Literature Review: Electricity Pricing

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Literature Review Electricity Pricing

• ECON 539
• 3/11/2009
• Presented by Paul Aljets

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Background

• Electricity markets are Different
• Must have a steady flow.
• Electricity cannot be easily stored.
• Prices are extremely volatile.
• Power grid must be constantly watched.
• Overloads (Blackouts) Too much power in the
  grid.
• Brown-outs Too little power to meet demand.

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First Theory Forward PricingVehvilainen, Ilvo
(2001).Basics of Electricity Derivative pricing
in Competitive Markets. Applied Mathematical
Finance. 9, 45-60.

• Dr. Ilvo Velvehilainen
• Professor in Fortum, Finland.
• Forward Pricing
• Observing the changes in a country and regressing
  predicted future prices for the next time period.
  
• Dr. V. says the model needs more variables.
• Adds variables for seasonal demand and for
  wholesale contracts.

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First Paper Analysis

• No data presented.
• So, cant replicate or test robustness.
• Written for people already knowledgeable in the
  topic.
• No consideration for regional price differences.
• No obvious agenda.
• Widely accepted model theory in Europe.

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Second Paper Mean reverting Jump
DiffusionCartea, Alvaro, Figueroa, Marcelo G.
(2005). Pricing in Electricity Markets a Mean
Reverting Jump Diffusion Model with Seasonality.
Applied Mathmatical Finance. 12-4, 313-335.

• By Alvaro Cartea and Marcelo Figueroa.
• Professors at Birkbeck College, London.
• Originally from Chile.
• One of the first countries to privatize
  electrcity.
• Model accounts from time on a business cycle,
  month and weekly basis.
• Model accounts for Regional Differences.
• Demand in London is different than demand in
  Wales.
• MOST IMPORTANT Control for freak jumps in
  demand.

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Second Paper Analysis

• Lots of Data!
• If I cared, I could replicate the data.
• More accurate than forward pricing.
• Total lack of self-evaluation and consideration
  for further research.

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Third Theory Nodal Bid-based PricingHogan,
William W. (2008). Electricity Market Structure
and Infrastructure. Conference on Acting in Time
on Energy Policy.

• Nodal Pricing
• Different prices at every power node.
• Based on contract bidding.
• Spinning Reserves.
• Back-up energy to avoid brown-outs.
• Leading American Expert Dr. William Hogan
• Professor at Harvard.
• Free-market advocate.
• His paper make recommendations for Federal Energy
  regulatory Commission.
• More regional regulation.
• Increase information transparency.

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Third Paper Analysis

• Completely Qualitative.
• No data.
• FERC was his audience.
• Very accessible.
• All American papers seem to have less data
  emphasis.
• Takes most of the credit.
• The coauthors are placed in a footnote.

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Conclusions on the Literature

• Forward Pricing/ Mean reverting Jump Diffusion.
• Requires lots of data to calculate price.
• More prone to brown-outs.
• Tend to underestimate.
• Nodal Pricing
• Bid based, making it easy to price.
• Chaotic, Confusing
• Prone to black-outs.
• Questions?????????