Renewable forecast errors: the primary driver of intraday price swings

Different types of energy market forecasting entail varying levels of risk. Day-ahead forecasts, for example, come with high levels of balancing penalties because they forecast for the day ahead with none of the flexibility of real-time adjustments that come with intraday forecasting, which update continuously throughout the 24-hour period.

Forecast deltas are designed to shift supply expectations: changes in forecasts are known as forecast deltas, and they allow traders to respond to market changes in real time.

While intraday trading seems like a less risky option, it comes with its own challenges. This is in part due to the unpredictability of the weather and its impact on pricing. For example, unexpected weather patterns, such as cloud cover in the case of solar, can't usually be predicted, even with shorter-term, real-time forecasting. Temperature and humidity can also affect real-time forecasting, as well as more extreme weather events such as tornadoes, flooding, typhoons, or droughts. This can affect not only trader decisions but also investor confidence and how much they are willing to invest.

Intraday trading relies on meteorological data that takes time to regenerate, which is always slightly delayed relative to the weather.

How forecast revisions translate into price moves

It's key to bear in mind that it's the changes that drive volatility rather than volume: for example, if solar power output is consistently higher than expected, this won't negatively impact pricing, but if it is wrongly forecast, it will negatively impact pricing, causing intraday price swings and traders must react. To understand how forecast revisions translate into price moves, we need to understand market dynamics. For example, low forecast errors lead to low prices, whereas high forecast errors lead to price spikes and drops. To trade effectively in this environment, traders need to trade with flexibility and use intraday trading to exploit these drops in price by being nimble and fast-acting.

Timing, magnitude and direction of repricing

While trading occurs continuously, there are repricing hotspots that are key avoiding intraday price swings. For example, 1-3 hours before closing is often the most frantic period of repricing,  while 3pm or evening slots offer the highest liquidity, triggering shorter 15-minute updates. However, repricing can take place right up until minutes before energy is physically delivered.

Price sensitivity can be observed under both tight and loose trading systems, each with its own set of challenges. Tighter systems come with higher price limits or restrictions, which can result in lower intraday volatility before limits are reached, but higher levels of intraday price swings when the market reopens the next day. Looser systems, on the other hand, display much higher intraday volatility across all trading hours, both at closing and reopening.

Forecast error vs forecast uncertainty

Forecast errors in wind and solar generation can create intraday price volatility when output deviates from predicted levels, but it's important to understand that focusing on revisions, not absolute levels, moves markets. This means traders need to be more nimble and fluid in their strategic approaches. Forecast errors can drive intraday volatility because participants must revise positions very close to delivery.

Why renewable forecasts change close to delivery

Renewable energy can be an unpredictable commodity to trade, in part due to its intermittent output, which can make forecasting difficult as repricing approaches delivery. Wind or solar production tends to be one of the biggest sources of volatility close to delivery due to meteorological factors such as cloud cover or wind droughts. So Balance Responsible Parties (BRPs) often have to avoid large penalties by rebalancing portfolios at the last minute in the intraday market. Expanding grid interconnections between regions can also allows for sharing reserves, reducing the impact of localised, and often uncorrelated, weather-induced forecast errors.Introducing storage could help to reduce intraday price swings further by safeguarding certain amounts of banked renewable energy reserves, which can be released close to delivery to help mitigate the effects of low supply levels and high demand patterns close to the end of day balancing.

Trading implications of forecast-driven volatility

The difficulty with renewables and intraday trading is that production doesn't always match forecasts. Expected production vs. actual production can create supply-and-demand imbalances, leading to price increases. This is because demand can outstrip supply; for example, during wind droughts, a supply deficit follows, and more costly power must be procured to plug the gap. When too much power is generated, and demand doesn't reach the same levels, energy must be dumped at a lower price, causing price drops. However, traders shouldn't avoid renewable energy to pursue what they deem to be a more stable market: it's possible that trading higher levels of renewable generation, for example, up to 40%, can actually help stabilise pricing, while smaller amounts or poorly forecasted amounts increase volatility.