Submitted on November 17, 2016

The 10th annual Symposium of the Otago Energy Research Centre (OERC) was held in Dunedin on 10th and 11th November.  I presented at the conference, and Fergus Bevin-McCrimmon gave a presentation of the results of his research on the efficiency of electricity futures markets.  Energy Link was very pleased to sponsor the prize for the best student presentation, won by PhD candidate Paul Crane for his presentation titled “Helping Support Energy Management Systems at the University of Otago”.

By Greg Sise, 17 November 2016

The OERC “creates opportunities for high-impact and internationally recognised energy-related research via an interdisciplinary network of University of Otago researchers and their external collaborators.”  OERC was founded in 2005 by Emeritus Professor Gerry Carrington and today “encompasses over 30 staff and over 40 postgraduate students from 20 departments drawn from all four Divisions of Otago University.”

Energy Link’s collaboration with the OERC Co-Director Dr Ivan Diaz-Rainey, Masters in Finance student Fergus Bevin-McCrimmon, and Lecturer in Finance Dr Xing Han currently focusses on electricity markets and has already produced research on premia and liquidity in the New Zealand electricity futures market.  

Financial Efficiency of Electricity Futures Markets

Fergus Bevin-McCrimmon’s presentation on Friday 11th November presented the first results of a study titled “An International Comparison of the Efficiency of Electricity Futures Markets”, covering New Zealand, Australia, Germany, the Nordic states and the PJM Interconnection which is a regional market in the north east of the United States covering 13 states and the District of Columbia, all of which have had electricity futures markets for some years.

The aim of the research is to test the financial efficiency of established electricity futures markets.  Fergus tested the hypothesis that futures prices are unbiased predictors of future spot prices, and he also tested the forecast power of futures prices in respect of spot prices.  Futures prices could be unbiased predictors in the sense that on average they equal the spot prices, but at the same time they could have large errors when used as a forecast of spot prices.  For example, the errors could be +$10 one month, -$30 the next month, +$40 the next month (in other words large errors) and so on, but still average out at zero in which case the futures prices would be unbiased.  Or the errors could be small but consistently overestimate actual spot prices, and hence be biased on the positive side (and thus exhibit a positive premium over spot prices).

Fergus found that the German base contracts and New Zealand baseload contracts met the two conditions required to be classed as an unbiased predictor of future spot prices, which is surprising as these represent the most and least liquid and mature markets in the sample, respectively.  However, the New Zealand market exhibits the largest errors when used as a forecast of future spot prices, and Germany the least.

100% Renewables and Electricity Market Failure

My presentation was on whether the electricity market would fail in the economic sense as the percentage of renewables approaches 100% (if it ever does), reflecting progress on a research project commenced earlier this year.  Renewables currently sit at just over 80% of total annual generation, and the government has a target of 90% by 2025, although there is no policy mechanism in place which can mandatorily make this happen.

Energy Link’s quarterly Price Path sees the renewable percentage get above 85% by around 2030, based on current information, so from our point of view 90% and higher is a long way off.  However, penetrations in excess of 90% could occur as technology develops and costs come down, and could even move close to 100% under some scenarios.  

How electricity markets might function with close to 100% renewables is a research area of growing international interest and activity, and Energy Link has the models, data and knowledge to contribute to this body of research, with an emphasis on New Zealand.  

In our electricity market, we generate in excess of 55% of our electricity from hydro power stations but our storage lakes collectively have limited storage compared to many other countries, leading to the requirement to maintain a fleet of fossil-fuelled generators to keep the lights on when our hydro lakes get low.

Which raises the question:  how close can we get to 100% renewables and still have secure supply?  

This obviously raises technical issues, but also market issues.  The aim of my research is to investigate outcomes in the electricity market if renewables were to approach 100% to determine if our existing market structure is capable of delivering secure supply at a reasonable price, and if not then what might need to change.

Preliminary results were presented at the Symposium and showed that as the percentage of renewables comes within a few percent of 100%, spot prices collapse because most of the time prices in the spot market are set by renewables which offer into the market at prices close to zero.  At the same time, the amount of spare capacity available to cover dry years and short term grid emergencies is low and would ideally be higher.  But here’s the crunch:  building more renewable capacity reduces prices even further, which would be a disincentive to build new renewable capacity.

This could constitute a market failure, in which the costs and benefits of supplying and consuming electricity are not reflected in the price of electricity.

These are preliminary results and based on some key assumptions about how the market works now, both in terms of its regulated structure, and how market participants behave.  These assumptions may not hold in future if we actually do ever face the prospect of reducing our reliance on fossil-fuelled generation down to a few percent or less.  Testing the impact of these assumptions, and perhaps trialling alternative market scenarios, will be part of the overall research project.

The picture below shows, from left, Associate Professor Sarah Wakes (Centre for Materials Science and Technology at the Uni of Otago), Greg Sise, Paul Crane (PhD candidate in the Computer Science Dept, Uni of Otago), Dr Ivan Diaz-Rainey (Senior Lecturer in Finance, Dept of Accounting and Finance, Uni of Otago, and Co-Director of OERC), Dr Michael Jack (Senior Lecturer in Physics, Director of the Otago Energy Studies Programme, and Co-Director of OERC).

OERC prize giving