Cross-hedging and forward-contract pricing of electricity in the Pacific Northwest

Abstract

This paper develops a linear regression model for using actively traded NYMEX natural gas futures as a cross-hedge against electricity spot-price risk in the Pacific Northwest and for pricing the forward contracts in the presence of temperature and hydro risks. Our approach comports with reality and provides power purchasers with an effective instrument through which they can hedge their electricity bets through natural gas futures. It also demonstrates the sharp month-to-month variations in the natural gas futures' optimal hedge ratios and hedge effectiveness. Finally, it finds significant risk premiums in the Pacific Northwest forward prices, supporting the hypothesis that forward-contract buyers are relatively more risk-averse than sellers.

Managing colombian farmers price risk exposure with electrical derivatives market

“…The inclusion of differences over spot and future prices, as well as the logarithm of levels was introduced to model influence not only the level but also in the reduction of volatility of the agri-prices- Of these models, the most recent literature indicates the appropriacy of the last two, as compared to the first two, for effects of avoiding spurious relationships ( Adams and Gerner, 2012 ; Engle, 1982 ). Moreover, in an effort to incorporate the variable that is hypothesized to link the two markets, a variable associated with ENSO occurrence, a very relevant climatic event for both markets, was incorporated into the hedge ratio estimation model ( Woo et al, 2011 ). As the electricity derivative market has permanent derivatives futures contracts with multiple hedging horizons, the models proposed herein aimed to identify the most appropriate vehicle to carry out financial cross-hedging.…”

“…This phenomenon occurs due to seasonality, volume traded, open interest, incentives such as subsidies, government promotion of certain crops ( Garcia, 2004 ) interdependences between commodities even if they are not from the same market – oil and wheat-, substitutes -agricultural and energy related commodities- or derived from -sugar and soy-beans ( Tsuji, 2020 ). Due to this phenomenon, studies have generalized the use of models of the ARCH family (GARCH, E-GARCH, M-GARCH) ( Ankirchner and Heyne, 2012 ; Brooks and Chong, 2001 ; Lien and Luo, 1994 ) as well as the estimation of the coefficients as if they were dynamic over time or by seasons ( Baillie and Myers, 1991 ; Woo et al., 2011 ) or the use of techniques to estimate causality among commodities ( Chiu et al., 2016 ). With the use of these estimation methods, authors seek to overcome these characteristics of the agri-prices time series and in general the prices of futures contracts.…”

“…Woo proposes to realize hedging of electricity spot-price risk in the United States Pacific Northwest with futures of NYMEX natural gas futures, recognizing the presence of temperature and hydro risks. To do this, he includes in the estimation of the MV cross-hedge ratio the variables Degree-Day (a heating and cooling load measure) and Columbia River Flow (a capacity production output measure in hydro based electricity generation systems) ( Woo et al., 2011 ). Accordingly, we included in the study the Multivariate ENSO Index Version 2 (MEI2) v in order to incorporate the effect of weather on hedge performance.…”

The Impacts of Wind Speed Trends and 30-Year Variability in Relation to Hydroelectric Reservoir Inflows on Wind Power in the Pacific Northwest

“…The dominance of hydroelectricity in the PNW, combined with natural variation in precipitation and streamflow, result in large seasonal and interannual fluctuations in potential generation, which can place the electricity system under stress during extreme high and low inflow periods. The value of energy, capacity, and system flexibility vary greatly between high and low inflow conditions [ 55 , 56 ], and therefore the behavior of wind power during these periods is extremely important in determining its economic and social benefits.…”

“…Increased wind power during the low inflow winter months can increase system flexibility, and can help to meet higher energy demands caused by increased heating requirements [ 58 ]. Electricity prices are also typically highest during the summer and winter [ 55 ], making increased energy exports or decreased imports during these periods more profitable.…”