Short-Term Electricity Futures Prices: Evidence on the Time-Varying Risk Premium

Abstract

This paper examines empirically the relationship between electricity spot and futures prices, by analysing a decade of data for a set of short term-to-maturity futures contracts traded in the Nordic Power Exchange, Nord Pool. It is found that, on average, there are significant positive risk premiums in short-term electricity futures prices. The significance and size of the premiums, however, varies seasonally over the year; whereas it is greatest during winter, it is zero in summer. It is also found that time-varying risk premiums are significantly related to unexpectedly low reservoir levels. Furthermore, before the unprecedented supply-shock that hit the Nord Pool market around the end of year 2002, the variation of the risk premiums was related to the variance and the skewness of future spot prices. This result is consistent with the view that risk considerations played a role in the determination of futures prices. Finally, additional evidence provided throughout the paper supports the view that circumstances changed in the Nord Pool market after the shock period.