Is Power Production Flexibility a Substitute for Storability? Evidence from Electricity Futures Prices

Tinbergen Institute Discussion Paper No. 10-070/2

16 Pages Posted: 21 Jul 2010

See all articles by Mehtap Kilic

Mehtap Kilic

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: July 19, 2010

Abstract

Electricity is not storable. As a consequence, electricity demand and supply need to be in balance at any moment in time as a shortage in production volume cannot be compensated with supply from inventories. However, if the installed power supply capacity is very flexible, variation in demand can be counterbalanced with flexible adjustment of production volumes. Therefore, supply flexibility can replace the role of inventory. In this paper, we question whether power production flexibility is a substitute for storability. To do so, we examine power futures prices from countries that differ in their power supply and test whether power futures prices contain information about expected future spot prices and risk premiums and examine whether futures prices from a market in which power supply is more flexible would lead to futures prices that are more in line with the theory of storage. We find the opposite; futures prices from markets with flexible power supply behave according to the expectations theory. The implicit view from futures prices is that flexibility is not a substitute for storability.

Keywords: Electricity, Futures Prices, Forward Risk Premium, Theory of Storage, Expectations Theory

JEL Classification: G13

Suggested Citation

Kilic, Mehtap and Huisman, Ronald, Is Power Production Flexibility a Substitute for Storability? Evidence from Electricity Futures Prices (July 19, 2010). Tinbergen Institute Discussion Paper No. 10-070/2, Available at SSRN: https://ssrn.com/abstract=1646366 or http://dx.doi.org/10.2139/ssrn.1646366

Mehtap Kilic (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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