Abstract
This paper develops an equilibrium electricity forward pricing model which explicitly accounts for constrained capacity. The model is able to reproduce the price spikes observed in wholesale electricity markets using reasonable parameter values. The equilibrium forward premium, defined as the forward price minus the expected spot price, decreases in spot price variance when the expected spot price is less than the retail price, but increases in spot price variance when the expected spot price is greater than the retail price. The forward premium is an increasing function of the ratio of the expected spot price to the retail price.
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