Including climate-induced jumps in forward price trends in wholesale energy markets

Luis Antonio Pascua-Guerra and Javier Orlando Pantoja-Robayo

Journal of Energy Markets

Abstract: Forward contracts mitigate price risk in electricity markets, but varying pricing methodologies can create confusion and lead to prices that do not accurately reflect spot prices, potentially causing losses at maturity. Our study proposes a forward contract pricing model based on an Ornstein–Uhlenbeck stochastic process, incorporating a climate risk factor as its main contribution. In addition, we analyze the forward risk premium derived from the model and suggest an adjustment using a generalized autoregressive conditional heteroscedasticity (GARCH) model to improve future price estimates in the Colombian wholesale electricity market. This approach makes the market more complete and fairer for all participants, particularly in the case of hydroelectric generation. The proposed model has significant implications for market participants, as it provides a more realistic, and therefore fairer, price assessment, which stands as the primary contribution of this research.

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Persistent link: https://EconPapers.repec.org/RePEc:rsk:journ2:7962182

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