Expectations and Forward Risk Premium in the Spanish Deregulated Power Market

Abstract

Deregulation in energy markets has entailed important changes in the way agents conduct business. Price risk arises as a result of fluctuations in the future price of electricity and agents assume long or short positions in the forward and spot markets to hedge their exposure to price risk. The presence of forward risk premium in prices is an evidence of the fact that agents act in the market according to risk considerations. This work aims to analyse the information content of the difference between the forward and spot prices (the so-called forward premium) regarding the agents’ decisions. To do so, we adopt not only an ex post approach, but also an ex ante. We find that the sign of the ex post forward premium depends on the unexpected variation in demand and on the unexpected variation in the hydro-energy capacity, and that the ex ante forward premium varies with the expected demand in tight market conditions. We provide additional insights about relevant aspects of spot price pricing in the Spanish electricity market – such as the positive relation between spot price and CO2 emission allowance price or the (non) impact of the market reform introduced in the spot market in March 2006.

Keywords: deregulation, agents’ behaviour, forward premium

JEL Classification: G13, L94, G18