Unifying the theory of storage and the risk premium by an unobservable intrinsic electricity price

TL;DR

This paper introduces an unobservable intrinsic electricity price to unify storage theory and risk premium concepts, deriving prices for various contracts and empirically finding a negative risk premium.

Contribution

It proposes a novel unobservable intrinsic price model that links storage theory with risk premium, providing explicit pricing formulas and empirical validation.

Findings

Overall negative risk premium observed

Derived prices for intraday, day-ahead, and futures contracts

Proposed a structural model for electricity prices

Abstract

In this paper we introduce a new concept for modelling electricity prices through the introduction of an unobservable intrinsic electricity price $p(\tau)$. We use it to connect the classical theory of storage with the concept of a risk premium. We derive prices for all common contracts such as the intraday spot price, the day-ahead spot price, and futures prices. Finally, we propose an explicit model from the class of structural models and conduct an empirical analysis, where we find an overall negative risk premium.