OverviewElectricity wholesale markets are characterised by the need to exactly match demand and supply at every point in time (although supply and demand shocks are existent) as well as by a very price inelastic short-term demand. Another important specific characteristic of these markets is the inability to store power. Financial risk management such as long-term contracts is, therefore, an important tool in order to reduce price risks when facing such volatile markets as a result of these described characteristics. At the European Energy Exchange (EEX) as one of the biggest European power exchanges electricity future prices are determined by long-term contracts in forward markets for specific time periods in the future in order to hedge against risks of future day-ahead spot prices.There exists a relationship between future and spot prices because the spot price is an important component when determining future prices (expected future spot prices plus unexpected shocks). Bessembinder and Lemmon (2002) developed an analytical equilibrium model, in which the forward premium (i.e. the difference between future and expected spot prices) is endogenously determined as a function of the variance and skewness of spot prices because these moments of the spot price distribution can be seen as measures of risk management.Although this theoretical result was supported by empirical analyses of non-European markets (such as in Douglas and Popova (2008) who analysed the PJM market), this result was only partly confirmed by past research analysing European markets empirically. Botterud et al. (2010) analysed risk premiums in the most mature hydro-dominated electricity market in the world (Nord Pool) empirically. They found that regarding this market other important drivers of the risk premium are variables referring to hydro power. Bessembinder and Lemmon (2002) used a marginal cost based approach, but at Nord Pool hydro power (with marginal costs equal or near to zero) contributes the largest share to total electricity supply. Redl et al. (2009) analysed forward premiums in markets (among others) managed by the EEX and, therefore, German markets as well empirically. They found that the premium does not depend on the variance of spot prices. Moreover, in addition to drivers regarding risk assessment, they included drivers referring to important variables of supply and demand in order to control for related shocks influencing spot prices.In recent years, there has been a rise in the level of renewable generating capacity in Germany. This is in part the result of the German energy transition (introduced by the government’s feed-in law of 1991 and formlated in further detail in the Renewable Energy Act (EEG) of 2000). Renewable energy such as wind or solar power nowadays contributes a large share to total German electricity supply. Spot prices depend negatively on wind and solar power. This refers to the so-called merit order effect (cf. Jensen and Skytte (2002)).Therefore, we argue that important renewable power variables should be taken into account as well when analyzing forward premiums in actual or rather recent German electricity markets. Thus, we contribute to the existing literature by investigating determinants of the forward premium empirically in German electricity markets and including also wind and solar power because to our knowledge these potential drivers have not been taken into account yet in analyses of forward premiums in German electricity markets. That is why we are interested in the effect of wind and solar power on the forward premium. As in Botterud et al. (2010) our aim is not to present a new theory for forward premiums. We want to analyse empirically to what extent wind and solar power can explain the forward premium.MethodsWe consider historical time series of a couple of recent years in order to analyse market situations when renewable power is relevant in German electricity markets. These markets have become even more volatile when increasing the feed-in of high fluctuating renewables. Therefore, moments of the spot price distribution as in Bessembinder and Lemmon (2002) are included as drivers in order to control for risk assessment. However, the theoretical approach of Bessembinder and Lemmon (2002) should only be able to explain forward premiums in recent German electricity markets to a limited extent, because marginal costs of renewables such as wind or solar power are also near or equal to zero and stand, therefore, in contrast to a marginal cost based approach. Thus, in addition to wind and solar power (main explanatory variables) other drivers of supply and demand are included as in Redl et al. (2009) in order to control for their related shocks.Effects on the forward premium will be estimated by Ordinary Least Squares (OLS) using a linear regression model. Bessembinder and Lemmon (2002) showed in their analytical model that the forward premium depends linearly on moments of the spot price distribution when constructing specific coefficients. As in Botterud et al. (2010) and in Redl et al. (2009) we use this as a starting point in order to take into account measures of risk management, but we extend the model by including further drivers as stated above.We will apply standard econometric preliminary analyses such as tests for stationarity or for multicollinearity as well as diagnostic checks for the estimated residuals. Moreover, it might be important to model the spot price itself as dependent on supply and demand drivers of the spot market (cf. Würzburg et al. (2013)). Therefore, a reasonable robustness check could be estimating forward premium effects using simultaneous equation models. A possible estimator would then be Two Step Least Squares (2SLS).Expected ResultsWe expect a rise in the forward premium on average as a result of a rise in wind or solar power. If the use of renewables rises in the spot market, the supply function (the merit order curve) shifts to the right. Thus, production types with higher marginal costs are forced out of the market and a lower equilibrium spot price is reached. As a result the forward premium increases. Furthermore, we expect that the spot price will fall below the future price and, therefore, we expect a substantial rise in the forward premium when there are large significant unexpected positive shocks of wind or solar power. A rise in the forward premium would lead to losses for those who purchase power and to benefits for power producers in the forward market because in the related long-term contract the price was then set higher than the realized spot price in the corresponding delivery period. Moreover, we expect a larger effect on the forward premium, if the future time period for delivery will increase due to lesser precise approximations of expected future spot prices.ConclusionsIn the near future, the EEX will introduce a new Wind Power Future as a new market instrument in order to provide market participants with the opportunity to hedge specifically against price and quantity risks of wind power generation (cf. EEX (2016)). Therefore, if we will find a significant positive effect of wind power on the forward premium in our analysis of German markets this will underline the necessity of creating a new instrument regarding risks of wind power. Power buyers suffer from losses in the forward market as stated in the expected results. The effect will indicate the need for a specific risk hedging instrument in order to reduce losses for buyers of power as much as possible. Of course, such a specific instrument should be important as well with regard to solar power, if we also will find significant effects of solar power on the forward premium.
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