Connecting countries electricity markets could make energy prices less volatile

Interconnecting countries electricity markets could make the markets much more stable, thus price differences (also called price spreads) between neighbouring countries are less volatile and more predictable, according to new research by emlyon business school.

In fact, the researchers showed that the coupling of electricity markets is likely to create a more equal cost, creating less disparity in energy costs across European countries.

These are the findings of research by Lorenz Schneider, Professor of Finance at emlyon business school, alongside Erwan Pierre, Quantitative Researcher at BCM Energy. The researchers wanted to understand the impact of interconnected markets on spread volatility, as well as investment in these markets.

Many countries in the European Union are increasingly interconnecting their electricity markets, with countries like France, Germany, Austria, Poland and Czech Republic already connected at certain periods of the day.

To conduct this research, Schneider and Pierre used a dataset from the period of January 2017 to August 2022, comprising European hourly electricity prices and European monthly futures prices from the European Energy Exchange, as well as European monthly auction prices from the Joint Allocation Office.

The researchers created a model which considered the price of electricity throughout Europe between various time periods, as well as the volatility of the market throughout, identifying a vast increase in volatility after September 2021, likely caused by a number of issues such as global conflicts, post-covid economic revivals and extreme weather conditions.

The model was then used to test for the impact of interconnectedness on the volatility of price spreads, as well as the monthly investment in spread options that were available to companies based off their future predictions in the volatile market.

The findings show that, not only has the market become much more volatile and difficult to predict, but creating a more interconnected could counter act this volatility, ensuring that the price spreads between neighbouring countries would be much more stable and predictable. Not only this, but the spread options available to companies who are keen to future-plan and make smart investments would be better as their predictions would be much more accurate and stable.

“The impact of geopolitical tensions on the energy market has been exacerbated in recent times – add in the current cost of living crisis and inflation that many are facing, and a volatile energy market is causing angst for many in an already worrying time.”, says Professor Schneider. “By coupling electricity markets, the pricing structure is much more stable and predictable, making investments within the market much easier than in a volatile, unpredictable environment”.

The researchers say that with increased volatility from geopolitical events like the Russian-Ukraine conflict, the energy crisis is causing huge volatility for consumers interconnectedness could ensure that the prices stay much more stable and companies can future plan better.

Whilst, the researchers state that an interconnectedness could benefit energy companies too, as they are more likely to stay afloat if they can future plan their investments much more predictably.

If you would like to speak to the researchers or receive the full research paper, please contact Peter Remon at BlueSky Education – peter@bluesky-pr.com.