Pricing of electricity futures based on locational price differences: The case of Finland

Highlights: • The market for Finnish electricity futures has been inefficient based on the most recent data. • Demand and supply side fundamentals have a role to play in the pricing. • Russian exports restrictions have had a strong effect on the Finnish electricity market pricing. • There has been a significant positive excess futures premium in the Finnish market. • Financial market participants should have been able to utilize this also in economic terms. - Abstract: We find that the pricing of Finnish electricity market futures has been inefficient during the latest 10 years, when the trading volumes of Electricity Price Area Differentials (EPADs) have more than doubled. Even though the calculated futures premium on EPADs is related to some risk measures and the variables capturing the demand and supply conditions in the spot electricity markets, there has been a significant positive excess futures premium in the Finnish market, and financial market participants should have been able to utilize this also in economic terms. This finding is new and relevant for the participants of the Nordic electricity markets also in the future, because both the speculative and hedging-based trading is increasing in the Nordic markets.