Fundamental and speculative shocks, what drives electricity prices?

Abstract

In the paper, Structural Vector Autoregressive models (SVAR) are used to identify fundamental and speculative shocks, in the UK electricity market. The structural shocks are identified via short run restrictions, which are imposed on the matrix of instantaneous effects. In the research, two main types of shocks are considered: fundamental shocks, which result from unexpected changes of demand, supply and generation costs and speculative shocks, which are associated solely with electricity prices. The results indicate that speculative shocks play an important role in the price setting process. Although they account for a significant part (from 30% to 95%) of the price volatility, I do not find evidence that the influence differs between peak and off-peak hours. When fundamental shocks are considered, some dependence between their effects on electricity prices and periods of the day is confirmed. For example, the impact of wind supply shocks on electricity prices is significantly stronger during the peak hours than during the off-peak hours. Moreover, the supply shocks become a major source of electricity price volatility during the peak hours. Finally, it is confirmed that shocks associated with generation costs (prices of fuels) don't have any instantaneous effect on the electricity prices.