Seasonality in power forward curves: why winter risk dominates pricing?

Forward curves can often be influenced by seasonal elements such as lower levels of renewable output and peak heating demands in the winter months. There will be occasions when traders may experience seasonal dislocations and have to employ tactics such as hedging to weather these metaphorical and genuine storms. Overall, it’s key that forward traders and analysts understand the structural drivers of seasonality, including summer dynamics and renewable effects. Traders will need to learn to manage factors such as winter risk premiums and scarcity expectations and to look out for patterns in seasonal spreads and curve structure.

Structural drivers of seasonality

Colder months can lead to increased electricity consumption. It is this element of winter risk, as demand increases, that drives forward curves.

Heating demand in winter vs lower summer demand

In the winter, electricity demand can be up to 36% higher as homes are colder and darker. While summer periods also bring cooling demand, it's not as consistently higher compared to winter months.

Industrial consumption patterns

During the winter months, industrial consumption can also increase. Hotter summer months can mean industrial operations are limited, while the need for industrial facilities to be heated during winter months can also increase.

Weather sensitivity of load

Temperature is closely linked to electricity requirements, with weather a major driver of load sensitivity. Low temperatures can reduce the amount of wind generated, for example, affecting how much energy can be produced from that wind.

Winter risk premium and scarcity expectations

Energy demand peaks in winter due to increased heating needs, but this also restricts energy supply as winter weather reduces output from energy generation facilities.

Tight capacity margins in winter

Tighter energy supply during the winter months compared to the summer means there is less excess energy available for emergency situations. This can mean power has to be moved between low- and high-need areas to meet demand; this is a common occurrence in Scotland.

Increased outage and weather risk

Because conditions are more extreme in the winter months, this can have an adverse effect on generation equipment, reducing supply. This impacts plants by damaging infrastructure, leading to power outages and plant shutdowns for extended periods. This becomes a problem when these issues coincide with increasing energy demand.  

Impact on Q1 and winter contracts

The earlier months of the year usually see much higher pricing due to the risk associated with winter. The forward curve reflects this, with January and February the most expensive time of year. Winter premiums can increase further if colder weather persists beyond normal levels.

Summer dynamics and renewable effects

We can see the impact of seasonality quite clearly in forward curves, with premiums peaking in colder periods due to limited energy storage, increased demand and a lower supply probability.

Solar generation suppressing midday prices

Solar generation can increase the amount of midday prices even further because it dips considerably in the winter months, thanks to a lack of sunlight to generate solar energy, compounded by shorter days. This leads to lower power solar prices overall.

Lower demand volatility

While winter periods have the highest levels of volatility, unexpected summer behaviour can also positively impact the forward curve. In the Nordics, for example, cooler summers will result in less energy-driven cooling demands, which result in more predictable load profiles in the summer months.

Hydro availability in Nordic markets

Elsewhere in the Nordic market, hydro energy can have additional impacts on the forward curve on a seasonal basis. For hydro energy t function correctly, water must be stored throughout wetter periods to sell during the high-price winter season, which can ease the impact of the volatility experienced in other areas of the energy market during the winter season.  

Seasonal spreads and curve structure

Seasonality has a huge impact on energy-related forward curves as energy prices are higher during the winter to service greater demand and usually lower during summer when the weather is finer and has less of an impact on the market.

 Winter vs summer contract pricing

As a result, winter risk premiums must be built into Q1 forward contracts to mitigate the risk of price increases due to seasonal weather. In the summer, however, lower prices thanks to more ideal generating conditions and lower energy demand result. This is linked to renewable energy, which has higher production levels during the summer months, for example, in Q3. It also doesn’t experience the negative issues of factors such as carbon pricing, making it a cheaper source of energy in the summer compared to coal or gas. Peak hours in Q1 tend to be in the mornings and evenings, when darker mornings and evenings increase demand for energy, making them more expensive times for energy purchasing.

Trading seasonal dislocations

Identifying overpriced winter risk is a crucial part of successful trading during seasonality risk. Winter premiums are often slapped onto energy prices, but sometimes these higher prices are unjustified. This may be the case when storage levels of summer-generated fuel is plentiful or if weather forecasts are milder than anticipated.

Traders should attempt to exploit misaligned seasonal spreads by identifying winter premiums that are too high or too low and trade on this premium. Forecasting using weather-related reporting can also help traders identify whether mispredicted prices have been applied, for example, if the winter is forecasted to be milder than wider, earlier predictions.

Winter contracts can sometimes be higher,and so consumers will lock in these prices in the event of a price hike, If an older winter actually occurs, traders can hedge against seasonal exposure to exploit profit.