Relationships between electricity and oil, gas and coal future prices

What is it about?

This paper investigates the relationship between futures prices of electricity, on the one hand and crude oil, natural gas and coal on the other hand, in the United Kingdom, German and Nordic energy markets. Energy traders and market participants use statistical models in their trading activities. We seek to establish robust cointegration based models as decision tools for energy commodity spread trading. We look at three different markets with different input mixtures, for electricity generation. Using daily futures data from period 2006 to 2012, we find cointegration between UK electricity prices and Coal and Gas, and between Nordic electricity prices and Coal. The spread between German electricity prices and Gas, Oil and Coal prices are also stationary. The consequence of this finding could be a possible trading strategy which involves buying electricity futures and selling gas or coal when the spread is above the mean and reversing the strategy when the spread is below the mean. The suggested strategy assumes a reversion to the mean, which we show takes some time, as displayed by the slow speed of adjustment.

Featured Image