Electricity Futures Prices: Time Varying Sensitivity to Fundamentals
Journal of Energy Markets, 2015
IEB Working Paper N. 2014/21
29 Pages Posted: 25 Jul 2014
Date Written: May 19, 2014
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
JEL Classification: Q41, Q48, C51
Suggested Citation: Suggested Citation
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