Market price volatility is one of the main drivers of the price for fixed and flexible price supply contracts and energy trading. Therefore, volatility should be a key input for financial and risk management decisions of energy buyers and energy traders. With the right information and resources, historical volatility is relatively easy to calculate; Energy Solutions believes that there is real value in publishing a transparent and objective energy volatility index.
For Facilities / Procurement Managers
As well as being useful for those actively trading energy, EVI is also helpful for facilities/procurement managers. With suppliers commonly offering contracts up to 12 months ahead of the start date, there are more than 200 working days on an agreement could be signed. However, which day is best? Without being able to see into the future, that is impossible to know, but there are some things we can do to help. If the markets are highly volatile, suppliers are taking a more significant risk offering a fixed price, and so charge a considerable risk premium. If markets appear stable, then the perceived threat is reduced, and so the risk premium is smaller.
How can a facilities manager who doesn’t have access to the live wholesale market, or daily pricing data measure the volatility on a day and compare it to the previous weeks and months?
EVI gives all of this information at a glance, allowing you to see how the markets have been behaving recently and in the longer term.
The Graphs – EVI-e and EVI-g
The blue lines are the wholesale price for day-ahead markets, in pence per therm for gas and £ per MWh for electricity.
The red lines are the Energy Volatility Index. EVI-e for Electricity and EVI-g for Gas. Volatility is measured as a percentage.
Historical volatility is a statistical measurement of the actual price variations of a specified contract over a specified period. At present, the indicator is only backwards looking; it is based on an analysis of historical price behaviour. The Energy Volatility Index indicates the fluctuations of the day ahead prices through time. Separate indices are produced for power (EVI-e) and gas (EVI-g).
Data set selection
Our volatility indices are based on the opening prices. The Day Ahead prices are used to calculate the index. Given the various uses for volatility tracking by utilities, generators, commodity traders and investment funds, we developed the annual volatility index based on the prices of the last 12 months. Alternative indices may appear in the future.
To be able to calculate volatility, a consistent measure of price fluctuations or price returns is required. The index uses a log return measure to calculate price fluctuations. Using logs has several advantages over looking at simple percentage changes. For example, if prices increase by 50% (e.g. from 40 to 60) and then declines by 50% (from 60 to 30), you’re not back where you started. If you calculate your average percentage return (in this case, 0%), that’s not a particularly useful summary of the fact that you ended up 25% below where you started. By contrast, if the price goes up in logarithmic terms by 0.5, and then falls in logarithmic terms by 0.5, you are exactly back where you started. The advantage of using a log return measure is that it normalises price changes, so they are independent of the absolute level of the market price. This means relative price movements when prices are high can be consistently compared with relative movements when prices are low.
- Calculate the natural log of the current stock price to yesterday’s wholesale price. This is the continuously compounded return.
- Calculate the average return over a moving time window of 10 days. A value of n = 10
- Calculate the standard deviation of the returns over the moving time window.
- Annualise the daily standard deviation by multiplying by the square root of the number of days in a year. The average number of trading days in a year is 252.
Energy Solutions provides high-quality information on the website. Daily checks assure the quality of the published information; however, we are dependent on the price data quality provided. The time stamp shows the last update of the indices. The volatility indices are updated at 11 am every day to ensure that the most recent prices are available.
Please contact us for further information.