atención en tres mercados europeos en los que la participación del gas natural en el mix de generación es muy diferente: Alemania, Reino Unido y Holanda. Un primer resultado es que las rentabilidades del spark spread son parcialmente predecibles y, en consecuencia, el enfoque de cobertura mínima varianza propuesto en Ederington y Salas (2008) debe ser aplicado. La cobertura del riesgo del spark spread resulta ser mucho más difícil que la cobertura individualizada del riesgo de precio de la electricidad y el gas natural con sus respectivos contratos de futuros. Mientras que la reducción del riesgo alcanzada para el spark spread para coberturas mensuales obtiene reducciones de riesgo de entre el 21,22% y el 48,90%, las coberturas individualizadas de ambas commodities alcanzan reducciones de entre el 31,22% y el 69,06%. Estos resultados son de interés para aquellos agentes en cuyos mercados en el gas natural forma parte del mix de generación eléctrico.

Suggested Citation

  • Beatriz Martínez Martínez & Hipolit Torro Enguix, 2017. "Hedging spark spread risk with futures," Working Papers. Serie EC 2017-01, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    • Handle: RePEc:ivi:wpasec:2017-01
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    More about this item

    Keywords

    mercado del gas natural; mercado de la electricidad; contratos de futuro; contratos forward; spark spread; ratio de cobertura; efectos estacionales. natural gas market; electricity market; futures contracts; forward contracts; spark spread; hedging ratio; seasonal effects.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • L95 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Gas Utilities; Pipelines; Water Utilities

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