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Modelling and Forecasting Power Prices

Ruohao
Sun

In countries that have liberalized their electricity sectors, the price of electricity is no longer regulated by state-owned
monopolies, but determined by competitive market forces. The dynamic behavior of the spot prices has therefore
become one of the most important areas of deregulated electricity market study. In particular, short-term price
forecasting (STPF) has emerged as a novel yet pragmatic research field.

In practice, short-term price forecasting is an important tool for market participants to build their bidding strategies.
Power plants need to plan the production according to their forecasting of the price movement. For example, they
would bid to offer more electricity to the market if they predict an up-moving price in a specific hour of the next day.
Furthermore, this insight can help the demand side to hedge against the risk of price volatility through physical
bilateral contracts. If the prediction is reliable and accurate, then market participants could, by doing so, maximize
their profit and control for risks related to price uncertainty.

A large number of forecasting techniques have been proposed and empirically applied to different electricity markets
during the past two decades. However, so far there is no systematic evidence that one model can outperform others.
Among different approaches, two groups of models received intensive attention. One group consists of econometric
time series models and the other is based on non-parametric techniques, such as artificial intelligence.

My Msc thesis , under the supervision of Francisco Santos, examined the forecasting performance of the two above-
mentioned modelling techniques: the time series models and artificial intelligence. The Nordic electricity wholesale
market Nord Pool Spot is selected as the primary case market and its price fundamentals are studied in detail.
The relationship between electricity price and a number of factors is discussed with the intention to explain price
behavior. In particular, short term effects of external impacts are emphasized. Before, most studies have selected
input variables based on experience and didnt talk in-depth about the statistical issues that might lead to biased
estimates. As a result, it can be frequently found that the effects of selected input variables are either uncertain or
insignificant. We attempted to address those issues and better utilize relevant information. Other important modelling
issues, such as autocorrelation, stationarity, seasonality, cointegration, and non-linearity are taken into account.

The multivariate autoregressive integrated moving average model (ARIMAX), the threshold autoregressive model
(TAR), and the artificial neural network (ANN) are three models I proposed, developed and applied in out-of-sample
forecasting. These models are calibrated with hourly system prices from 3/1/2011 to 27/9/2013, which is the most
recent available data. After estimating the parameters for each of the 24 hours, we obtained a total number of 72
models, which is later used to forecast the day-ahead system price of 30 consecutive weeks (figure 1).

The ANN model produces the lowest mean absolute percentage errors (MAPE) for 20 weeks and achieves an
average MAPE of 5.15%. The ARIMAX model is the most accurate over six weeks, although it has an average MAPE
of 5.94%. Finally, the TAR model has an average MAPE of 5.71%, which falls in the middle. It is therefore clear that,
in general, the artificial neural network approach is superior

The superiority of the ANN model is not only reflected by the number of best performing weeks and the lowest
average MAPE, but also its promising performance during winter (week 1 to 10); i.e. when electricity prices of Nord
Pool Spot are more volatile than the rest of the year. The threshold model outperforms the linear time series model in
most weeks, especially during winter.
 Figure 1: Model comparison of Out-of-sample forecasting performance

The accuracy of forecasting is also affected by the accuracy of load and wind-power. We performed the same
forecasting test with real loads, instead of predicted loads. Real-time inputs can be viewed as perfectly forecasted
inputs. This controlled experiment intends to identify the sensitivity of model performance to input errors. This time,
the ANN produced 17 of the lowest MAPEs and obtained an average of 4.86%. The threshold model is the most
accurate over 4 weeks and has an average MAPE is 5.49%. The ARIMAX model, on the other hand, yields 8 of the
lowest MAPEs, but only achieves an average of 5.73% still higher than the Threshold model, but inferior to the
ANN model.

Some additional findings of interest include: 1) The ANN model is capable of capturing some non-linear behavior of
electricity prices, given an accurate forecast of exogenous variables. 2) Compared with the ANN model, the ARIMAX
and TAR models can underestimate large price deviations, especially during peak hours. 3) In contrast, during base
hours it is possible that the ANN model overestimates the effect of external signals.

The forecasting results show that the ANN model outperforms the other two models over the majority of tested weeks.
Better forecasting accuracy indicates that the ANN model is more powerful to uncover the non-linear relationship
between electricity price and its drivers, at least in the short-term. More important, ANN models have the potential to
perform well under highly volatile periods. The TAR model generally leads to better forecasting results than the
ARIMAX model. During fluctuating seasons, a non-linear model is much more accurate than linear model, but a
regime switching (i.e. threshold) approach does not help to improve the forecasting accuracy during calm seasons.
Although it is difficult to compare the forecasting accuracy between this paper and previous studies due to different
forecasting time horizon and inputs, the MAPEs achieved in this study are, on average, lower than most of the
reported results. In addition, the three proposed models are easy to apply, require only available information and can
be conveniently adjusted to include other inputs as required by specific applications.