Price Forecasting in Spot Markets: Hidden Risks in Single-Part Bidding

Fortnightly Magazine - October 15 1998
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The California Power Exchange doesn't solicit separate bids for plant start-up, spinning reserve or base load operation. That can make spark spreads a bit misleading

IT SHOULD COME AS NO SURPRICE THAT THE PROSPECT OF electric competition has created a huge demand for price forecasting services. To their credit, the forecasters have obliged, supplying an abundance of tools and techniques. Do the forecasts serve the needs of those who would use them?

Some might wish to use a price forecast to assign a value to assets. They may wish to buy some of the many generating plants that utilities have decided to sell as part of a settlement to allay stranded costs of alleged market power. Ordinarily, a plant's value reflects the income stream it will produce. Forecasting that income requires an estimate of both market price and the plant's production profile. Moreover, any useful forecast must take volatility into account. It has been argued empirically, in fact, that electricity shows more volatility than other markets, including other energy markets.

Unfortunately, however, real market prices are much more complex than the simple supply-and-demand diagrams of elementary economics texts. Yes, supply and demand remains important, but so are the details of market structure. And in the newly evolving electricity markets, structure is still in question. Valuation becomes especially difficult, for example, when the assets in question are the very units that, when bid into the market, actually help set the prevailing price. To know the price requires, at the very least, that we know the market rules.

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