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Beyond alarming headlines, there is a coherency in the electricity markets prices

AleaSoft, May 7, 2021. The specific situations, and especially if they are exceptional, may not reveal the general context. At AleaSoft, the exceptional nature of the current high price situation in the energy markets, both of electricity and of gas and CO2,  will be analysed in the next webinar and will be framed within the general behaviour of the prices in the energy markets.

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With some notable exceptions of specialised media in the energy sector, the electricity markets and their volatile prices are a source of alarming headlines, often bordering on sensationalism. It is understandable to want to highlight the exceptional situations that occur in the markets, but it is also important to convey a message of optimism and calm, to both consumers and producers, either the situation of high prices like the current one or of very low prices such as, for example, during 2020 and in February of this year.

In this regard, AleaSoft has always persevered in trying to explain the exceptionality and the temporary nature of many of the situations of the energy markets that fill the headlines from time to time, and the balance in which the prices move when they are analysed with a long‑term vision.

The movements of the electricity markets and their real impact

The vast majority of episodes of extreme prices or large price variations in the electricity markets are temporary. The prices are influenced by many factors, and many of these factors correlate and feed back into each other. Therefore, it is common and recurrent to find a combination of factors or events that causes large variations in prices and that can cause an alarm situation.

A situation that occurred a few times, and that is a clear example, is a cold snap. During a cold snap, the electricity demand increases due to the use of electric heaters and, if it is accompanied by a storm, of the lighting due to the lower existing ambient light. An increase in electricity demand obviously causes an increase in prices in the electricity markets. But, in addition, with the drop in temperatures, the gas demand for heaters that run on this fuel also increases. This increases the gas prices since its demand increases and the reserves decrease. But the electricity generation, and more so in situations of high demand, also uses gas in the combined cycle gas turbine plants, and that makes the electricity prices even more expensive. In addition, the increase in gas prices tends to incentivise the CO2 emission rights prices, which also end up increasing. This causes an increase in costs in the combined cycle gas turbine plants that end up making the electricity prices more expensive.

As mentioned, a temporary combination of events that ends up causing a significant variation in prices. But beyond the exceptional nature of these situations, it is necessary to analyse which is the real impact on the costs for the consumers and on the income of the generators. To do this, it is necessary to look at the medium and long term, and, when zooming out of the specific situations, it is observed that the average of the prices is stable, fluctuating around an equilibrium price.

The existence of a balance in the electricity market

This equilibrium price is what makes it possible for the market to function. It is a balance between the supply and the demand. A balance between the cost of generating the electricity and the price that the consumers are willing to pay. A balance between the long‑term return on investment and the expected demand growth.

The fact that the prices fluctuate around a breakeven point means that they cannot be too high for too long. That would discourage the demand and there would be an oversupply situation that would push the prices down. Nor can the prices be too low for too long, because that would stimulate the demand while discouraging the investment in new capacity, leading to a tight supply situation with a rise in prices.

Thus, the price fluctuations in the electricity markets are a normal and common phenomenon that will continue to occur in the future. The important thing is not to focus the attention on the exceptional periods and always analyse the medium and long term. Because in some situations the harmed will be the consumers and on other occasions, they will be the electricity generation plants.

MIBEL long term price forecast made in November 2010. Source: AleaSoft.

The current situation is exceptional but it is not new

According to the AleaSoft models, right now the prices in the MIBEL Iberian electricity market are above the market equilibrium prices. Therefore, the natural tendency of the market will be to reverse this upward escalation in the medium term.

In the graph above, which shows a long‑term forecast of November 2010, it is clearly observed how, since then, the prices were fluctuating around that equilibrium point projected by the models at that time. Other episodes can be observed where the prices moved away from the equilibrium, such as, for example, during 2020 due to the COVID‑19 crisis and the restrictions and confinements, in 2016 due to large renewable energy production with low gas prices, in 2018 due to the high gas and CO2 prices, a situation similar to the current or to late 2016 and early 2017 with the nuclear power plants crisis in France.

In all those situations, the prices always reversed their tendency to move away. In addition, rebound effect situations tend to occur, where after an episode of high prices there is a situation of low prices, and vice versa. An effect that shows the existence of an equilibrium point in the market.

A message of calm and optimism to convey

In this sense, in the face of the understandable concern shown by the large consumers and electro‑intensives, or the feeling of uncertainty that led to a delay in the IPO of some renewable energy companies, the message that AleaSoft wants to convey is one of calm and optimism in the face of the prospects for this temporary situation to stabilise.

The analysis of the current situation of high prices in the markets, both of electricity and of gas and CO2, will be one of the central topics of the next webinar organised by AleaSoft, which will be held next Thursday, May 13, aimed at companies interested in forecasts in the energy sector. Other topics that the AleaSoft experts will discuss in the webinar are how, in a context such as the current one, the long‑term price forecasting is essential for the renewable energies when it comes to obtaining financing, through PPA, auctions or in pure merchant projects. The invitation to the webinar can be requested at the following link.

Source: AleaSoft Energy Forecasting.

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