Locational Price Spreads and the Pricing of Contracts for Difference: Evidence from the Nordic Market

Posted: 9 May 2008 Last revised: 15 May 2009

Date Written: October 14, 2008

Abstract

In electricity markets, not only does the risk of substantial price variations over time exist, but so does the risk of price variations over space, as prices between locations can differ due to transmission congestion. To manage this risk, Contracts for Difference (CfDs), i.e., forwards on the spread between a particular area price and the (unconstrained) system price, were introduced at the Scandinavian electricity exchange Nord Pool at the end of 2000. We empirically investigate the pricing of these CfDs over the period 2001 through 2006 and find that CfD prices contain significant risk premia. Their sign and magnitude, however, differ substantially between areas and delivery periods, because areas are subject to transmission congestion to a varying extent. While the relation between risk premia and time-to-maturity is not uniform for CfDs, there is a negative relation for implied area and system forwards, which can be explained by the relative hedging demand of market participants. In addition, we find that risk premia of CfDs and implied area forwards vary systematically with the variance and skewness of the underlying spot prices. This confirms both implications of the Bessembinder and Lemmon (2002) model.

Keywords: Electricity, Contract for Difference, Implied Area Forward, Risk Premium

JEL Classification: G13, G15, Q40

Suggested Citation

Marckhoff, Jan and Wimschulte, Jens, Locational Price Spreads and the Pricing of Contracts for Difference: Evidence from the Nordic Market (October 14, 2008). Energy Economics, Vol. 31, No. 2, 2009. Available at SSRN: https://ssrn.com/abstract=1130831

Jan Marckhoff (Contact Author)

University of Bamberg ( email )

Kirschaeckerstrasse 39
Bamberg, 96045
Germany

Jens Wimschulte

Independent ( email )

No Address Available
United States

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