Auctions mitigate transmission access and price risk
Energy Marketing Editor
Power market participants still shudder when they speak of “the great price spike” in the summer of 1998. Stoically, participants reminisce of heat waves, generating unit outages, transmission constrictions, breaches of contract-and price differentials in the thousands of dollars. Today in hindsight, there were valuable lessons learned from that wallop of spot daily and hourly prices, and one of them was the improved risk management of access and congestion charges; charges which, when unhedged, can climb to heights of $900/MWh and higher.
Yet only since 1999 have independent system operators (ISOs) begun to offer a much-needed cure for healing the pains of congestion fees through financial transmission rights (FTRs), and Transmission Congestion Contracts (TCCs). Working like a soothing ointment on the over-burdened and often gridlocked transmission systems, the auctioning of FTRs offers power generators, marketers and end-users welcome protection from serious financial danger and price uncertainty exposure by ensuring the cost of transmission and transmission access availability.
What FTRs do
For starters, locational pricing provides a method to distribute the use of the transmission grid, but does not, in fact, allot the right to use the grid without paying congestion fees to those that pay for the embedded cost of the grid itself.
So when there is transmission congestion, according to Scott Harvey, Managing Director of LECG/Navigant Consulting, Inc., four primary effects can occur. First, locational pricing will cause the ISO to collect congestion rents, the right to use the grid becomes very valuable, the price of transmission use can be very volatile, and actual re-dispatch costs remain unknown until generators provide bids for re-dispatch and transmission schedules are set. A risky set of occurrences, to be sure.
Generally speaking, there are several key reasons why market participants should consider utilizing FTRs/TCCs:
– FTRs create a financial hedge, which provides transmission users price certainty when delivering energy across an ISO-controlled grid;
– FTR auctions create a liquid market for transmission entitlements;
– Firm Transmission Rights provide for more than financial certainty, they can assure scheduling certainty;
– FTRs can offer firm transmission service without congestion costs;
– FTR auctions maximize trading efficiencies and flexibility, and allow for the possible reconfiguration of FTRs and FTR trading in secondary markets (bilateral contracts between participants), and
– FTRs provide a methodology to allocate congestion charges to those who pay the fixed cost of a transmission system.
Now more than ever, as the energy industry undergoes deregulation and restructuring, congestion management and transmission access are playing critical roles in the trading, transmission and risk management of power. Yet in the formation of FTR auctions, various systems have addressed crucial elements, like rules, regulations, auction structure, offerings, allocation of FTR revenues, alternative bidding approaches, options, auction frequency and Internet-enabled bidding, in a variety of methods.
Different models for different folks
Currently, there are several systems planning, implementing or offering TCC/FTR auctions, including the likes of NEPOOL, the California ISO, PJM Interconnection, the New York ISO, the Midwest ITC (a sub-set of Midwest ISO) and Desert STAR. And even though PJM, the Cal ISO and the N.Y. ISO began their auctions in last year, each ISO runs its auction differently, offers various financial and/or physical instruments and serves differing markets and market players.
In a juxtaposition of convoluted terminology, the California ISO (Cal ISO- www.caiso) offers an “FTR auction.” the New York ISO (www.nyiso.com) offers a “transmission congestion contract (TCC) auction,” New England regions refer to FTRs and TCCs as “Financial Congestion Rights (FCRs),” and PJM Interconnection (www.pjm.com) offers a “Fixed Transmission Rights auction.” Though some of the core concepts may be the same, the terminology differs by both region and ISO. International market experts claim that both New Zealand and Australia are currently considering FTR auctions on their reform agendas. One market insider claimed that two of his Australian clients, both merchant banks, recently lost a whopping $53 million in a single day due to congestion and prices sky-rocketing to over $5,000/MWh.
That said, let`s go ahead and compare the differing rules, models, participants, volumes, revenues and regulations for some of the auctions currently available in the U.S. markets.
The first PJM pioneers
Pioneering the industry`s FTR auction, Norristown, Pennsylvania-based PJM Inter- connection, L.L.C. (PJM) began its FTR auction in April of 1999. PJM offers fixed transmission rights-a financial entitlement product that is not tied to physical and is responsible for the operation and control of the bulk electric power system throughout major portions of five Mid-Atlantic States and the District of Columbia. Information on the PJM eFTR Web site includes auction-clearing prices, a list of all FTRs owned by market players and other public information.
“You`re going to see different players in our FTR auction. You`ll see some purely for speculation purposes, people who have no intention of transmitting energy,” said PJM Interconnection Market Implementation Strategist Linda Clarke, “We believe our method provides a deeper market … We offer FTRs anywhere we do locational marginal pricing, and not just along particular paths. That`s about 2,200 points. And we put 100 percent out in the market, so if there`s 200 megawatts available, we`ll put up all 200 megawatts.”
TCCs in the “Big Apple”
As for the “Big Apple,” the New York ISO offers an auction for the sale of transmission congestion contracts (TCCs). The N.Y. ISO`s first six-month “capability” auctions began in September of 1999, with a “summer” auction spanning May-October and a “winter” auction covering November-April. In May of 2000, according to Art Deselle, the N.Y. ISO manager of resource reliability, six-month to two-year contracts become available.
Deselle said that the New York ISO has a transmission service charge for each load-serving entity, usually in the $4-$9 per/MWh range. Much of the revenue generated in the auction, said Deselle, goes towards the system and the revenue is used to reduce the transmission fees that the load-serving entities pay.
“I think the revenues will increase through time. But until we get into the summer period, where the prices could be more volatile, my crystal ball is as good as yours,” said the N.Y. ISO manager.
When comparing the various FTR auction models, Navigant consultant Harvey is sold on the New York methodology: “I think the New York model is the future, where everything is available. In its formation now, NEPOOL is closely following the N.Y. approach. PJM was the first and it was modeled after FERC Order 888 on open transmission access, but since then New York has been able to learn a lot from PJM and make some changes.”
Now that we`ve taken a bite out the apple, let`s head out to the West Coast and see how California is running its FTR auction.
Surfin` the FTR wave in California
The California ISO, which handles 40 percent of the electricity volume within the Western Systems Coordinating Council (WSCC), began its FTR auction in November of 1999. Its secondary markets opened Dec. 13, 1999 and daily auctions began in February of this year. Three definitive FTR models are offered through Cal ISO: financial rights, physical rights, and a blend of physical and financial. Revenues from Cal ISO`s auction go directly toward transmission owners to offset the fixed costs of the transmission system and may lead to reduced consumer rates.
“The more FTRs we sell, the less the consumer has to pay for the fixed costs of the transmission system,” said the Cal ISO Director of Market Operations Ziad Alaywan. Of the “trickle down” effect of FTR revenues, Alaywan said, “Utilities and market participants should see about a $10 million to $15 million savings in the beginning of the year 2001, because access fees are assessed once a year. These are savings which they can then pass along to the end-user.”
Alaywan explained that the role of the ISO as the facilitator of its congestion management can best be summarized as follows:
– Continuous dissemination of relevant information;
– Minimal role in forward energy markets;
– Clear market rules and processes;
– Preservation of competitive markets;
– Scheduling coordinators empowered with maximum scheduling flexibility;
– Reliance on markets to value and alleviate congestion;
– Scheduling coordinators participate voluntarily in congestion management;
– All scheduling coordinators compete equally for transmission;
– Allocation of transmission to most cost-effective users;
– No forced trades (except as a last resort for reliability);
– Recognition and separation of scheduling coordinators portfolios;
– Minimum rescheduling to alleviate congestion; and
– Creation of market opportunity through payment for counter-flow schedules.
In other words, the Cal ISO facilitates its congestion management and FTR process while providing flexibility so that market participants can recognize, value and implement strategies to relieve congestion on the power grid system.
As for volumes, PJM`s May-September 1999 auction revenue hit $94,000 (megawatt total 8,700), and its July revenue alone topped $27,000 (July`s FTR market value, or value of FTR in real-time market, totaled $458,000). In Cal ISO`s first two-day auction (November 1999), over $41 million in FTRs were traded on 19 available paths, with a total of 9,689 megawatts sold. In N.Y. ISO`s September 1999 auction, 102 bids for TCCs (representing approximately 6,400 MW) were evaluated and 63 bids (about 2,900 MW) were awarded. The value of N.Y. ISO`s TCC auction (objective function) was about $4.6 million; the revenue from the auction topped $250,000.
“The trend is that more entities are entering the auction, and auction participants are analyzing their risk and realizing the use of more exotic and complex risk management strategies. In FTR auctions, we`re at the very beginning of the process and how they can apply it,” Harvey said.
Finding the value in FTRs
“The biggest factors in FTR auctions are limited experience and understanding of open access electricity markets and people have a hard time analyzing the value of FTRs. It`s like valuing an IPO without any prior historical information about a company`s performance. It`s tough, but the tools are there now and people are beginning to learn how to use them,” Harvey explained.
During his years of work with power market design and FTRs, Harvey has been able to assess some FTR valuation through the net returns to FTR buyers at PJM. By calculating both on-peak and off-peak positive and negative net returns, he concluded that in May 1999 a total of $29,358 was realized, in September $577,864, and in October over $747,140 was awarded. He also noted that September and October were extremely congested months, where September saw more hours of congestion in 1999 than those in both September and October of 1996, 1997 and 1998 combined.
With such a growing need, Cal ISO`s Alaywan holds a positive outlook for the future growth of FTR auctions: “The product is going to be more valuable in the future, and load growth is high. I think people will be looking for more price certainty, the volume of bids will increase and the price of FTRs will go up.” Harvey concurs with Alaywan`s cheery assessment of FTR market growth, saying he expects that “in the long run, they will go for a premium. Like insurance, we pay more than we get back because we want to hedge the risk. In insurance, we pay in $1 to get 90 cents, but in FTR auctions they`re paying $1 and getting $1.20 back, so to speak.”
Now that there`s a ready remedy from getting blindsided by congestion fees, companies who find themselves at risk from unhedged transmission pricing charges need to consider utilizing the new financial tools of FTR auctions. n
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