Financial transmission rights: Valuation and auction structure
Abstract
The acceptance of the nodal pricing system as a mechanism to organize wholesale power markets has exposed both generators and consumers to unprecedented volatile prices. Most of the volatility follows from the method for valuing congestion on the network. Generators and wholesale consumers pay or collect a charge depending on whether their actions cause or relieve congested bottlenecks on the grid. The charges vary according to the location of the injection (source-node) or withdrawal (sink-node) relative to the overall grid topography. Following Hogan (1992), a hedging contract called Financial Transmission Right (FTR) Obligation was introduced in most wholesale power markets. A FTR Obligation, designated in Megawatts, is defined by a source node and sink node. The holder of the contract is entitled (obligated) to a stream of cash flows that exactly offsets the volatile congestion charges. They are initially sold in an auction. This thesis advances the understanding of the market for FTR Obligations. Two specific areas are addressed. Firstly, the format of the auction for initial sale of FTR Obligations is examined for possible inefficiencies. One such inefficiency – that the multi-round format creates an opportunity for acquiring a zero-payoff portfolio for net negative cost – is described. Secondly, this dissertation develops a method for consistently comparing the value of different source-sink node FTR Obligations. 1. Auction Structure and Implications for Bidding Strategy. Congestion charges across the network are jointly determined. Among a subset of FTR Obligations, the relationship assumes a simple form. The thesis demonstrates that the dependency together with a particular auction format creates a profitable opportunity. Examination of the annual auction conducted by PJM Interconnection reveals that investors benefit from this opportunity through systematic bidding beyond first round. 2. Valuing FTR Obligations. FTR Obligations are essentially non-hedgeable contracts. Owing to the joint determination of congestion charges, the values of FTR Obligations exhibit a structure. This thesis capitalizes on the dependence structure to relatively value FTR Obligations. By suitably depicting the common sources of uncertainty, the dissertation derives the parameters of individual contracts’ payoff distributions thus facilitating a consistent comparison among different source-sink FTR Obligations.
Degree
Ph.D.
Advisors
Preckel, Purdue University.
Subject Area
Finance|Electrical engineering|Industrial engineering
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