Handbook of Multi-Commodity Markets and Products: Structuring, Trading and Risk Management

CHAPTER 14 How to Build Electricity Forward Curves

Ruggero Caldana,Gianluca FusaiAndrea Roncoroni

14.1 INTRODUCTION

The electricity forward curve (EFC) f_t( · ) quoted in a given market at a point in time t is a mathematical function associating with each day in the future a price for the commitment to deliver one megawatt-hour for every hour of that specific day. In other terms, it is the term structure of electricity forward prices as quoted with daily granularity across the maturity dimension, which is represented by the dotted argument “·” in the expression f_t( · ).¹

EFCs are particularly useful for marking to market (i.e., pricing compatibly with market quotes) a standing portfolio of electricity-related positions of an industrial company or financial institution. Another important instance is the modelling of electricity price dynamics for the purpose of pricing contingent claims or monitoring the net exposure of a company. Strictu sensu any EFC is a purely mathematical abstraction in that actual market quotes refer to commitments to deliver over a time period as opposed to a single day. Popular maturities for which electricity exchanges provide traders with quotes are:

• full day
• week
• month
• quarter
• calendar year.

We may shortly say that each of these maturities is “quoted by the market”. However, several tailor-made contracts which trade over-the-counter (OTC) actually involve maturities other than those quoted by exchanges. Moreover, OTC quotes provided by brokers may ...