Structural models for coupled electricity markets

Abstract

One of the major changes in European electricity markets is – besides the increasing share of renewable infeed – the fact that previously independent market areas have been connected. Day-ahead auctions are no longer done separately and available interconnector capacity is not always auctioned independently from electricity. Instead, interconnector capacity is implicitly auctioned in the day-ahead auction of electricity such that price differences between market areas are minimized, respectively overall welfare is maximized. The latest cornerstone in this evolution of the European electricity market is the so called North-Western European Market Coupling (NWE) which is online since February 4, 2014.For market participants, such a change in the structure of the market naturally leads to the question of how to model prices in the affected market areas. Particularly, if positions in more than one market area exist, it becomes crucial for risk and portfolio management to model electricity prices in all areas consistently in one integrated framework.In order to construct a model suitable for these tasks, we extend the class of structural or hybrid models, which were introduced by Carmona et al. (2013) and Aid et al. (2013), to a multi-market framework. We derive analytical formulae for the distribution of spot prices, for futures prices, and for plain vanilla options. We also calibrate the model to the French–German market area and study the effect of market coupling on electricity prices and the value of power plants.