The relationship between spot and futures prices in the Nord Pool electricity market

We analyze 11 years of historical spot- and futures prices from the hydro-dominated Nord Pool electricity market. We find that futures prices tend to be higher than spot prices. The average convenience yield is therefore negative, but varies by season and depends on the storage levels in hydro reservoirs. The average realized return on holding a long position in the futures market is also negative. The negative convenience yield and risk premium contrast empirical findings in most other commodity markets. We argue that differences between the supply and demand sides in terms of risk preferences and the ability to take advantage of short-term price variations can contribute to explain the observed relationship between spot-and futures prices. In addition, our analysis shows that the relationship between spot and futures prices is clearly linked to the physical state of the system, such as hydro inflow, reservoir levels, and demand. (C) 2009 Elsevier B.V. All rights reserved.