Intermittently coupled electricity markets

Erwan Pierre and Lorenz Schneider
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Lorenz Schneider: EM - EMLyon Business School

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Abstract: Auctions of transmission rights between neighbouring countries are becoming increasingly active. In a parallel development, the introduction of market coupling frequently leads to smaller price differences between such countries. Indeed, if two countries are completely coupled, the price of a given hour of electricity will be identical in each country, resulting in a price spread of zero. Clearly, it is important to take this market coupling into account when evaluating transmission rights, as neglecting it would lead to a significant overvaluation of these rights. In order to address this issue, we introduce a general regime-switching mechanism that can be applied to many models in the literature. In particular, we focus on extending the model proposed by Cartea and González-Pedraz (2012). We describe the model estimation procedure in detail, and compare model and market prices of European spread options. We observe a dramatic paradigm shift in our data set at the end of the summer of 2021, and show that this shift has a strong effect on the model parameters. We also see that the reliable pricing and trading of spread options becomes problematic in such a volatile and uncertain market environment.

Keywords: Electricity markets; Interconnectors; Market coupling; Spread options; Regime switching (search for similar items in EconPapers)
Date: 2024-02
New Economics Papers: this item is included in nep-ene and nep-reg
Note: View the original document on HAL open archive server: https://hal.science/hal-04411166v1
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Published in Energy Economics, 2024, 130, pp.107327. ⟨10.1016/j.eneco.2024.107327⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04411166

DOI: 10.1016/j.eneco.2024.107327

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