EU Cross-Border Power Trading – Measuring the Impact on Volume, Volatility and Price Discovery

Cross-border connectivity is an important step towards a steady reduction of price volatility.
Published: Fri 09 Oct 2015

Cross-border power trading is one of the most important drivers of price and volatility. Therefore, there shouldn’t be any surprise that the EU Energy Work Plan places a great deal of attention on the timely implementation of a single European price market coupling model, explains Georgi S. Slavov, F.I.C.S, Head of Research, MAREX SPECTRON who will also be presenting at EMART Energy.

Improving cross-border connectivity is seen as an important step towards a steady reduction of price volatility with the help of market-based tools. This is a topic which is likely to have profound impact on the price formation, trade flows and trading dynamics across EU for years to come.

The evidence suggests that while nearly perfect market coupling has already been achieved between some markets within the EU, there is a lot more to be done for the rest. In other words, this is a process still in its very early stages of implementation and the energy system, power market included, is likely to evolve for years.

“If we assume the existence of price convergence/market coupling in certain regions of the EU, we should therefore also assume that correlation between the related markets is positive and increasingly strong. This is necessary, but not a sufficient condition to prove market coupling.”

Mr Slavov suggests that in order to build a more complete view, there is a need to take into account the cross-border trade flows and the market volatility trends.

Increase in cross border transactions through regulation and market forces

The direction of the regulatory pull is fairly clear. What we don’t know is how the marketplace will adjust to it, explains Mr Slavov.

“The data we have in hand offers evidence that cross-border trading volume between certain EU power markets has increased steadily at the time when the year-over-year power generation in some of these countries has actually been trending down. This is a fact which firmly supports the process of market integration.”

After all, he explains, the most important aim of the single power market is security of supply and supporting the development of the renewables sector. “Price convergence is welcomed but it is a secondary effect in the process.”

Market coupling and increased complexity  

Complexity in the price discovery for energy (not only electricity but also natural gas) is likely to increase even if volatility decline, he explains, “But, this is a big IF because our recent research into the topic concluded that volatility should actually increase as any two markets couple. This comes on the back of cycles overlay which was not the case only a couple of years ago.”   

His advice to market participants is to prepare for more closely correlated markets. This means that trading strategies will need to change as existing inter-market correlations and volatility profiles will change.

It is likely that many of the existing inter-market arbitrage opportunities will disappear but at the same time, more intra-market arbitrage is expected to open up.

Also, more in-depth analytical tools will be needed as the factors driving the price formation will also change. For example, due to the increased cross-border liquidity, broader macroeconomic knowledge and pan-European power supply and demand models need to be implemented. Local knowledge will no longer be sufficient.    

In conclusion, Mr Slavov says that the EMART Energy conference programme reflects the most important topics discussed on the market very well.

“I would very much like to hear views on the impact from continuous market integration, rising share of renewables in the energy mix as well as any guidance on the storage of power on industrial scale. Here in Research we believe that after the structural shift caused by the renewables, storage of power will be the next big disruptor to the existing market infrastructure and trading practices.”

Georgi Slavov joined Marex Spectron in January 2014 as a Head of Research. His team is responsible for the research and analysis of all key energy, basic materials and industrial transportation markets. At the very beginning of his career, Mr Slavov spent 2 years in the Marine Coast Guard, and subsequently graduated from the Naval Academy. He is a former Navy Officer and holds Engineering and Economics degrees. He is a member of the Business Advisory Committee at Henley Business School ICMA Graduate Center and a guest lecturer in International Trade at the graduate school. He is also a Fellow of the I.C.S. in London and a published author by Incisive Media/Risk Books in the derivatives markets, statistical arbitrage and technical analysis trading field.