An analysis of the relationship between electricity and natural-gas futures prices

This article analyzes the relationship between electricity futures prices and natural-gas futures prices. We find that the daily settlement prices of New York Mercantile Exchange's (NYMEX's) California-Oregon Border (COB) and Palo Verde (PV) electricity futures contracts are cointegrated with the prices of its natural-gas futures contract. The coefficient of natural-gas futures prices in our model of COB electricity futures prices is not significantly different from the coefficient of gas prices in our model of PV electricity although there are differences in the production of electricity in these two service areas. The coefficients in our model do reflect differences in the consumption of electricity in the COB and PV service areas, however. Our trading-rule simulations indicate that the statistically significant mean reversion found in the relationship between electricity and natural-gas futures prices also is economically significant in both in-sample and out-of-sample tests. (C) 2002 John Wiley & Sons, Inc.