Abstract
In vein with the new energy market rules drafted in the EU this paper presents and discusses two contract types for hedging the risks connected to long-term transmission rights, the financial transmission right (FTR) and the electricity price area differentials (EPAD) that are used in the Nordic electricity markets. The possibility to replicate the FTR contracts with a combination of EPAD contracts is presented and discussed. Based on historical evidence and empirical analysis of ten Nordic interconnectors and twenty bidding areas, we investigate the pricing accuracy of the replicated FTR contracts by quantifying ex-post forward risk premia. The results show that the majority of the studied FTR contain a negative risk premium, especially the monthly and the quarterly contracts. Reverse flow (unnatural) pricing was identified for two interconnectors. From a theoretical policy point of view the results imply that it may be possible to continue with the EPAD-based system by using EPAD Combos in the Nordic countries, even if FTR contracts would prevail elsewhere in the EU. In practice the pricing of bi-directional EPAD contracts is more complex and may not always be very efficient. The efficiency of the EPAD market structure should be discussed from various points of view before accepting their status quo as a replacement for FTRs in the Nordic electricity markets.
Highlights
New electricity market rules, commonly called “network codes” are being drafted for the EU.The target is to create a framework that allows meeting the set 20-20-20 climate and energy targets and more recently building a basis for the “Energy Union”
Among others, the Nordic electricity market participants need efficient hedging mechanisms to manage the price risks that occur in transmission between price areas
In light of the accepted European network code on forward capacity allocation (FCA), this paper has presented the structure and characteristics of two types of long-term transmission right contracts
Summary
Commonly called “network codes” are being drafted for the EU. The recently approved EU network code on forward capacity allocation (FCA) expects that a standard and securitized contract type called “financial transmission right” (FTR), will be used as the main vehicle on the markets for securing the distribution of long-term transmission capacity in Europe This being the case one needs to observe that the Nordic electricity market has, since the year 2000, had its own standard securitized contract vehicle in use for the purpose of hedging bidding area price differences, the “electricity area price differential” (EPAD). With the FTR system, transmission system operator (TSO) as the auctioneer redistributes the bottleneck income to FTR holders as a compensation for the area price difference This means that challenges, such as revenue adequacy [8], financial regulation, and/or firmness risk [9] appear, and must be faced by the TSOs. Aside from the market participants’ point of view, the bottleneck income issue connected to using EPAD Combos and FTR contracts is theoretically similar. Before presenting the structure of the three LTR vehicles, we take a look at the previous literature on the subject matter
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