Properties of Electricity Prices and the Drivers of Interconnector Revenue

Abstract

This paper examines the drivers behind revenues of merchant electricity interconnectors and the effect of arbitrage trading over interconnectors on the level and volatility of electricity prices in the connected markets. It sets out a simulation methodology that allows the stochastic and deterministic properties of prices, as well as most model parameters, to be varied freely. The effect of electricity flows over interconnectors on prices and thus on interconnector revenues is modelled explicitly by a mathematical algorithm. It is found that arbitrage can reduce the volatility and to some extent the mean of electricity prices in both markets when two markets with a similar distribution of prices are connected. It is also found that it is possible for interconnectors to generate considerable revenues without any consistent price differences between the connected markets. This shows that interconnectors between seemingly very similar electricity markets can be an attractive proposition for a profit-seeking investor.