Structural Analysis of High Frequency Electricity Demand and Supply Interactions

Abstract

A dynamic, structural asymmetric vector-error correction model is used to identify and estimate the demand and the supply functions for hourly, day-ahead electricity wholesale markets. The analysis provides new insights on a well-established but unresolved aspect concerning the extent of demand elasticity to price. We argue that the conventional meanreverting,stationarity assumption for electricity prices raises subtle issues of specification and must be carefully evaluated. We present evidence for adopting a non-stationary specification in the short-window, high-frequency context, and thereby estimate a cointegrating system. This allows us to distinguish between long run and short run effects, and to estimate an error-correction term embedded in a simultaneous equation model. We show that, whilst demand appears to be inelastic in the short run, the quantity traded on the market reacts significantly to previous disequilibria in the supply curve through an asymmetric error-correction mechanism, and does in fact adjust to positive changes in the price level, but not to negative ones.

Keywords: Electricity Markets, Demand Elasticity, Simultaneous Equations, Asymmetric Vector Error-Correction

JEL Classification: C32, Q41, L94