Abstract
Financial Transmission Rights (FTRs) are financial derivatives in wholesale electricity markets that are sold in auctions. The revenue collected from FTR auctions is passed through to electricity customers to reimburse them for transmission congestion payments they make in the spot energy market. On average, electricity customers’ congestion payments greatly exceed auction reimbursements in electricity markets across the United States. We study the issue of auction revenue deficiency through the lens of Auction Revenue Rights (ARRs), which is the predominant mechanism used in U.S. electricity markets to distribute auction revenue to electricity customers. We demonstrate how the ARR process influences fundamental supply conditions in the FTR auction market and show how divergent auction equilibria emerge under different ARR decision-making regimes. Using market data from PJM, we find empirical evidence that variation in ARR management strategies helps explain differences between an FTR’s auction price and its realized ex post value.
Highlights
Since the passage of FERC Order 888 in 1996, competitive electricity markets have expanded in the United States to serve roughly two-thirds of electricity consumers in the country
Given that the choices made by load-serving entities (LSEs) in the Auction Revenue Rights (ARRs) process determine fundamental supply conditions in the Financial Transmission Rights (FTRs) auction market, we develop a conceptual framework that describes how different auction equilibria emerge under different ARR decision-making regimes
The average level of Hedging Pressure on an ARR allocation is less than 50% of the average level of Path Capacity, which is consistent with the right frame in Figure 6 of our conceptual model where the supply shift from the ARR management decision overwhelms buyers’ desire to hedge, resulting in an equilibrium auction price below the expected value of the FTR
Summary
Since the passage of FERC Order 888 in 1996, competitive electricity markets have expanded in the United States to serve roughly two-thirds of electricity consumers in the country. The Order encouraged open access to transmission facilities, the divestiture of vertically integrated utilities, and the creation of Independent System Operators to administer competitive markets. A key feature of competitive electricity markets is a location-based pricing system. Location-based pricing implies location-specific price risk due to potential network congestion that can cause price differences across nodes. The presence of uncertain network congestion inspired the creation of a financial product to hedge locational price differences (Hogan, 1992). In U.S electricity markets, this financial product is called a Financial Transmission Right (FTR). These financial products are used by market participants to manage exposure to the risk of price differences between two locations on a transmission network
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