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Electricity price forecasts put to the test

Simon Goess's picture
Co-founder cr.hub

Simon Göß studied Environmental and Resource Management (B. Sc.) at the Brandenburg University of Technology Cottbus and Sustainable Energy Technology (M. Sc. Honours) at the Delft University of...

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  • Apr 27, 2022
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Originally posted here and co-authored by Matthis Brinkhaus.

Nobody predicted the current record prices. Skeptics of the "crystal ball" feel confirmed that the electricity price forecasts are "wrong". Modelers and analysts have to explain and defend their models again. How does this happen? We provide a brief overview of the current market situation and suitable procedures.

 

Welcome to the new world of volatility

In fact, the current global political situation is leading to completely new volatilities on the commodity and electricity markets. The gas price has repeatedly reached new record prices since October 2021 due to feared or impending bottlenecks. The price of coal has also climbed to unprecedented heights. After rising steadily in 2021 following Russia's invasion of Ukraine in February 2022, the price of CO 2 allowances (EUAs) has slipped from EUR 95/t to EUR 56/t in just a few days.

 

Spot market volatility in March 2022

Commodity prices naturally have an impact on electricity prices, since the price-setting power plant in the energy-only market is often a coal or gas-fired power plant. And so we're seeing a new level of price volatility there, too. In March alone, the daily base price on the EPEX spot market fluctuated between 55 and almost 500 EUR/MWh. On March 18, 2022, the price was just under EUR 230/MWh, two days later it was EUR 55/MWh again thanks to strong wind feed-in. A day later the price was over 200 EUR/MWh again.

On March 26, 2022, a sunny Saturday, the hourly price fluctuated during the day between EUR 80/MWh at 1 p.m. and EUR 292/MWh at 7 p.m. Figure 1 shows the development of daily spot prices over the last month (source: Montel , EPEX Spot ).

Development of daily spot prices in March 2022 (Source: Energy Brainpool, 2022)

Figure 1: Development of daily spot prices in March 2022 (Source: Energy Brainpool, 2022)

In addition to the overall high price level, it is the volatility in particular that causes headaches for many players. Commodity prices, which result from global economic and political contexts, as well as the weather have a major impact on the spot market price. Both are relatively difficult to predict. But that doesn't mean that electricity price forecasts will become obsolete.

"What's next?" is a question that buzzes in many heads. The future development of the electricity price is of great importance for suppliers, power plant operators, traders, bulk consumers, investors, banks and the like. However, the perspective of these actors on the electricity price is different.

 

Which electricity price forecast do I need?

What they all have in common is that prices are hedged via the futures market in order not to be exposed to the extreme fluctuations on the spot market. The futures market is always a kind of bet on the future spot market price. If a trading department has to hedge certain quantities within a few days, the question arises as to how the price of a futures market product will develop over the next few days. In other words, when is the best time to buy or sell a futures contract in this short period of time?

Investors and banks in a new PV park, which is to be secured via PPAs, on the other hand, are asking themselves how the price will develop over the next 15 to 20 years.

These two situations have to be served with completely different methods. While the trading department will conduct both fundamental and technical analysis (chart analysis, technical signals), for the investors and banks a fundamental electricity price scenario is the right choice.

 

Brief portrait of the most important forecasting methods

Technical analysis for the futures market uses historical data. Price trends are analyzed using graphical or numerical methods and attempts are made to derive buy or sell signals from them. Conclusions for the near future can be, for example, that a price will continue to follow the current trend or that a trend reversal will occur. This method is very subjective and depends heavily on the expertise of the analyst.

The spot price forecast , on the other hand, is a method for forecasting the hourly market prices on the spot market. This is where fundamental data comes in, such as:

  • the power plant availability
  • commodity prices
  • the expected demand based on type days (summer, winter, weekday, weekend, etc.)
  • the weather.

A price can then be derived from historical data via regression analysis. The effect of individual parameters on the frequency distribution of expected electricity prices can be quantified using scenario swarm analysis, as we describe in this article .

Fundamental electricity price scenarios use similar input parameters as the spot price forecast, but go decades into the future. Therefore, they cannot be based on current weather forecasts or commodity prices. Modelers must therefore make a number of assumptions. These assumptions relate to the price level of the commodities, the weather, the capacities in the power plant park and the development of the demand for electricity. Good models not only calculate the annual mean, but also monthly or hourly values.

The indices from the futures market of the electricity exchanges can be used as a price indicator for the next three years. Because for the next three front maturities, the liquidity on the market is relatively high and thus a comprehensive market opinion is integrated into the price. However, fundamental analyzes are required for the future beyond the three front years. The different approaches to electricity price forecasting are summarized again in Figure 2.

Characteristics of different methods for forecasting electricity prices (source: Energy Brainpool, 2022)

Figure 2: Characteristics of different methods for forecasting electricity prices (source: Energy Brainpool, 2022)

 

Electricity price forecasts will probably not get any easier

In the new world of high volatility, electricity price forecasts have not gotten any better or worse. However, it has become more difficult to choose the input parameters for the models correctly. Market psychology has gained importance thanks to digital communication channels. It is driven by the entanglement of the market and politics. Political influences and an increasing global networking of the markets cannot be dismissed out of hand. Even an inconspicuous short message on the Internet can cause short-term price jumps on the futures market.

In August 2021, for example, the gas price on the TTF trading floor collapsed by around 17 percent within two days. This comes after Gazprom tweeted that around 5.6 billion cubic meters of gas would still be delivered via Nord Stream 2 in 2021. As is well known, it never happened.

While operators of storage facilities welcome the high volatility on the spot market, participants in the futures market and operators of conventional power plants are likely to be longing for the markets to relax.

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Bryan Leyland's picture
Bryan Leyland on May 2, 2022

It really demonstrates two things: the electricity market is not fit for purpose and relying on unreliable wind and solar turns everything into a lottery.

As far as I can see, what we need is a "single buyer" market where a central organisation independent of the government and the industry places contracts with generators who can best contribute to providing a reliable and economic supply. The generators are paid a fixed annual sum representing their fixed costs, return on capital and profit. They are paid for kWh generated at the cost of operation and fuel. This allows the single buyer to ensure that there is adequate security of supply at the lowest cost.

What's the present market fails to recognise is that the value of electricity is far greater than its cost so that with the supply is constrained, the price is a "trade off between the grid and guilt". Guilt is not much in evidence....

Michael Keller's picture
Michael Keller on May 2, 2022

Nobody predicted current record prices? Hogwash. 
Replacing reliable generation with unreliable generation while severely limiting resource availability inevitably leads to unstable and higher prices. Throw in witless politicians and you have all the elements for a complete crapshoot.

The analytical experts and traders continue to believe their fancy models can accurately predict the future and are stunned when reality rears it’s ugly head.

“It’s tough to make predictions, especially about the future” Yogi Berra


Power generation and distribution are inherently monopolistic and needs to be regulated. The traders should shown the exit.
 

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