Working Paper: NBER ID: w25851
Authors: Akshaya Jha; Frank A. Wolak
Abstract: The introduction of purely financial participants into commodity markets is thought to yield forward prices that better reflect future spot prices, and ultimately, more efficient future production and consumption decisions. However, there are sizable transaction costs associated with trading in most commodity markets. This paper develops a statistical test of the null hypothesis that expected forward/spot price spreads cannot be arbitraged even after accounting for these transactions costs. We apply this test to hourly, location-specific day-ahead and real-time prices from California's wholesale electricity market. The implied trading cost required to reject the null hypothesis of no profitable arbitrage opportunities falls significantly after California allowed purely financial participation. Moreover, variable input costs per MWh of electricity produced fell by 3.6% in high demand hours after the introduction of purely financial participants. Combined, our evidence supports the hypothesis that the introduction of purely financial participants into the California wholesale electricity market decreased the average difference and the volatility of the difference between day-ahead and real-time prices, which ultimately lowered the total variable cost of serving demand
Keywords: No keywords provided
JEL Codes: G13; G14; Q02; Q4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Introduction of purely financial participants (G19) | Decrease in average difference and volatility between day-ahead and real-time prices (C22) |
| Introduction of purely financial participants (G19) | Decrease in implied trading costs (G19) |
| Introduction of purely financial participants (G19) | Drop in variable input costs per MWh of electricity produced during high-demand hours (L97) |
| Introduction of purely financial participants (G19) | Reduction in total variable cost of serving demand (D24) |
| Introduction of purely financial participants (G19) | No increase in number of high-demand hours requiring startup of fossil fuel units (L94) |