EBF 301
Global Finance for the Earth, Energy, and Materials Industries

Summary and Final Tasks

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Key Learning Points: Lesson 12

  • Since electricity cannot be stored in large volumes at a reasonable cost, supply and demand has to balance at every moment.
  • Unlike transportation cost in the oil and gas market, electricity transmission cost is highly volatile.
  • Prior to the process of electricity restructuring, the primary players in the electric power business in the United States were vertically integrated utilities and their state regulators.
  • Regional Transmission Organizations (RTOs) have responsibility for ensuring reliability and adequacy of the power grid.
  • Under the uniform price auction, generators submit supply offers to the RTO, and the RTO chooses the lowest-cost supply offers until supply is equal to the RTO’s demand.
  • Locational Marginal Price (LMP) at some node k in the network is the marginal cost to the RTO of delivering an additional unit of energy to node k.
  • We generally define two dimensions of risk in electricity markets: temporal risk and locational or "basis" risk.
  • Temporal risk pertains to volatility in the LMP at a specific location over time.
  • Locational or "basis" risk pertains to volatility in the LMP across space (between two or more locations)
  • Two of the most common ways of exercising arbitrage in electricity markets are through:
    • "virtual bidding“: arbitraging the difference between the clearing price in the day-ahead and real-time electricity market
    • "spark spread“: the difference between fuel and electricity prices
  • Locational and temporal risk in electricity markets can be hedged through:
    • Financial Transmission Rights (FTR): financial instruments that entitle the holder to the difference between LMPs at two defined locations
    • Contracts for Differences (CFD): a bilateral agreement in which one party gets a fixed price for electric energy (the strike price) plus an adjustment to cover the difference between the strike price and the spot price.
  • A combination of CFDs and FTRs can be used to create a "perfect hedge" that shifts all temporal and locational risk.

Reminder - Complete all of the Lesson 12 tasks!

You have reached the end of Lesson 12. Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there before beginning the next lesson.