Abstract
Nord Pool is the leading power market in Europe. It has been documented that the forward contracts traded in this market exhibit a significant forward premium, which could be a sign of market inefficiency. Efficient power markets are important, especially when there is a goal to increase the share of the power mix stemming from renewable energy sources. We therefore contribute to the understanding of this topic by examining how the forward premium in the Nord Pool market depend on several economic and physical conditions. We utilise two methods: ordinary least squares and quantile regression. The results show that the reservoir level and the basis (the difference between the forward and spot price) have a significant impact on the forward premium. The realised volatility of futures prices and the implied volatility of the stock market have strong effects on both the conditional lower and upper tails of the forward premium. We also find that, as the market has matured, the forward premium has decreased, indicating an increase in market efficiency.
Highlights
There are important differences between electricity and other commodities and financial assets.It cannot be stored in economically meaningful quantities and its demand and supply are highly dependent on the weather conditions
We propose a model that can explain the forward premium by the demand for futures, temperature, the volatility of the spot price, reservoir levels, overall market risk as expressed by the Volatility Index (VIX) index and the basis
The forward premium is larger during the winter months than during the summer months, the largest negative forward premiums coincide with the largest spikes in spot prices, which usually happen during the winter
Summary
There are important differences between electricity and other commodities and financial assets. Botterud et al [8], Lucia and Torró [4] and Weron and Zator [5] all found evidence of a forward premium in futures contracts traded on the Nordic electricity market. These papers use regression methods to describe the relationship between the observed forward premium and market conditions. While quantile regression has been utilised in various fields of energy economics such as modelling electricity price [10], to our knowledge, it has not been used within this research area This approach provides important information to market participants about what influences the tails of the forward premium.
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