What Models Tell us about Long-term Contracts in Times of the Energy Transition

Value of long-term LNG contracts: A theoretical and empirical study

“…Especially for countries heavily relied on LNG imports, considering that short-term trading of natural gas has transaction volume risks, price risks, and infrastructure risks, short-term efficiency is not sufficient to guarantee a well-functioning long-term market, these countries are willing to forgo some flexibility in favor of supply security (Mazighi, 2004;Ruester, 2009;Abada et al, 2019). Therefore, spot volumes of LNG may continue to grow in the future, but there will eventually be an upper limit to the ratio of spot to long-term contract transactions (Hartley, 2015;Nikhalat-Jahromi et al, 2017a;Alim et al, 2018).…”

Why the sustainable provision of low-carbon electricity needs hybrid markets

“…Risk and risk aversion are not an issue per se provided that markets are complete, i.e. Arrow-Debreu securities exist for every possible state of nature and agents can trade and transfer risk via adequate hedging instruments (Willems and Morbee, 2010;Léautier, 2016;Abada et al, 2019). Simply put, market completeness corresponds to an ideal situation where all relevant risks can be traded over all relevant time horizons (i.e.…”

“…That the power sector is particularly subject to market incompleteness has much to do with the preceding issues, notably the semi-public good nature of electricity as a product, its specificities (multiple services and technical constraints with strong intertemporal dependencies) or its high price volatility (in part due to limited storage and demand participation). Insufficient long-term hedging is also due to consumers' perception of paternalist intervention or regulatory insurance in case of price spikes (Vázquez et al, 2002;Batlle and Pérez-Arriaga, 2008), uncertainty about long-term fundamentals or relative technology costs (Newbery et al, 2018), and regulatory risk that is unhedgeable in nature (Abada et al, 2019). 13 As Newbery (2016) notes, generators and consumers are poorly equipped to deal with uncertainty about future regulatory choices when "politicians and/or regulators are not willing to offer hedges against future market interventions that could adversely affect generator profits".…”

“…efficient short-term prices are essentially irrelevant if they cannot be properly conveyed to and appraised by investors. Such backpropagation will fail if significant risks cloud the investment path and cannot be adequately hedged (Abada et al, 2019). 15 Additionally, under uncertainty and investment irreversibility, there is an option value in deferring decisions to invest in new plants (e.g.…”

The Texas Energy Debacle and the Economists

“…Recent scholarship is beginning to provide models that challenge that folk theorem and to place the analysis of risk in power markets in perspective. 15 But that new scholarship is in its infancy. crisis, provided an example of something that Brandeis and Commons would view as a public service supply system "fracturing under the hammer" of the rules that Texas chose to administer its power market.…”