What’s Driving the Nordic Power Market?
Hydrology or coal: What is driving the Nordic power market in the aftermath of the commodities boom? Lars Olav Fosse, an analyst with Point Carbon (a Thomson Reuters company), looks at what is driving the Nordic power market in the wake of recent market turmoil.
LAST YEAR, while visiting clients in Norway, some of the traders I met unexpectedly left the meeting because (it was explained) the monthly US Housing Price index had been released. Back then, keeping an eye on news with no obvious connection to the Nordic power market was a relatively new routine for Nordic power traders. But then again, last year brought with it a number of new routines. The previous summer the commodity markets had all been
following the same bull trend. Before the summer of 2008 a Nordic power trader could have his eyes on the latest weather forecasts, while glancing at the German power market and the coal market every now and then. Then, suddenly, the US housing index became relevant. The logic was that the housing index was driving the US stock market, crude oil was following the stock market and crude oil was the leader among commodities. So crude oil pushed up coal, which pushed up the German power market, which again pushed up the Nordic power market. However, there wasn’t time to think about the logic behind it all, instead it was all about riding the biggest wave the market had ever seen, and getting off before it broke. In the autumn of 2008 the wave did indeed break. Some
made fortunes, others got severely wounded. Have the markets normalised since then?
The Nordic Power Market Power derivatives in the Nordic power market are traded on
NASDAQ OMX Oslo ASA (formerly Nord Pool ASA). The reference price for all derivatives is the system price – the price that would have cleared the market in Norway, Sweden, Finland and Denmark if there had been no congestion on the interconnectors. The Nordic power market is, of course, dominated by hydro
generation. Of the installed capacity, 52% is hydro, with the majority of this located in Norway. From North to South there are several mountain ranges in Norway that block the Atlantic lows coming in from the west. This leads to huge amounts of precipitation, especially in Western Norway. The total reservoir capacity in the Nordic power system is around 120 TWh. The hydro producers thus have the possibility to either produce today or store the water in order to produce when power prices are higher. This ability to store the water could be seen as a real option with a value, the water value. On the margin, a hydro producer should be indifferent to producing today or storing water for later. The hydro balance, the difference between the actual and normal total hydro resources in both reservoirs and snow and
soil, can change by 10 TWh from one week to another and changes of up to 30 TWh within a quarter is not uncommon. In a dry year the total inflow to the Nordic hydro system can be as low as 150 TWh , while in a wet year up to 245 TWh of inflow forces the hydro producers to run at full capacity twenty four seven. Thermal power generation makes
up 42.7% of the total capacity. Of this share, nuclear is 12.2% of the total capacity and combined heat and power (CHP) is 20.5%. Although some of the CHP plants optimise at least part of their production on marginal cost considerations, only 10% mainly considers their marginal costs when deciding whether to produce. Of this share, 6.2% is coal and 3.8% is gas and oil. Since gas
Of the installed capacity, 52% is hydro, with the majority of this located in Norway
is on the margin only in really dry or cold situations, for most of the time the water values of the hydro producers or the marginal cost of coal sets the price.
Coal vs. Hydrology Figure 1 shows the system price,
the short run marginal cost (SRMC) of coal and the hydrological balance in the Nordic market from 2008 and onwards. It is easy to spot the correlation between the system price and the hydrological balance, at least when looking at the price peak last winter. In the period prior to the commodities boom of 2008, the marginal cost of coal was quite flat and the system price was more or less
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