Supply, Demand, and Risk Premiums in Electricity Markets

Abstract

We model the impact of supply and demand on risk premiums in electricity futures, using daily data for 2003-2014. The model provides a satisfactory fit and allows for unspanned economic risk not embedded in the futures price. The spot risk premium and forward bias implied by the model are on average large and negative but highly time-varying. Risk premiums display strong seasonal patterns, are related to the variance and skewness of the electricity spot price, and help predict future returns. The risk premium associated with supply constitutes the largest component of the total risk premium embedded in electricity futures.

Keywords: Electricity Futures; Economic Determinants; Supply; Demand; Risk Premium; Unspanned Risk

JEL Classification: G12, G13, Q02