Including climate-induced jumps in forward price trends in wholesale energy markets

Luis Antonio Pascua-Guerra; Javier Orlando Pantoja-Robayo

Save this article

Need to know

Incorporating climate risks into electricity price models enhances market fairness, particularly for hydroelectric generation.
Models with stochastic jumps improve performance by 13-15%, offering more realistic pricing for participants.
GARCH (2,0) modeling boosts in-sample accuracy, though out-of-sample forecasting remains limited for longer periods.
Price responds to current and anticipated weather, with notable spikes during El Niño, enhancing model outcomes when using future ONI data.

Abstract

Forward contracts mitigate price risk in electricity markets, but varying pricing methodologies can create confusion and lead to prices that do not accurately reflect spot prices, potentially causing losses at maturity. Our study proposes a forward contract pricing model based on an Ornstein–Uhlenbeck stochastic process, incorporating a climate risk factor as its main contribution. In addition, we analyze the forward risk premium derived from the model and suggest an adjustment using a generalized autoregressive conditional heteroscedasticity (GARCH) model to improve future price estimates in the Colombian wholesale electricity market. This approach makes the market more complete and fairer for all participants, particularly in the case of hydroelectric generation. The proposed model has significant implications for market participants, as it provides a more realistic, and therefore fairer, price assessment, which stands as the primary contribution of this research.

As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.

If you would like to purchase additional rights please email info@risk.net

You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.

If you would like to purchase additional rights please email info@risk.net