Now we can turn to the question of how locational and temporal risk can be hedged in electricity markets, and what the RTO does with the congestion revenue that it collects. In summary:
- Market participants can hedge locational price risk using Financial Transmission Rights, which are instruments that offset differences between LMPs at defined locations.
- The RTO uses this congestion revenue to pay the holders of Financial Transmission Rights.
- Financial Transmission Rights are auctioned off by the RTO, and the proceeds from the auction are paid to holders of "Auction Revenue Rights," which are typically transmission companies or electric utilities.
- Finally, market participants can hedge temporal price risk using Contracts for Differences. These financial instruments are not bought and sold through any RTO market, but involve bilateral agreements between individual market participants.