financial transmission rights: design options
DESCRIPTION
Financial Transmission Rights: Design options. Presentation to Electricity Commission 2 September 2009. Background. Transpower was asked for advice on how to: Simplify and make 2002 FTR more appealing to participants Deal with Dr Read’s 2002 concerns Implement an FTR market. Background. - PowerPoint PPT PresentationTRANSCRIPT
For discussion purposes only
Financial Transmission Rights: Design options
Presentation to Electricity Commission
2 September 2009
© Transpower 2009
For discussion purposes only slide 2
Background
• Transpower was asked for advice on how to:
– Simplify and make 2002 FTR more appealing to participants
– Deal with Dr Read’s 2002 concerns
– Implement an FTR market
© Transpower 2009
For discussion purposes only slide 3
Background
• Transpower’s advice is a suggested starting point for discussion
• Pricing should reflect underlying physics
• FTRs are internally consistent with locational marginal pricing
• Regulatory arrangements are different to 2002
• FTR trading platform can be significantly simplified without affecting dispatch
• Start simple and evolve with users
© Transpower 2009
For discussion purposes only slide 4
What is the problem?
• Nodal prices are consistent with physical dispatch (i.e. they obey the laws of physics!)
• Locational price differences are caused by constraints in the transmission system NOT energy availability
• Commercial implications of transmission constraints:
– Bilateral contracts can only hedge energy costs
– Volatile and unpredictable locational price differences must be hedged separately
© Transpower 2009
For discussion purposes only slide 5
What is the problem?
• There is little ability to hedge locational price difference
• Incentive is to vertically integrate and regionalise generation and retail
• Consequences:
– At best a partial locational price hedge
– Barrier to retail competition
– Significant cost to consumers
– Inefficient use of transmission assets
© Transpower 2009
For discussion purposes only slide 6
What are the possible solutions?
• Remove locational price differences altogether
– Removes demand side response
• Use “rentals” to fund a hedge product
– The net amount that needs to be hedged is EXACTLY the rentals collected
– Preserves demand side “signals”
© Transpower 2009
For discussion purposes only slide 7
Report Structure
• Part 1 – what is an FTR? How do they fit into integrated market design?
• Part 2 – design options
• Part 3 – implementation options
© Transpower 2009
For discussion purposes only slide 8
Markets with locational marginal pricing
• A system for the efficient trading of electricity using supply and demand to set price
• Separate contestable and monopoly functions
• Characterised by “spot prices” that differ by location
• Wholesale market = competitive trading
• Retail market = customer choice
© Transpower 2009
For discussion purposes only slide 9
Integrated market design
Co-ordinated spot market
Bid-based, security-constrained,
economic dispatch with nodal prices
ENERGY PRICINGBilateral contracts at nodal
price differencesT
RA
NS
MIS
SIO
N P
RIC
ING
Non
-dis
tort
iona
ry a
cces
s ch
arge
s
NE
W IN
VE
ST
ME
NT
Market-driven
RISK MANAGEMENTHedge against locational price
differences
NE
W G
EN
ER
AT
ION
Location and timing
NE
W T
RA
NS
MIS
SIO
NLocation and tim
ing
DE
MA
ND
SID
E P
AR
TIC
IPA
TIO
NN
EW
TR
AN
SM
ISS
ION
Cen
tral
ly p
lann
ed,
regu
lato
ry p
roce
ss,
TP
M
TRANSMISSION CONGESTIONFTR, LRA, vertical integration
RISK MANAGEMENTHedge against locational price
differences
© Transpower 2009
For discussion purposes only slide 10
Physics – Kirchoff’s law
• This means that . . .– Every injection into and off-take from the grid effects electricity
flows on every circuit– Physical capacity rights cannot be meaningfully defined
• Which leads us to constraints and nodal prices . . .
© Transpower 2009
For discussion purposes only slide 11
Commercial risk
• Kirchhoff's law and the occurrence of constraints create commercial risk:– Actions of other parties can impact on nodal price– Constraints impact on nodal prices
• Two primary risk management tools– Bilateral energy contracts referenced against price at a node
(often internalised by vertical integration) – Hedge to manage locational price risk arising from constraints
© Transpower 2009
For discussion purposes only slide 12
Energy contract – example 1
GeneratorOffered at $2300 MW dispatched
Load300 MW
200 MW
100 MW
10
0 M
W
At limit
$2
$2
$2
Vertically integrated utility generates at A, commitment of 300 MW at $2 at B
Generation:
Cost to generate at A: -$600
Gets paid at A $600
Retail:
Buys 300MW from A -$600
Gets paid for 300MW at B: $600
© Transpower 2009
For discussion purposes only slide 13
Energy contract – example 2
• Third party load increases at BGenerator 1Offered at $2240 MW dispatched
Load 1300 MW
200 MW
160 MW
40
MW
Constrained
Generator 2Offered at $3120 MW dispatched
$2
$4
$3
Load 260 MW
• Line A – B constrained
• Price at B increases to $4
• Retailer can’t meet obligation of 300MW at its generation cost of $2 to load at B ($600)
• To meet obligation of 300MW at B retailer must purchase all 300MW at B for $4 ($1200)
• Additional cost to gentailer is equivalent to the rentals of the system ($600)
© Transpower 2009
For discussion purposes only slide 14
From an energy contract perspective
• The transmission price risk between A and B is the price difference B − A– Generation at A cannot offer an
energy contract referenced at B without taking the transmission price risk
– Load at B cannot accept an energy contract referenced at A without taking the transmission price risk
Generator 1Offered at $2240 MW dispatched
Load 1300 MW
200 MW
160 MW
40
MW
Constrained
Generator 2Offered at $3120 MW dispatched
$2
$4
$3
Load 260 MW
© Transpower 2009
For discussion purposes only slide 15
How can A or B manage the transmission price risk?
• Either A or B needs a financial product that recompenses the value (PriceB - PriceA)/MW.– Generation at A can then offer a fixed energy price at B, or – Load at B can accept a fixed energy price hedge referenced at A
• The only cash stream correlated with nodal price differences is the rentals
• FTRs use this correlation to hedge price differences
© Transpower 2009
For discussion purposes only slide 16
Energy price hedge values differ by location and over time
© Transpower 2002
Transmissionprice risk
Time
Price / MW h
$3
$1
$2
$4
$5
A
Nodal price at A
A
Nodal price at B
B
BEnergy price hedge value at A
Energy price hedge value at B
© Transpower 2009
For discussion purposes only slide 17
Features of FTRs – trading risk
• Can be matched to an energy contract of a specified capacity and duration between two nodes – near perfect hedge
• Holder receives the rentals between two specified points for an agreed capacity and duration
• Protect the holder against extreme price risks (constraints, scarcity pricing)
• Can be allocated explicitly and/or through an auction• Traded in secondary auctions or markets• Only known product that exploits correlation of rentals with
locational price differences
© Transpower 2009
For discussion purposes only slide 18
Features of FTRs – efficient investment
• Grid could operate with more constraints (more efficient)
• Signal the market value of constraints (FTR auction value)
• Provide an important economic signal to assist with the correct location and timing of new transmission investment
© Transpower 2009
For discussion purposes only slide 19
Rental flows without FTRs
Electricity market
Rentals allocation
mechanism (TPM)
Rentals
Those who pay for transmission
Allocation minimises impact on nodal prices
– not paid to energy purchasers
© Transpower 2009
For discussion purposes only slide 20
FTR market participants
Rentals
Residual revenue
Post allocation
mechanism
Electricity market participants
FTR Auction mechanism
FTR pre-allocation
mechanism (optional)
Auction revenue
Net revenue
Auctioned FTRs
FTR payments
Cas
h flo
ws
with
FT
Rs
FTR rentals + premiumFTR rentals
Rentals + premium
© Transpower 2009
For discussion purposes only slide 21
Design emphasis?
• Merchant new investment?– Network investment governed by Part F of EGRs– Merchant investment in connection assets possible (probable?)– Allocation of FTRs to investors not high priority in short term
• Locational hedging– Reduce reliance on physical hedging– Reduce barriers to new retail entry (increased competition)– Provide means to fully hedge against transmission congestion
• High degree of user influence on design• Start simple and build with experience and need• WHAT DOES THIS MEAN FOR DESIGN?
© Transpower 2009
For discussion purposes only slide 22
New Investment
• New investment – Merchant investment no longer the primary mechanism for
transmission upgrades– Allocation of FTRs to investors not high priority in short term
Pre-allocation of FTRs Pre-allocation to investors
No pre-allocation
2009 FTR recommendation
2002 FTR design
© Transpower 2009
For discussion purposes only slide 23
Coverage
• Node to node, hubs and nodes, hubs only• Market power?• Start simple
FTR coverage
2002 FTR design
High coverage, Complexity
Low coverage, Simplicity
2009 FTR recommendation
HVDC only 2 hubs
Large hubs
Small hubs Interconnected grid
Whole grid
© Transpower 2009
For discussion purposes only slide 24
Constraints only?
• Losses should be reasonably predictable• Constraints are not predictable• FTRs with losses are complicated and confusing
Losses and constraintsLosses and constraints
2002 FTR design
Constraints only
2009 FTR recommendation
© Transpower 2009
For discussion purposes only slide 25
Revenue adequacy
• Dependent on FTR grid design• Incorrect grid outage assumptions, unplanned outages,
emergencies
FTR Revenue Risk
2002 FTR design
To FTR market participants
To FTR market operator/grid
owner
2009 FTR recommendation
© Transpower 2009
For discussion purposes only slide 26
Revenue adequacy
• PJM, CAISO, MISO– FTR Credits are prorated proportionally
• Payments derated when revenue shortfall occurs• Excess rentals and auction revenue occurring over a month
are transferred to a balancing fund• At end of period balancing fund is used to clear unpaid FTRs
(pro rata)– NYISO
• Revenue shortfall is compensated for by imposing an uplift charge on transmission owners
• Attempts to link transmission maintenance standards with revenue adequacy
© Transpower 2009
For discussion purposes only slide 27
Revenue adequacy in PJM
© Transpower 2009
For discussion purposes only slide 28
FTR Duration
• Any duration required• Start low for accelerated learning• Change with market requirement
FTR duration2002 FTR design Long durationShort duration
2009 FTR recommendation
Hours Weeks Months Years Decades1 Month
© Transpower 2009
For discussion purposes only slide 29
Obligations or options?
• Obligation FTRs can become a cost (obligation FTRs are directional)
• Obligation FTRs still hedge price difference even when –ve• Option FTRs always cash positive BUT lower capacity and
computationally different
OptionsObligations or optionsObligations 2002 FTR design
2009 FTR recommendation
© Transpower 2009
For discussion purposes only slide 30
Post allocation of residual revenue
• Any allocation possible• Change results in value transfers• Simplest approach is to initially make no change
Pre-allocation of FTRs Pre-allocation to investors
No pre-allocation
2009 FTR recommendation
2002 FTR design
© Transpower 2009
For discussion purposes only slide 31
Implementation
• Transpower’s system is “up and running”• Can assist establishing an FTR market quickly if required• Transitional arrangements could see separation of systems from
Transpower