Electricity futures prices: time varying sensitivity to fundamentals

Stein-Erik Fleten, Ronald Huisman (), Mehtap Kilic (), Enrico Pennings and Sjur Westgaard ()
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Ronald Huisman: Erasmus School of Economics and IEB
Mehtap Kilic: Erasmus School of Economics
Sjur Westgaard: Norwegian University of Science and Technology

No 2014/21, Working Papers from Institut d'Economia de Barcelona (IEB)

Abstract: This paper provides insight in the time-varying relation between electricity futures prices and fundamentals in the form of prices of contracts for fossil fuels. As supply curves are not constant and different producers have different marginal costs of production, we argue that the relation between electricity futures prices and futures prices of underlying fundamentals such as natural gas, coal and emission rights are not constant and vary over time. We test this view by applying a model that linearly relates electricity futures prices to the marginal costs of production and calculate the log-likelihood of different time-varying and constant specifications of the coefficients. To do so, we formulate the model in state-space form and apply the Kalman Filter to observe the dynamics of the coefficients. We analyse historical prices of futures contracts with different delivery periods (calendar year and seasons, peak and off-peak) from Germany and the U.K. The results indicate that analysts should choose a time-varying specification to relate the futures price of power to prices of underlying fundamentals.

Keywords: Electricity futures prices; prices of fossil fuels; time-varying coefficients; statespace model (search for similar items in EconPapers)
JEL-codes: C51 Q41 Q48 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2014
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