Forward curve dynamics in the Nordic electricity market

Abstract

The purpose of this paper is to investigate the forward curve dynamics in an electricity market. Six years of price data on futures and forward contracts traded in the Nordic electricity market are analysed. For the forward price function of electricity, we specify two different multifactor term structure models in a Heath-Jarrow-Morton framework. Principal component analysis is used to reveal the volatility structure in the market. A two-factor model explains 75% of the price variation in our data, compared to approximately 95% in most other markets. Further investigations show that correlation between short- and long term forward prices is lower than in other markets. We briefly discuss possible reasons why these special properties occur, and some consequences for hedging exposures in this market.