Journal of Energy Markets

The papers in this issue of The Journal of Energy Markets all touch upon topics of considerable importance and relevance. They involve aspects of theory or methodology but, in keeping with the objectives of the journal, they also seek to inform and improve professional practice. Their subjects range from the well-established themes of oil price modeling and optimal oil production to the more recent market for green certificates and the emerging interest in flexibility provisions in power markets.

In the first paper, “Optimal management of green certificates in the Swedish– Norwegian market”, Fred Espen Benth, Marcus Eriksson and Sjur Westgaard develop a valuation model for the tradeable green certificates (TGCs) in the Swedish–Norwegian market. This is formulated as a stochastic control problem in which the model takes into account the production rate of renewable energy from a typical plant, the price of TGCs and the cumulative amount of certificates sold. With particular stochastic assumptions, the authors derive optimal decision rules and a closed-form solution to the control problem. A case study on data from Denmark validates the model choice and shows the practical relevance of the proposed methodology.

“Barriers for district heating as a source of flexibility for the electricity system” by Klaus Skytte, Ole Jess Olsen, Emilie Rosenlund Soysal and Daniel Møller Sneum is the issue’s second paper. Here, the authors examine the important role that district heating facilities can provide in meeting the flexibility requirements that large amounts of intermittent energy, such as wind energy, impose upon the power system. However, regulatory barriers and different energy market designs may hinder the potential benefits from system integration and lower the potential that can be realized. Combined heat and power (CHP) is widely integrated into the power market in Scandinavia, but it is threatened by low electricity prices due to the increasing amounts of wind power. Power-to-heat technologies, electric boilers and heat pumps are blocked by high tariffs and taxes. A calculation of the heat costs of different district heating technologies demonstrates that CHP and power-to-heat under the present price and tax conditions in Denmark and Sweden are unable to compete with heat-only boilers that use tax-free biomass. This paper provides important quantitative insights into a topic that has been attracting considerable interest.

Moustapha Pemy looks at optimal oil production in our third paper, “Optimal oil production under mean-reverting Lévy models with regime switching”. How quickly an oil producer should, or might, extract resources has often been a question of international relevance and speculation. In this context, Pemy’s paper is concerned with finding the optimal extraction policies of an oil field under various financial and economic constraints. Taking into account the fact that the oil price in worldwide commodity markets fluctuates randomly following global and seasonal macroeconomic parameters, oil price is modeled as a mean-reverting regime-switching jump–diffusion process. The author demonstrates the convergence of a numerical solution for approximating the optimal reward function and the optimal extraction policy.

Continuing with the theme of oil price modeling, in “Modeling superior predictors for crude oil prices”, Sjur Westgaard, Petter Osmundsen, Daniel Stenslet and Jo Ringheim question the common perception in the literature that oil price dynamics are most adequately explained by fundamental supply-and-demand factors. In contrast, they find that financial indicators are even more significant for modeling and predicting oil prices. They demonstrate empirically that the futures spreads level, high-yield bond spreads and the PHLX Oil Service Sector (OSX) index are the best predictors of oil prices in the period February 2000–June 2013. The OSX index is particularly interesting, as no study has analyzed its predictive power prior to this paper. The relationship is intuitively meaningful, as stock prices, which strongly depend on the oil price, are determined in a market with well-informed investors. The authors also demonstrate through an out-of-sample analysis that their most parsimonious model is superior to various relevant benchmarks. Evidently, these findings do not imply that the financial sector determines oil prices but, rather, that fundamental information of practical importance is traceable from financial markets.

Derek W. Bunn
London Business School