Discovering the effect of RES on risk premia in electricity markets

This paper is part of a broader project aimed at discovering the effect of Renewable Energy Sources (RES) on electricity markets. The recent massive RES production in Europe is relatively recent: it started since 2009-2010 due to system of incentives introduced in almost all European countries. Nowadays, the technologies are consolidated and even though the incentive system has stopped (due also to the economic crisis), RES produce energy and have contributed at lowering (at least in the wholesale markets) prices. However, the effect of RES production on risk premia is still quite elusive and requires deeper analysis. In this exploratory and preliminary paper, we develop an ex post analysis on risk premia on the Italian futures market. The peculiarities of the electricity markets make electricity futures very different than financial or commodity futures. In fact, it is well known that a consequence of non-storability of electricity is that the only possible delivery in a forward or futures contract is through a supply over a period of time. The entire lifecycle of a standard futures/forward contract on electricity can be divided in a trading period and a delivery period. Differently from the classical case, the convergence of futures price to spot prices does not hold here. Indeed, at the end of the trading period futures expire, yet the spot price continues evolving during all the delivery period. Parties can open positions on forward and futures contracts only before the delivery period. At maturity (T), that is at the end of the delivery period H, contracts expire. Our work contributes to the existing literature on futures in electricity markets by analyzing empirically the deviation of futures prices from observed spot prices. The analysis is carried on the Italian forward base load monthly contracts (2008-2012). The results show, case by case, a clear non convergence of futures to the underlying spot prices or average of them (see Figure). However, at an aggregate level, a positive risk premium is found, which is somehow coherent with findings in the literature (see Figure). Moreover, given the absence of convergence of futures to spot prices at the end of trading period, a positive variance of the payoff is found at delivery. The results show that more research should be done on modelling average spot prices and futures, since most of the rules valid for other financial and commodity markets do not hold here. In fact, the underlying price is the average of ex post prices over the delivery period, which can last one month, three months or even one year. Modelling such a price can be even more challenging than modelling spot price and we know that modelling spot prices in electricity markets is a demanding task and still in progress.