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.