LITERATURE REVIEW: ELECTRICITY PRICING ECON 539

3/11/2009

Presented by Paul Aljets

BACKGROUND

Electricity markets are Different Must have a steady flow. Electricity cannot be easily stored. Prices are extremely volatile.

Power grid must be constantly watched. Overloads (Blackouts) = Too much power in the

grid. Brown-outs = Too little power to meet demand.

FIRST THEORY: FORWARD PRICINGVEHVILAINEN, ILVO (2001).BASICS OF ELECTRICITY DERIVATIVE PRICING IN COMPETITIVE MARKETS. APPLIED MATHEMATICAL FINANCE. 9, 45-60.

Dr. Ilvo Velvehilainen Professor in Fortum, Finland.

Forward Pricing Observing the changes in a country and

regressing predicted future prices for the next time period.

Dr. V. says the model needs more variables. Adds variables for seasonal demand and for wholesale

contracts.

FIRST PAPER: ANALYSIS

No data presented. So, can’t replicate or test robustness. Written for people already knowledgeable in the

topic. No consideration for regional price

differences. No obvious agenda. Widely accepted model theory in Europe.

SECOND PAPER: MEAN REVERTING JUMP DIFFUSIONCARTEA, ALVARO, & FIGUEROA, MARCELO G. (2005). PRICING IN ELECTRICITY MARKETS: A MEAN REVERTING JUMP DIFFUSION MODEL WITH SEASONALITY. APPLIED MATHMATICAL FINANCE. 12-4, 313-335.

By Alvaro Cartea and Marcelo Figueroa. Professors at Birkbeck College, London. Originally from Chile.

One of the first countries to privatize electrcity.

Model accounts from time on a business cycle, month and weekly basis.

Model accounts for Regional Differences. Demand in London is different than demand in

Wales. MOST IMPORTANT: Control for freak jumps in

demand.

SECOND PAPER: ANALYSIS

Lots of Data! If I cared, I could replicate the data.

More accurate than forward pricing. Total lack of self-evaluation and consideration

for further research.

THIRD THEORY: NODAL BID-BASED PRICINGHOGAN, WILLIAM W. (2008). ELECTRICITY MARKET STRUCTURE AND INFRASTRUCTURE. CONFERENCE ON ACTING IN TIME ON ENERGY POLICY.

Nodal Pricing Different prices at every power node. Based on contract bidding. “Spinning Reserves.”

Back-up energy to avoid brown-outs.

Leading American Expert: Dr. William Hogan Professor at Harvard. Free-market advocate.

His paper make recommendations for Federal Energy regulatory Commission. More regional regulation. Increase information transparency.

THIRD PAPER: ANALYSIS

Completely Qualitative. No data. FERC was his audience. Very accessible.

All American papers seem to have less data emphasis.

Takes most of the credit. The coauthors are placed in a footnote.

CONCLUSIONS ON THE LITERATURE

Forward Pricing/ Mean reverting Jump Diffusion. Requires lots of data to calculate price. More prone to brown-outs.

Tend to underestimate.

Nodal Pricing Bid based, making it easy to price. Chaotic, Confusing Prone to black-outs.

Questions?????????