Structural Models for Coupled Electricity Markets

Abstract

One of the major changes in european electricity markets is - besides the increasing share of renewable infeed - the fact that previously independent market areas have been connected. Day-Ahead auctions are no longer done separately and available interconnector capacity are not always auctioned independently from electricity. Instead, interconnector capacity is implicitely auctioned in the Day-Ahead auction of electricity such that price differences between market areas are minimized, respectively overall wellfare is maximized. The latest cornerstone in this evolution of the european electricity market is the so called North Western European Market Coupling (NWE) which is online since February 4th, 2014.

For market participants, such a change in the structure of the market naturally leads to the question of how to model prices in the affected market areas. Particularly, if positions in more than one market area exist, it becomes crucial for risk- and portfolio-management to model electricity prices in all areas consistently in one integrated framework.

The model we present extends the class of structural or hybrid models which were introduced by Carmona et al. (2013) and Aid et al. (2013) to a multi market framework. We derive analytical formulae for the distribution of spot prices, for futures prices and even for plain vanilla options.

Keywords: Electricity Markets, Hybrid Models, Market Coupling

JEL Classification: C61, C63, C67, F17, Q41