Mathematical Institute, University of Oxford, 24–29 St Giles, Oxford OX1 3LB, UK; email: [email protected]
The Oxford-Man Institute of Quantitative Finance, University of Oxford, Blue Boar Court, 9 Alfred Street, Oxford OX1 4EH, UK; and Mathematical Institute, University of Oxford, 24–29 St Giles, Oxford OX1 3LB, UK; email: [email protected]
We develop a fundamental model for spot electricity prices, based on stochastic processes for underlying factors (fuel prices, power demand and generation capacity availability), as well as a parametric form for the bid stack function that maps these price drivers to the power price. Using observed bid data, we find high correlations between the movements of bids and the corresponding fuel prices. We fit the model to the PJM and New England markets in the US and discuss its performance in terms of capturing key properties of simulated price trajectories, as well as comparing implied forward prices with observed data.