Effects of Uncoupling the North Sea Link : An empirical analysis of risks and premiums in the two day-ahead auctions in bidding area N0 2

2023

In this thesis, we study the impact of the current auction solution on the North Sea

Link (NSL), an interconnector between the electricity systems of Great Britain (GB) and

Southern Norway (NO2). Due to Brexit, interconnector capacity is allocated through

an implicit day-ahead auction, which closes before the regular NO2 (SDAC) auction.

Consequently, traders in NO2 can decide to participate in two consecutive auctions.

To address this decision problem, we develop a forecast model to predict day-ahead NO2

(SDAC) prices. Using these forecasts, we approximate the premium that the marginal

trader requires to take positions in the first auction (NSL). Contrary to initial expectations,

we find that traders are, on average, pricing in a positive premium in the NSL auction.

This results in a systematic difference between the NO2 and NSL prices.

We further examine the drivers behind the premium to determine when and why it arises.

Our findings indicate that when traders have less confidence in their NO2 price forecasts,

they demand a larger premium for trading with the NSL. On average, the marginal trader

in our model requires a 0 . 2 2 /MWh higher premium for each incremental increase in the

prediction interval of the point forecast. In an efficient market with risk-neutral traders,

such premiums would not exist as the traders would increasingly take advantage of the

arbitrage opportunity. Therefore, we argue that traders in the NSL auction are risk-averse.

The risk premium comes with a commercial cost for the interconnector owners. We find

that Statnett has lost 2 7 million in congestion revenues since the opening of the NSL on

the 1st of October 2021 to the 15th of January 2023. This amounts to approximately 10%

of the total congestion revenues accumulated during the period.

Overall, we find that the implicit auction solution on the NSL leads to a redistribution

of socio-economic welfare from the interconnector owners to the traders in the form

of a systematic risk premium. We argue that this finding should be acknowledged in

future research on the socio-economic welfare gains from the NSL and in future projects

considering the use of an implicit auction to connect uncoupled markets.