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El. Market Design > Session 10 > Flashcards

Session 10 Flashcards

Cross-border Forward Markets

1
Q

What is hedging about?

A

It’s not about selling electricity, but about stabilizing cash-flow at the firm level

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2
Q

What’s proxy hedging?

A

Use another (but correlated) derivative to hedge an income stream.

e.g. a different commodity (gas instead of electricity) or a different delivery period/ geography

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3
Q

How to reduce the remaining basis risk?

A

Cross-border derivatives can reduce the remaining basis risk.

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4
Q

What are / aren’t Long-term transmission rights (LTTRs) and financial transmission rights (FTRs)?

A

What they are:
Financial derivatives on a locational spread.

What they aren’t:
not “transmission” rights, cause it’s not about transmitting electricity and not a right, as it can also be an obligation.

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5
Q

Simple definition of an FTR-obligation (financial transmission rights)

A

A financial contract on price difference

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6
Q

What’s the underlying of a (locational) spread future?

A

The spread between two zones, rather than a single zone’s spot price.

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7
Q

Formula for calculating the payment of a locational spread future

A

Payment = contract price - Σ(spot price A - spot price B)

contract price: forward
Σ(spot price A - spot price B): underlying

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8
Q

What’s an LTTR?

A

Derivatives issued by the TSOs, regardless of the type, regardless of the marketplace.

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9
Q

Four main problems ACER diagnoses LTTRs

A
  1. Poor liquidity and limited depth of many zonal forward markets with trading concentrated on the German zone.
  2. LTTRs not combine well with domestic forwards for hedging, because they are a) options, b) not continuously available, c) limited to one-year maturities
  3. Auction revenues regularly fall short of the payouts during settlement (underpricing).
  4. Impacts on forward markets if the German zone would be split (stumbling stone for a split).
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10
Q

ACER proposal to solve the four issues LTTRs have

A
  1. Establish a virtual hub
  2. Improving cross-border forward markets:
    - Replace non-firm products with fully financially firm derivatives
    - Increase maturities offered to three years, up from one year today
    - More frequent auctions, e.g. weekly or daily
    - A statistical approach to volumes, balancing 3 objectives: max volume, min revenue inadequacy, min underpricing
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11
Q

TSO’s role in issuing LTTR

A
  • TSOs often say they’re ‘just providing market access’
  • But: Issuing LTTRs will always impact forward markets (if volumes are non-marginal)
    -> this has an influence on forward premia, hence on forward prices (& spread futures & options)
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12
Q

Most fundamental economic questions on TSO-issued LTTRs (4)

A
  1. IF: Should TSOs provide LTTRs at all?
  2. WHY: What is the objective such a provision aims to achieve?
  3. WHAT: What type of derivative should be issued, options or futures?
  4. HOW MUCH: Which volume should, and can, be offered?
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13
Q

What implicates TSO’s are issuing LTTRs as a form of hedging congestion income?

A
  • Interconnectors are options
  • The fact TSOs issue non-firm options
  • BUT: TSOs are regulated entities and do not face uncertain income
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14
Q

What’s the objective for TSOs of LTTR provision, if not hedging?
+++ unsure if the answer is correct, if it’s not balancing the forward market through integration of imports&exports +++

A

Enabling market participants to hedge.
- There is demand for cross-border products from market parties who use foreign forward markets for hedging.
- TSOs are in a position to provide cross-border products, because congestion income provides a natural hedge.

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15
Q

Preconditions for a balanced forward market / a forward market in equilibrium

A
  • Only if all supply/demand entities engage in it
  • Then: forward price = expected spot price (no forward premium)

For an interconnected market:
- Imports and exports must be present in forward market
- Imports are supply
- Exports are demand

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16
Q

What if TSOs do not engage in the forward market?

A

No TSO engagement:
- Import-export volumes are missing on the forward market
- This leads to an imbalanced forward market

17
Q

What’s the effect/ advantage of forward markets with TSO volumes?

What’s the side benefit?

A
  • By issuing cross-border products, TSOs bring imports& exports to the forward market
  • Fundamental equilibrium is re-established
  • All fundamental demand& supply is present in forward markets

Side-benefit:
- Congestion income is (partly) hedged.

18
Q

Forward equilibrium… should TSOs provide cross-border products?

A

Yes!

Otherwise, the absence of import/export volumes from forward markets would distort forward prices.

19
Q

What volume of obligations should TSOs buy or sell?

A

Expected net imported energy.

20
Q

Which transactions does a ‘buy forward’ consist of?

A

Buy call, sell put option

21
Q

What does ‘time value’ mean?

A

The longer the time is (e.g. until strike day of option), the higher are the chances that things change.

22
Q

Parts of the value of an option

A
  1. Intrinsic value: Payout of the option if current underlying asset price were settlement price
  2. time value: Additional value representing the chance of the underlying price to go up
22
Q

What increases the value of an option?

A

Volatility of the underlying asset.
The more uncertainty, the more “extra” worth are options.

23
Q

Delta (regarding option pricing)

A

Delta measures how much an option’s price can be expected to move for every $1 change in the price of the underlying asset.

24
Q

What’s the cross-border correspondent of what domestically is a:
1. Physical forward
2. Financial option
3. Financial forward

A
  1. PTR (?)
  2. Spread option
  3. Spread future
25
Q

What do you require for a ‘perfect’ hedge on a foreign market?

A

Combining a freign forward with a spread future

26
Q

What’s needed to ‘perfectly’ hedge spot congestion income?

A

Selling a pair (a->b; b->a) of spread options will lead to settlement payouts identical to spot congestion income –> to a perfect hedge.

27
Q

What does “issuing a spread future” actually mean?

e.g.: Sell a A-B spread future

A

Trading on forward markets

e.g. sell a future in A and buy a future in B

28
Q

How to translate/ What actually is “Sell FR-DE spread future”?

A

Sell FR forward
Buy DE forward

29
Q

What did this session do to our view on TSOs?

A

They’re not neutral market parties. By trading/ engaging in forward markets (through spread & options), they’re taking a position on forward markets and influence the forward prices.

El. Market Design (11 decks)

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