13 November 2008

Representative Fuel Oil Reference Price

Energy Market Authority uses the 3-month forward price of fuel oil to dampen the effects of volatility on the electricity tariff.

A forward price is strongly correlated to the spot price on the fixing day.  So when determining the average forward price, as many fixing days as practical should be used to smoothen out price volatility.

Why then does EMA fix the forward price of fuel oil for, say, January to March 2009 based on the average forward prices in October only.  Forward prices in October may not necessarily be representative of forward prices in November or December.

Perhaps, EMA should base the forward price for January to March 2009 on the average forward prices from October to mid-December.  Or better still, use rolling 3-month periods such as mid-September to mid-December or September to November, so that over four consecutive calendar quarters, every market day in a year is used for fixing.

We may not necessarily get lower tariffs by doing so, but we will avoid being hit by exceptionally high prices if these should occur in January, April, July or October.

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