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Intermittently coupled electricity markets

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  • Pierre, Erwan
  • Schneider, Lorenz

Abstract

Auctions of transmission rights between neighbouring countries are becoming increasingly active. In a parallel development, the introduction of market coupling frequently leads to smaller price differences between such countries. Indeed, if two countries are completely coupled, the price of a given hour of electricity will be identical in each country, resulting in a price spread of zero. Clearly, it is important to take this market coupling into account when evaluating transmission rights, as neglecting it would lead to a significant overvaluation of these rights. In order to address this issue, we introduce a general regime-switching mechanism that can be applied to many models in the literature. In particular, we focus on extending the model proposed by Cartea and González-Pedraz (2012). We describe the model estimation procedure in detail, and compare model and market prices of European spread options. We observe a dramatic paradigm shift in our data set at the end of the summer of 2021, and show that this shift has a strong effect on the model parameters. We also see that the reliable pricing and trading of spread options becomes problematic in such a volatile and uncertain market environment.

Suggested Citation

  • Pierre, Erwan & Schneider, Lorenz, 2024. "Intermittently coupled electricity markets," Energy Economics, Elsevier, vol. 130(C).
    • Handle: RePEc:eee:eneeco:v:130:y:2024:i:c:s0140988324000355
    DOI: 10.1016/j.eneco.2024.107327
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    References listed on IDEAS

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    More about this item

    Keywords

    Electricity markets; Interconnectors; Market coupling; Spread options; Regime switching;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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