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Are Monthly Electricity Price Area Differentials (Epads) Efficient Hedging Instruments Against the Basis Risk in the Nordic Energy Market?

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Are Monthly Electricity Price Area Differentials (Epads) Efficient Hedging Instruments Against the Basis Risk in the Nordic Energy Market? View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by HSN Open Archive Master’s Thesis 2016 30 ECTS Faculty of Social Sciences School of Economics and Business Are Monthly Electricity Price Area Differentials (EPADs) Efficient Hedging Instruments Against the Basis Risk in the Nordic Energy Market? Mona Helen Heien Master of Science in Business Administration I Preface This thesis represents the end of my master’s degree at the School of Economics and Business at the Norwegian University of Life Sciences (NMBU). I have written this thesis in conjunction with my major in finance and my minor in energy economics. During my studies I have gained valuable knowledge about the Nordic energy market, and my interest for this field of study has also grown substantially. I would especially like to thank my supervisor, Associate Professor Olvar Bergland, for invaluable assistance and guidance throughout this process. I would also thank Montel for providing me with all relevant data. I take full responsibility for all possible mistakes throughout this thesis. Ås, 11. Mai 2016 Mona Helen Heien I Abstract The price of commodities and financial products varies over time, but in the electricity market there are also substantial variations over space. This spatial price variation becomes visible whenever there are congestion in the transmission grid, resulting in a difference between area and system prices. In the Nordic energy market Electricity Price Area Differentials (EPADs) were introduced at the end of year 2000 in order to manage this risk. This thesis investigates the pricing of the monthly EPAD contracts by applying the methods of Marckhoff and Wimschulte (2009) to a new time period, 2008-2015. I find that the EPAD prices contain significant ex-post risk premiums, however their sign and magnitude differ substantially both spatially and temporally. My findings regarding the ex-post risk premiums coincides with those of Marckhoff and Wimschulte (2009), who said that ex-post risk premiums varies because areas are subject to transmission congestion to varying degrees. I find no relationship between ex-post risk premiums and time-to-maturity, nor between ex-post risk premiums and the variance and skewness of area and system prices. This suggests that there are other determinants of ex-post risk premiums in the short run, and that the trading period for monthly contracts might be too short to show clear trends or relationships. II Sammendrag Prisen på råvarer og finansielle produkter varierer over tid, men for elektrisitet vil det også forekomme betydelige prisvariasjoner mellom områder. En områdepriser vil være forskjellig fra systemprisen når en kapasitetsskranke i overføringsnettet til det aktuelle området blir brutt. For å håndtere denne områderisikoen ble Electricity Price Area Differentials (EPADs) introdusert til det nordiske energimarkedet i slutten av året 2000. Denne avhandlingen undersøker prisingen av månedlige EPAD kontrakter ved å prøve ut metodene til Marckhoff and Wimschulte (2009) på en ny tidsperiode, 2008-2015. Jeg kommer frem til at prisene på de fleste EPAD kontrakter inneholder signifikante ex-post risikopremier, men at fortegnet og omfanget av denne premien varierer både over tid og mellom områder. Funnene mine angående ex-post risikopremier er sammenfallende med de tidligere funnene til Marckhoff og Wimschulte (2009), som også påpekte at risikopremiene kom til å variere på grunn av at områdene i ulik grad opplever brudd på kapasitetsskrankene. Jeg finner ingen sammenheng mellom ex-post risikopremier og tid til forfall, og heller ingen sammenheng mellom ex-post risikopremier og varians og skjevhet av område- og systempriser. Dette antyder at det er andre faktorer som påvirker størrelsen på risikopremien på kort sikt, og at handelsperioden for månedlige kontrakter muligens er for kort til å vise klare trender og sammenhenger. III Table of contents Preface ......................................................................................................................................... I Abstract ..................................................................................................................................... II Sammendrag ............................................................................................................................. III Figure list .................................................................................................................................. VI Table list ................................................................................................................................... VI 1 Introduction ........................................................................................................................ 1 2 The Nordic Energy Market ................................................................................................ 3 2.1 Restructuring ............................................................................................................... 3 2.2 Power production ......................................................................................................... 4 2.3 Features of hydropower ............................................................................................... 5 2.4 Transmission congestion ............................................................................................. 6 2.5 Trading platform .......................................................................................................... 7 2.5.1 The physical market ............................................................................................. 8 2.5.2 The financial market ............................................................................................. 9 3 Theoretical Framework .................................................................................................... 11 3.1 Risk aversion ............................................................................................................. 11 3.2 Hedging ..................................................................................................................... 11 3.2.1 The price risk ...................................................................................................... 12 3.2.2 The volume risk .................................................................................................. 12 3.2.3 The basis risk ...................................................................................................... 12 3.3 Electricity Price Area Differentials ........................................................................... 13 3.3.1 The pricing of EPADs ........................................................................................ 13 3.3.2 Risk premium in EPADs .................................................................................... 15 3.4 The Efficient Market Hypothesis - EMH .................................................................. 16 3.5 Research question and hypotheses ............................................................................ 17 4 Methods ............................................................................................................................ 19 IV 4.1 Time series data ......................................................................................................... 19 4.2 Electricity Forward Pricing Model ............................................................................ 19 4.2.1 Assumptions for time series models ................................................................... 21 5 Data .................................................................................................................................. 23 5.1 Data overview ............................................................................................................ 23 5.2 Area and system prices .............................................................................................. 23 5.3 Differences between area and system prices ............................................................. 26 5.4 EPAD prices .............................................................................................................. 28 6 Results and Discussion ..................................................................................................... 30 6.1 Potential data problems ............................................................................................. 30 6.2 Hypothesis I ............................................................................................................... 30 6.3 Hypothesis II .............................................................................................................. 32 6.4 Hypothesis III ............................................................................................................ 33 6.5 Hypothesis IV ............................................................................................................ 35 6.6 Discussion .................................................................................................................. 37 6.7 Further research ......................................................................................................... 39 7 Conclusion ........................................................................................................................ 40 8 Reference List .................................................................................................................
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