Fundamental drivers of electricity prices in the pacific northwest

We estimate an AR(1)/GARCH(1, 1) model that shows the impact of natural-gas prices, hydro conditions, and temperatures on wholesale on-peak electricity prices at the Mid-Columbia (Mid-C) trading hub in the Pacific Northwest of the United States. After controlling for the effects of these three factors, prices are seen to exhibit a weak seasonal pattern, but a strong day-of-week pattern. It is also shown that price spikes can persist for several days. Finally, in support of the GARCH hypothesis, Mid-C prices are seen to have a time-dependent variance that primarily moves with natural-gas prices, and that large price variances tend to persist. Thus, even though buyers might cross hedge using natural-gas futures and temperature-based weather futures, the effectiveness of any hedge is compromised by randomness in hydro conditions. To be sure, a buyer can eliminate the electricity price risk by entering into a forward contract, but only at the expense of what is likely to be a large risk premium embodied in the forward price. Copyright © 2007 by World Scientific Publishing Co. Pte. Ltd.