Managing Weather Risks in Electricity Markets

Wind and solar energy, the fastest growing renewable energy sources globally, as well as hydro energy, are directly influenced by variations in the weather conditions.

Demand for electricity and heating soars up in cold winters in Europe when people spend more times indoors with heating and their appliances turned on. This higher demand results in higher prices for electricity as well. And conversely, in warmer winters, power companies are faced with lesser demand for energy. In a world that is transitioning more into renewable sources of energy, the weather has become a more significant factor than ever in electricity generation & pricing. Approximately 44% of Germany’s power consumption in the first half of 2019 came from renewable energy. If we are to go by these trends, in the next couple of decades, renewables will replace fossil fuels to become the major source of energy globally. Wind and solar energy, the fastest growing renewable energy sources globally, as well as hydro energy, are directly influenced by variations in the weather conditions.

Wind and solar are intermittent sources of energy. Solar energy generation is not possible at night and when it’s overcast; and wind energy generation is influenced by windspeeds. This means that electricity generation from solar and wind sources are lowest when it is cold, dark and with low wind speeds. Also, it is during these periods that are cold, dark or without wind that the electricity needs are also the highest. To ensure sufficient supply of electricity during these periods, traditional sources of power generation that can supply electricity to the grid at any time such as coal, natural gas and biomass ( baseload) need to be maintained and available on standby. Even in a world that wishes to be sustainable, the maintenance and running of fossil fuel plants contribute to the price of electricity.

Developing accurate models is key to managing the weather risk in the electricity market, both in the demand and supply side. Increased digitalization in the power & utility industries is now helping the companies predict demand and optimise generation more accurately. However, even at its best, about 5 to 7 days is the average forecast for accurate weather predictions. Marta Gonzalez Torrabadella, Head of Energy Models & Risk Metrics at Naturgy will speak at the 8th Electricity Price Forecasting & Market Arrangements 2020 about managing weather risks in electricity markets and developing accurate models that appropriately include the relationships between weather factors and prices. Piergiacomo Sabino, Quantitative Risk Modeling Expert at E.ON will present a new and fast simulation technique of jump processes that can be combined to the standard Gaussian OrnsteinUhlenbeck process in order to generate realistic spikes in the commodity prices and temperature values.

In addition to improving the accuracy of forecasting and modelling, power companies also rely on weather derivatives to hedge their risks. The boom in renewable energy has created a more complex weather risk market, increasing the demand for weather derivatives to cover the losses for adverse weather conditions. The weather risk transfer market has evolved from the traditional temperature-based products such as CDD/HDD (Cooling Degree Days/Heating Degree Days) puts and swaps to more complex products such as ‘Lack of Sun’ coverage and put options on wind volume. The traditional Power Purchase Agreement (‘PPA’) has been improved to create Proxy Revenue Swaps to protect against risks.

Managing and mitigating risks will be discussed at the Impact of COVID-19 on Energy Markets 2020 ForumConnect with us to be part of the discussion on crisis management in energy markets.