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Do Day-Ahead Electricity Prices Reflect Economic Fundamentals? Evidence from the California ISO

This paper hypothesizes that if day-ahead markets for electricity are efficient, then the day-ahead prices will reflect the processed information and expectations of all market participants regarding the next day's electricity load and thus the prices may be useful in actually predicting the next day's load. We test this hypothesis using data for the PG&E aggregation area in the California ISO. The results provide evidence of a positive and significant relationship between the hourly day-ahead electricity price (relative to the natural gas price) and the subsequent actual hourly load. The reported relationship is sufficiently robust to produce a forecast based on the day-ahead hourly price relative to the price of natural gas, some binary variables, and a number of estimated ARMA disturbances that is considerably more accurate than the ISO's day-ahead forecast. Keywords: Electricity markets, Electricity prices, Market efficiency, Load forecasting, Smart grid, California ISO

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JEL Codes: C53: Forecasting Models; Simulation Methods, Q41: Energy: Demand and Supply; Prices, Q48: Energy: Government Policy, C51: Model Construction and Estimation

DOI: 10.5547/01956574.35.3.6

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Published in Volume 35, Number 3 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.