Commodity Derivatives: Markets and Applications

7

Electricity

One of the biggest surges in the electricity in the UK occurred at the end of an international soccer match in 1990 when England lost to Germany. Demand soared by 2,800 megawatts, which was equivalent to more than a million kettles being switched on as the English drowned their sorrows with the answer to all of the world’s problems – a cup of tea.

Source: National Grid

SYNOPSIS The purpose of the chapter is to describe a number of electricity markets and the nature of the most popular derivative products.

 

The first part of the chapter includes a description of electricity, how it is produced and how it is measured. Each market for electricity will be structured in a different manner but a generalised overview of a physical supply chain is outlined.

From this the main drivers of the wholesale price of electricity are outlined, which includes an overview of how regulation has shaped the evolution of the physical supply chain. Since electricity is a secondary source of energy, the difference between the price of the input (typically natural gas or coal) and the output is often expressed as either a “spark” a “dark” spread. The cost of emitting carbon dioxide is now a key consideration when generating electricity, and so the adjusted spreads are calculated.

The trading of electricity is still evolving in many countries and the present structures that exist in Scandinavia, the USA and the UK are detailed.

The chapter concludes with a description of the main derivative ...