Electricity and natural gas are traded in European markets in the form of blocks. A block is a fixed power in MW delivered over a certain period (delivery period). When this block is delivered at all hours of a certain period, it is referred to as "baseload." If a block is only delivered from 8 AM to 8 PM, Monday to Friday, excluding certain holidays, it is referred to as "peakload."

 

These blocks can be purchased on the futures markets through "forward" contracts several years in advance, up to one hour ahead. The granularity of these blocks varies according to the considered maturity and is limited by the number of listed contracts available. It is possible to buy calendar blocks from A+1 to A+5, quarterly blocks from T+1 to T+8, monthly blocks from M+1 to M+6, etc. However, it is not possible (at least on organized markets) to purchase hour 3 of March 24, 2023, in 2022.

 

To estimate what the price of a contract/block would be at a finer granularity, market players need to create or access a Price Forward Curve. For example, on March 24, 2022, if a player needs hourly prices (an Hourly Price Forward Curve or HPFC) for 2023, they can only use the price of the calendar contract for 2023 to construct it; they will not have other listed prices. They will need to resort to a model to estimate 8,760 hourly prices based on a single listed calendar price.

 

What are the uses?

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Why do market players need to estimate a Forward Curve at a finer granularity than that of the market (hourly instead of annual, for example)? The main utility of such a curve is asset or contract valuation, referred to as pricing.

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To evaluate the price of a supply contract for a consumer, the supplier will rely on that consumer's consumption profile (whether "real" in the case of a remote-read site or estimated in the case of a profiled site) on an hourly basis (or daily for natural gas). This profile is generally far from a baseload block. A typical residential consumer will consume more in winter, less in summer, more during the day, and less at night, etc. To estimate the actual cost of purchasing energy for this profile, the supplier cannot solely rely on listed market prices; they must use an Hourly Forward Curve (or a Daily Forward Curve in the case of gas) to estimate this cost and the supply price they need to propose to cover it.

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The same applies to evaluating the production price of a renewable asset (mainly run-of-river hydro, solar, wind), whose production varies significantly throughout the year and thus has selling prices that differ considerably from a baseload futures contract. An HPFC is necessary to "price" the purchase price of electricity produced by such assets (PPA or otherwise) or to calculate their market value in the context of an investment.

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Monitoring the cost of profiling is particularly important for renewables, as this cost can increase as they develop. Indeed, in the presence of a significant volume of variable renewables in the electrical system, a negative correlation between production and price will develop (this phenomenon is often referred to by the somewhat obscure term "price cannibalization"). As this phenomenon increases, the gap between the baseload price and the actual selling price will widen, deteriorating the revenues of the renewable asset.

More broadly, Price Forward Curves are used in various applications by market players (hedging optimization, exposure tracking of an asset, etc.).

 

How to Estimate It?

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There are various methods to estimate a Price Forward Curve, but the general approach remains the same. Based on historical spot prices, weights are estimated at the required granularity. These weights are then applied to the prices of listed contracts to generate an estimate at the desired granularity.

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It is also essential in this estimation process to ensure the "no-arbitrage" condition of the Price Forward Curve. For example, if the price of the April 2022 contract is listed, it must be equal to the average of the estimated hourly prices of the Price Forward Curve.

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Noos Energy automatically creates an Hourly Price Forward Curve daily based on the settlement prices published by EEX. This HPFC can be customized to include real-time or OTC data. It is also possible to integrate temperature scenarios or renewable production to simulate the sensitivity of profiling costs to these factors.

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Do you need a Price Forward Curve for electricity or natural gas? Contact us at : sales@augmented.energy