PRESENTATION ON FINANCIAL MARKETS

,ELECTRICITY DERIVATIVES AND POWER

EXCHANGES
In this presentation

Introduction to Indian Power Market

Product Portfolio

Trading Mechanism

Market snapshot
Participation Volume Price

Trade @ IEX
Installed Capacity of India (Figures in GW)
State Private Central All India
105 164.4 86.5 356 356.1
100% 344
29.5% 46.2% 24.3% 326.85
298 69 77.64
57.26
268 39
243 32 44.48 44.77 45.4
223 29
43
6.78 6.78
200 41 6 6.78 25.57
28 26.17 26.02
41 6 26
24
39 5 24
39 5 23
132.21 21
7.76 5
20
34.65 197.17 200.7
3.9 185.17 192
14.89 165
130 145
112
71

10th Plan 11th Plan FY 13 FY 14 FY 15 FY 16 FY 17 FY 18 FY 19

Coal Gas & Diesel Nuclear
Hydro RES Total
Power Supply situation in the Country

Installed Capacity Energy Available

Peak Met
Year (at the end of FY) (Excluding RE Gen.)
(MW) ( MW ) (MU)
2011-12 1,99,877 1,16,191 8,57,886
2012-13 2,23,344 1,23,294 9,11,209
2013-14 2,43,029 1,29,815 9,59,829
2014-15 2,67,367 1,41,160 10,30,785
2015-16 2,98,060 1,48,463 10,90,713
2016-17 3,26,848 1,56,934 11,35,332
2017-18 3,44,002 1,64,066 12,01,528
2018-19 3,56,100 1,77,022 12,44,758
• During the last 8 years, capacity has increased at a CAGR of 8.7 % i.e. from 199 GW to
356 GW in FY 19, peak demand met increased at a CAGR of only 5%

Installed capacity has grown at a faster pace compared to demand

Source: CEA 1
Indian Power Market Development trend

Spot trading
OTC on Exchanges
Markets
Multi
Buyer/Seller

Single
buyer/seller

Improved liquidity and Efficiency

 Growing share of Short-term market
FY 2009 FY 2019*

Long Term
PPA for over 25 years through long term 93.86% 88.3%

Short-Term 6.1% 11.7%

Exchanges 0.4% 4.0%

Through traders 3.2% 4.1%

Direct Bilateral 0.5% 1.5%

Unscheduled Interchange 2.1% 2.0%

Source: Percentage as per CERC Report on Short Term Power Market (Till March‘19)
 7

IEX Market Segments

Day-Ahead • Delivery for next day

Market • Price discovery: Closed , Double-sided Auction
since June,08

Intraday Market & Day- • Intraday: For Delivery within the same day
Ahead Contingency • Day Ahead Contingency: Another window for next day
Round the clock since Jul’15 • Gate closure : 2.5 hours

Term-Ahead Contracts • For delivery up to 11 days

since Sep,09 • Daily Contracts, Weekly Contracts

Renewable Energy • Green Attributes as Certificates

Certificates • Sellers : RE generators not under feed in tariffs
since Feb,11 • Buyers: Obligated entities; 1MWh equivalent to 1 REC

Energy Saving Certificates • 1 Ecert= 1 Mtoe( Metric Tonne Oil Equivalent)

since 27 Sep’17 • Trading Session on every Tuesday of the Week
• Trading time 1300 hrs to 1500 hrs
Auction Continuous
 8

Company Snapshot

97.5% Market Share 5500+ MW average daily trade

6000+ Participants
4100+ Industries 70+ Commercial 50+ Discoms
500+ Conventional Generators 1500+ RE Participants

Transparency Liquidity

Market Share-FY 19 (DAM+TAM)

Competition
Average Daily Trade- FY19(DAM)
Participation-as on 30 May’19
What benefits does the power exchange provide?

Nation-wide
voluntary
access

Delivery Based
E-trading
contracts

No
Robust Platform counterparty
risk
 Da y
ekl
y il W
e

Intra
Day REC

A n ge

D
D nt i

AM
Co y
nc

Product Portfolio
Product Segments

Day Ahead Trade for the following day

Market (DAM)
Contracts for every 15 min, closed auction

Term Ahead
Market (TAM) From 3 Hrs ahead to •Intraday
11 days in advance •Day Ahead Contingency
Renewable 4 types of •Daily
Energy contracts •Weekly
Certificates
(RECs)
Trade green attributes of electricity

1 REC = 1 MWh of green energy

 Contract Characteristics
TERM AHEAD MARKET

Contract
Day Ahead Intraday Day Ahead Daily Weekly
Characteristi
Market Contracts Contingency Contracts Contracts
c

0400-2400 Hrs From 2nd day to

Delivery Next day For next day For next week
same day next 8 days

Continuous Continuous Continuous

Auction Type Closed Auction Open Auction
trading trading trading

Block of Hours Block of Hours

Contracts 15 min Hourly Hourly
(Fixed) (Fixed)

Trade All Days; All Days; Wed & Thur, Fri;

All Days All days
Availability 1500-2300 1200-1500 1200-1600

Financial Pay-In- D-1; Pay Pay in: T+1 Pay in: T+1 Pay-In- D-1; Pay Pay-In- D-1; Pay
Settlement Out – D+1 Pay out: T+1 Pay out: T+2 Out – D+1 Out – D+1

T = Trade D = Delivery
DAM and TAM Trading Timeline
Trading Mechanism
Features of Day Ahead Market

A closed double-sided anonymous auction for

each 15-min time block for the following day
N1
N3
The intersection between the aggregated sale
and purchase curves defines the market clearing N2 N2
A2

price (MCP) A1
E1
W1
W3

13 Bid area defined W2

E2

Congestion Management through market S1

splitting and determining Area Clearing Price

(ACP) specific to an area S3 S2
Bid types: Portfolio Orders or Block Orders S2

Minimum bid=Re.1 for 0.1MWh

13 Bid Areas
Minimum Price & Volume Step = 0.1p * 0.1
MWh
Understanding exchange mechanism

Bidding
and
Matching

Risk
Management

Congestion
Management
Treatment
of losses
and charges
DAM trading process

Review corridor
Bidding Matching and funds Result Confirmation Scheduling
availability

10:00 am to 12:00 pm to 1:00 pm to 3:00 pm 5:30 pm 6:00 pm

12:00 pm 1:00 pm 2:00 pm

Bids for MCP Corridor Final ACV and Collective Final Schedule
15- min &MCV availability ACP transaction sent to RLDC
each or calculated and funds calculated. confirmation for
block bids verified Market by NLDC incorporation
can be splitting if
placed congestion
Bid Types

• Bids for each 15 min • Relational Block Bid

can be entered for any 15 min
• Varying price and • Mother or child bid
quantum pairs • No circular links
• Allow partial execution • No partial execution

Single/Portfolio
Block Bid
Bid
Matching: Model Price Calculation algorithm
(Example for a sample 15-min)
Price Tick 0 1 1.1 2 2.1 2.5 3 3.1 3.5 3.8 4 4.1 5 7 9 12 14 17 19 20
Portfolio A 20 20 20 20 20 20 20 10 7 4 0 0 0 0 0 0 0 0 0 0
Portfolio B 60 60 60 60 50 40 40 40 40 40 40 40 20 20 20 20 20 20 20 20
Portfolio C 70 70 70 70 70 60 50 50 50 50 50 50 50 10 10 10 10 10 10 10

Portfolio D 40 20 0 0 -40 -60 -80 -81 -85 -100 -120 -120 -120 -120 -120 -120 -120 -120 -120 -120
Portfolio E 0 0 0 0 0 -40 -50 -50 -50 -50 -60 -60 -90 -90 -90 -90 -90 -90 -90 -90
Portfolio F 0 0 0 0 0 -20 -20 -20 -20 -20 -20 -30 -40 -40 -40 -40 -40 -40 -40 -40

Total Buy, MW 190 170 150 150 140 120 110 100 97 94 90 90 70 30 30 30 30 30 30 30

Total Sell, MW 0 0 0 0 -40 -120 -150 -151 -155 -170 -200 -210 -250 -250 -250 -250 -250 -250 -250 -250

Net Transaction,
MW 190 170 150 150 100 0 -40 -51 -58 -76 -110 -120 -180 -220 -220 -220 -220 -220 -220 -220

20
Demand (Buy) Supply (Sell)
18
16
14
12
10
8
6
4
MCP: Rs 2.5 2

0
0 50 100 150 200 250 300
MCV: 120 MW
Congestion Management

SR WR

S3
S1
Deficit
50
50
150
30
40
B2
B3
S2
B1
MW
MW
MW
MW
507500
MW
Surplus
S1
B1
S2
S3
80 MW
120
100 MW
RS
100 MW
RS
RS 8000
RS 9000
7000
8500
8500 100
RS 9500
RS 6000
8000
5500
MW

B2 Required
S3 160 MW Flow
Rs 9/u S2
50 MW 100 MW
Rs 7.5/u 100 MW
Rs 5.5/u
B1
S1 50 MW S2
50 MW RS 8.5/u 20 MW
Rs 8/u Rs 8/u
S2 S1 B1
B3
40 MW 80 MW 100 MW
30 MW
Rs 8.5/u Rs 9.5 Rs 6/u
Rs 7/u
Congestion Management

SR WR

Deficit Surplus
100
20 MW
MW 100
20 MW
MW
Lowest Buyers getting rejected
Highest Seller getting rejected
B2
Allowed
160 MW
S3 RS 9000 Flow S2
50 MW 20 MW 100 MW
RS 7500 B1 RS 5500
S1 50 MW S2
50 MW RS 8500 20 MW
RS 8000 RS 8000
S2 S1 B1
B3
40 MW 80 MW 100 MW
30 MW
RS 8500 RS 9500 RS 6000
RS 7000
Term Ahead Market
22
TAM Market Segments

Weekly Daily
Trade power for an entire week
Trade power for an entire day
(on Wed & Thur, Fri 12 – 1600 (delivery starts after 2 days
hrs) from trade day till T+9)
Open Auction Continuous

DA Contingency Intraday
Trade power for an Trade power for same
entire day on hourly day on hourly basis
basis,1 Continuous
day ahead Continuous

23
Types of Contracts

 Weekly and Daily

– FBA -- Firm Base – 24 Hrs
– FNT -- Firm Night – 8 Hrs (0-7 & 23-24)
– FDY -- Firm Day – 11Hrs (7-18)
– FPK -- Firm Peak – 5 Hrs (18-23)

 Day Ahead Contingency and Intra-Day

– Hourly (DAC-24 hrs & Intraday-04-24)

Region Specific Contracts

24
Trading of Intra-day Contracts
Trading Hour
Trading Hours:20
(00:30-20:30)
0:30- 1:30- 2:30- 3:30- 4:30- 5:30- 6:30- 7:30- 8:30- 9:30- 10:30- 11:30- 12:30- 13:30- 14:30- 15:30-
1:30 2:30 3:30 4:30 5:30 6:30 7:30 8:30 9:30 10:30 11:30 12:30 13:30 14:30 15:30 16:30

16-:30- 17:30- 18:30- 19:30-

17:30 18:30 19:30 20:30

Delivery
Hours:20
(04-24)

4-5 5-6 6-7 7-8 8-9 9-10 10-11 11-12 12-13 13-14 14-15 15-16 16-17 17-18 18-19 19-20

20-21 21-22 22-23 23-24

Contracts available for delivery on the same day

25
Intra-day & DAC contracts with current trading
system
Trading Date Trading Time Intra-Day contracts Trading Time DAC contracts
17-04-2019 00:30- 01:30 H5 to 24 (of 17-04)
17-04-2019 01:30 – 02:30 H6 to 24 (of 17-04)
17-04-2019 02:30 – 03:30 H7 to 24 (of 17-04)
17-04-2019 03:30 – 04:30 H8 to 24 (of 17-04)
17-04-2019 04:30 – 05:30 H9 to 24 (of 17-04)
17-04-2019 05:30 – 06:30 H10 to 24 (of 17-04)
17-04-2019 06:30 – 07:30 H11 to 24 (of 17-04)
17-04-2019 07:30 – 08:30 H12 to 24 (of 17-04)
17-04-2019 08:30 – 09:30 H13 to 24 (of 17-04)
17-04-2019 09:30 – 10:30 H14 to 24 (of 17-04)
17-04-2019 10 :30- 11:30 H15 to 24 (of 17-04)
17-04-2019 11:30 – 12:30 H16 to 24 (of 17-04)
17-04-2019 12 :30- 13:30 H17 to 24 (of 17-04)
17-04-2019 13 :30- 14:30 H18 to 24 (of 17-04)
17-04-2019 14 :30- 15:30 H19 to 24 (of 17-04) 15:00 to 21:30 (of 17-04) H1 (of 18-04)
17-04-2019 15 :30- 16:30 H20 to 24 (of 17-04) 15:00 to 22:30 (of 17-04) H2 (of 18-04)
17-04-2019 16 :30- 17:30 H21 to 24 (of 17-04) 15:00 to 23:00 (of 17-04) H3 to 24 (of 18-04)
17-04-2019 17 :30- 18:30 H22 to 24 (of 17-04)
17-04-2019 18 :30- 19:30 H23 to 24 (of 17-04)
17-04-2019 19 :30- 20:30 H24 to 24 (of 17-04)
Market Place Functionality (TAM)

27
BID MATCHING

Open/Closed Continuous
Auction Trading
Orders accumulated during
call phase (no matching) Price-time priority based
continuous matching

Orders matched after call

period
The highest Buy order &
lowest Sell order gets the
Orders are used for priority
calculation common price
i.e. Equilibrium Price.
If the prices are same then
All successful orders priority is given to the time
matched at Equilibrium of the order received.
Price.
 TWS Screen
CONTINUOUS
Pending Buy Order TRADING PROCESS
Pending Sell Order
Buy 10 MW @ Rs 4500/MWh Sell 15 MW @ RS 5500/MWh

Trading Engine
Buy 10 MW @ RS 4500/MWh Sell 15 MW @ RS 5500/MWh

Buy 10 MW @ Rs 4500/MWh Sell 15 MW @ Rs 5500/MWh

 TWS Screen
Pending Buy Order Pending Sell Order
Buy
Buy1010MW
MW@ RS
@5000/MWh
4500 Sell 15 MW @ Rs 5500/MWh

Buy 10 MW @ RS 4500/MWh

Trading Engine
Buy 10 MW @ RS 5000/MWh

Buy 10 MW @ 5000/MWh
 TWS Screen
Pending Buy Order Pending Sell Order
Buy
Buy1010MW
MW@ RS
@4500/MWH
5000 Sell
Sell515
MWMW
@ Rs@
5000/MWh
5500
Buy 10 MW @ 4500

Trading Engine
Sell 15 MW @ Rs 5000/MWh

Trade 10 MW @ RS 5000/MWh
Bid Modified

Sell
Sell1515
MWMWh
@ RS 5000/MWh
@ 5500
Timelines for payment of Charges: DAM/TAM

• Application Fees is paid in advance = T

• NLDC Scheduling & Operational Charges is paid on T+1
NLDC • Transmission Charges CTU is paid on T+1
Charges

• SLDC Scheduling & Operational Charges is paid on T+1

• Transmission Charges STU is paid on T+1
SLDC
• Area Transmission Charges (ATU) is paid on T+1
Charges • Area Load Dispatch Centre (ALDC) is paid on T+1

• Application Fees/PoC/SLDC/RLDC charges is paid on Within 3 working days of

Acceptance
RLDC
Charges

T = Trade Date
In this Presentation…..
• Volatility in Electricity Markets
• Risk Management
• Forwards, Futures and Options
• Credit Risk
• Example: NordPool
• Example: PJM USA
• Example – The APX Power UK
Risk Management
 By providing an opportunity for participants to
manage their financial risks (as associated with power
prices).
 Investors accustomed to hedging out significant
portions of their risks will feel more comfortable
investing in infrastructure.
 Project financing may be cheaper if revenue
uncertainty is reduced.
 Customers faces increased financial certainty
Volatility in Electricity Markets
Short-term electricity prices are highly volatile due to:
• Electricity is not (economically) storable in big
volumes (pumping storage, batteries have
limited capacity)
• System must be balanced second to second
• Very low load-price elasticity on real-time
• Complex for demand to modify load on real-time
 Volatility in Electricity Markets
$/MWH Offer Curve D
90
80 Load curve changes because: daily patters (non
storable), weekly patterns, seasonal patters,
70 economy evolution

60
50 P
c
40
30 Offers curve changes because: water availability, fuel
prices, units availability, fuel availability,
20
10 MW

0 0 5000 10000 15000 20000 25000 30000 35000 40000 45000

What is needed to accomplish these goals?
• An understanding of market risk management
• Appropriate tools with which to hedge the
undesired financial risk
• The ability to understand and manage the credit
risk that arises from the use of financial
products to mitigate price risk.
 MCP ACP NR ACP SR ACP RoI
Q3 FY 19 Q3 FY 18 Q3 FY 19 Q3 FY 18 Q3 FY 19 Q3 FY 18 Q3 FY 19 Q3 FY 18
Daily
Volatility 16% 12% 16% 12% 21% 12% 16% 12%

Weekly
Volatility
16% 15% 18% 15% 18% 15% 18% 15%

Monthly
Volatility 28% 1% 26% 1% 39% 1% 26% 1%

MCP ACP NR ACP SR ACP RoI

Q2 Q2 Q2 Q2 Q2 Q2 Q2 Q2
FY 19 FY 18 FY 19 FY 18 FY 19 FY 18 FY 19 FY 18
Daily
Volatility 14% 14% 14% 17% 14% 13% 14% 17%

Weekly
Volatility 14% 16% 14% 17% 14% 17% 14% 16%

Monthly
Volatility 13% 2% 12% 5% 14% 1% 14% 3%

MCP ACP NR ACP SR ACP RoI

Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
FY 19 FY 18 FY 19 FY 18 FY 19 FY 18 FY 19 FY 18
Daily
Volatility 15% 9% 14% 10% 14% 11% 14% 10%

Weekly
Volatility 25% 8% 25% 8% 26% 9% 26% 8%

Monthly
Volatility 20% 8% 24% 9% 18% 3% 18% 9%
Volatility in Electricity Markets

Volatility of short-term (spot) prices:

• Create uncertainty on revenues of existing
and new generators
• Increases financial costs, and in extreme
cases, discourages investments
• Creates uncertainty on costs of industrial
processes,
• Adjustments in price creates social
unconformity and therefore, political
rejection
• Temporal volatility is higher in electricity than in
other commodities markets
• Spatial volatility is unique to electricity markets.
Further risks for participants with contracts
• Solutions are available:
• Hedging tools for temporal risks similar than for
commodities or financial products
• Financial Transmission Rights for spatial risks

Conclusion: hedging tools are available, need to hedge

is stronger in electricity than in other markets
Risk Management with Contracts

•Contracts are be used to alleviate part of the problems

related to spot price volatility. They allow the risk to be
passed to the most suitable agent, either by:
• “sharing” the risk, or by
• “spreading” it
Risk Management with Contracts

Risk Sharing - Suppose a power producer wants to sell a given

amount of MWh in a period of time. However, no one can be sure
what the spot price will be. Then, as an alternative, he can sign a
contract to sell his production at a fixed price, for example, to an
industrial customer. In doing so, the generator has transferred the
risk of low power prices to the consumer. Conversely, the industrial
consumer may be interested in signing the same contract in case
the spot market price goes up. In doing so, he has transferred the
risk of high power prices to the generator.

In summary, each agent shares part of the risk, thus decreasing

revenue uncertainty. Naturally, this type of contract, known as
“forward” contract, has been used for a long time. In financial
markets there other type of contracts to hedge price risks.
Risk Management with Contracts

Risk Spreading - Some risk in the power market may be “diversifiable”,

because fluctuations in the spot price are usually uncorrelated to
other prices in the economy.
If this is so, the generator may be able to go to a commodities broker
(or an insurance company) for a fixed price contract in exchange for a
premium. The broker may will to take the risk because in turn he or
she has signed a large number of such contracts for a variety of
different commodities. Some of these contracts will turn out to be
profitable and some loss-making. Taking several periods together, the
profits and losses should average out to some predictable level,
leaving an also predictable share of the premiums as net revenue. This
“risk spreading” is the basis of most insurance schemes..
Risk Management with Contracts

• However:
• How electricity spot markets are considered of very high
risk (volatility), risk spreading is not a common practice,
since there are not companies willing to take this type of
risk.
• Thus risk sharing is the common practice in electricity
• Currently, most contracts are signed by producers, traders
and consumers of electricity, with the intention of sharing
risk.
• Perhaps, risk-spreading contracts in competitive electricity
markets will begin to emerge.
Tools for Temporal Risk Management

Liquid and efficient for short term hedging

• Day-ahead markets
• Bilateral contracts:
• Physical
• Financial (CfD)
• Organized markets/Power Exchanges
• OTC agreed by parties
• OTC organized markets
• Financial derivatives markets

Effectiveness of Liquidity
hedging
Power Exchanges
 In general terms, a commodities exchange is an entity, that determines and enforces rules
and procedures for the trading of commodities, such as commodity futures. Commodities
exchange also refers to the physical centre where trading takes place.
 Trading can include spot prices, forwards, futures and options on futures. Other
sophisticated products may include interest rates, environmental instruments, swaps, or
ocean freight contracts.
 Commodities exchanges usually trade futures contracts on commodities, such as trading
contracts to receive something, in a certain month. A farmer raising corn can sell a future
contract on his corn, which will not be harvested for several months, and guarantee the
price he will be paid when he delivers; a breakfast cereal producer buys the contract now
and guarantees the price will not go up when it is delivered. This protects the farmer from
price drops and the buyer from price rises.
– If the contracts is traded bilaterally, it would be an OTC
– But the farmer may benefit of standard products, like a future that would have the
same effect, but lower transactions cost (and no need of looking for a counterpart)
 The power exchanges have some differences, mainly related with the products. Price of
electricity varies each hour, so products are on a period of time when price can be replaced
by an average value. An the delivery may be during a time period, day, week, month, etc.
Participants of Exchanges: Hedgers
 ”Hedging’’ means a reduction of risk, enclosing a position in order to restrain it from risky
factors/influences coming from current market situation. An investor who is aiming to
reduce the level of risk is usually called a hedger. A Hedger would usually strive at reducing
the exposure of his/her position to price volatility and in a derivative market, would enter
into a position, which is opposite to the risk he takes. Hedgers use different derivative
strategies in order to reduce or eliminate price risk
 In power markets the PPAs or bilateral contracts are the basic tool to hedge price risk. In
some cases also reduce the quantity risk, for instance a IPP selling to a single buyer. The only
manner to ensure to sell the energy produced is through a PPA with take or pay clause.
 In a power market, the contract aims mainly to hedge price risk. Bilaterally agreed contracts
(OTC) use to have a transactions costs (e.g. to find a counterpart and negotiate the terms)
and low liquidity in case one of the parties wishes to abandon the contract. Exchanges have
the role to introduce liquidity at hedging markets and allow to enter and leave contractual
position with low cost.
Participants of Exchanges: Speculators
 Speculators usually try to project price movements and enter into respective
positions in order to maximize their gains. Speculators are risk takers, their affinity
to risk is much higher than that of a risk-averse investor. They participate in the
derivative markets simply in order to profit. They need to effectively make
predictions for future trend in order to appropriately position themselves in the
market. Such behaviour does not in any way guarantee them safety of funds they
deposited or returns.
 Speculators usually try to catch and ride fast moving trends, so that they could
project in what direction the market will go. In this case they use technical
analyses alongside analysis of fundamentals, as the latter could range from
changing consumer sentiment, expectations, to fluctuating interest rates, retail
sales or consumer spending indicators, consumer price and producer price
indexes, etc.. They always pursue profit maximization within a short term.
Participants of Exchanges: Arbitrageurs
 The last major participants are the Arbitrageurs. They play in an fast paced environment
with decisions being made at a moment’s notice. Sometimes the price of a stock in the cash
market is lower or higher than it should be, in comparison to its price in the derivatives
market. Arbitrageurs exploit these imperfections and inefficiencies to their advantage.
 They do not take risk, but there are not continuous opportunities to arbitrate.
 They also play an important role in increasing liquidity in the market thus making it more
fluid. There are various arbitrage opportunities that can be explored in the derivatives
market.
 Cash-Futures arbitrage is one of the simplest forms. If the futures price is trading at a
premium to its underlying asset; it is referred to as a Contango. If the premium post
adjustment for transaction costs gives higher returns than the cost of capital, an arbitrageur
will initiate positions to benefit from this opportunity. The opposite scenario (where
Futures are at discount) is referred to as Backwardation.
FORWARDS, FUTURES AND OPTIONS
What is a forward?

• An agreement between two counterparties to:

• buy or sell a specified number of units of a specific asset (the
underlying)
• for a predetermined price (the forward price)
• on a particular date in the future (the delivery date)
• The agreement is a binding obligation between the two parties; it does
not represent a right or an option.
• A long forward position (buyer) benefits from a rise in the price of the
(underlying) asset.
• A short forward position (seller) benefits from a decline in the price of
the (underlying) asset.
Futures/Forwards Payoff at Delivery

Profit
Long a Forward
Asset Price

Loss
Forward Price

Profit

Forward Price
Short a Forward
Asset Price
Loss
Forwards vs. Futures

Forwards
• Over-the-counter
• Customized contracts
• Limited liquidity
• Settled at contract maturity
• Physical delivery or final cash
settlement usually occurs
• Delivery date
• Exact hedging
Futures
• Exchange traded (NYMEX, IPE)
• Standardized contracts
• High liquidity
• Settled daily (variation margin)
• Contracts usually closed out
prior to maturity
• Delivery period and other
options
• Approximate hedging
Quality of Hedging vs Liquidity

• With more financial products it is possible to improve

the quality of the hedging (for instance hourly futures)
• But the liquidity is jeopardized. Less demand for each
product
• Liquidity (which means that prices are market driven) is
essential for proper performance of an organized
financial market.
Quality of Hedging

Actual Demand

Standard Peak
Futures Contract

Energy Purchase

Standard Baseload
Off-peak Hours Peak Hours
Futures Contract
6:00 18:00 23:00
What is an Option?

• An agreement which gives the holder the right, but not

the obligation, to buy or sell a given number of units of
an underlying asset by a given time and at a given
price.
• The buyer of the option has a right to exercise while
the writer has an obligation (if the option buyer
chooses to exercise).
Options vs. Forwards
Options
• Upfront premium paid by
buyer
• Only seller obligated to trade
at the contract (strike) price
• Usually only buyer has credit
risk
• Asymmetrical profit/loss
profile
Forwards
• No upfront (premium)
payment
• Both parties obligated to
trade at the contract forward
price
• Mutual credit risk
• Symmetrical profit/loss profile
Types of Options – Calls & Puts

 Call Options
Give the holder the right, but not the obligation, to BUY the
underlying asset from the writer at a given time at a given price
 Put Options
Give the holder the right, but not the obligation, to SELL the
underlying asset to the writer at a given time at a given price
 Terminology
The “given time” is called the Expiration or Maturity date
The “given price” is called the Strike or Exercise price
Example : Call Options
Buyer Seller

St – X if St > X -(St – X) si St > X

Payoff($) 0 if St <= X Payoff($) 0 si St < = X
max (St – X, 0) -max (St – X, 0)

C
St1 X St2 St1 X St2
C value value

C: Premium – option fee

X: Exercise (strike) price
Option Pricing

• Value of an option: Present value (PV) of expected intrinsic

value at expiration
• Black Sholes formulae is normally used to compute value of
(European) options. Only applicable to storable assets
• Black’s formulae is used to compute the value of options on futures.
The use of this formulae requires the existence of a liquid futures
market.
• Need to determine the expected prices of the underlying at
maturity.
– Potential prices at maturity are estimated based on expected spot
prices and volatility
Value of an Electricity Option

Energy Spot Price

Spot price avoided

by buyer (grey)

Total Price for

buyer (green)
Strike Premium
Price

Spot Price for buyer (red)

Contracts for Differences and ‘Hybrid’ contracts

 CfD:
 Both parties agree on a contract price (CP) and quantity Q
(MW). When the market price is Ps:
 If Ps > CP, sellers pays buyer (Ps-CP)* Q
 If Ps < CP, sellers pays buyer (CP-Ps)* Q
 Hybrid
 Both parties agree on a contract price (CP) and quantity Q
 On settlement time:
 MO reduces power injection of the seller in Q MW
 MO reduces power withdrawn of buyer in Q MW
 The parties should inform the MO who will pay the difference
on nodal prices
 Node that injection may be negative, thus seller may need
to present prudential
Electricity Markets are physical, financial or both?

• Typically in other commodities markets, is easy to

differentiate physical (with delivery) from financial
transactions (price hedging, usually without delivery).
• As electricity is not traceable, in a market:
• Generators produces energy that injects into the
transmission network
• Consumers withdraws electricity from the transmission
network
• Is there really delivery from a generator to a consumer?
• Is matter of a convention if bilateral contracts or spot
markets are physical or financial. Even in “physical
contracts”, there is not a correspondence between
injections and withdrawals
• In the limit, a future or option can be considered
financial, but any bilateral might be interpreted in both
senses.
Credit Risk
Reducing Market Risk Creates Credit Risk

Entering into contracts with counterparties may reduce market

(price) risk, but it introduces credit risk!

Mkt. Risk Credit

Risk
What is Credit Risk?

• The potential loss in the event that a counterparty does

not fulfill its obligations.

• Two Types of Credit Risk:

– Actual Credit Risk (Mark-to-Market & Accounts Receivable) –
amount that would be lost by a party if the counterparty
defaulted today.
– Potential Credit Risk – the amount that could be lost at some
point in the future based on potential prices.
Credit Risk Mitigation

• Collateral Exchange
• Exchange of collateral based on changes in the value of positions is the
most effective option for providing tangible protection in the event of
counterparty default.

• Credit Limits
• Establish limits for actual and potential exposure

• Insurance/Credit Derivatives
– Instruments that pay in the event of counterparty default.
– Generally too expensive to be practical.
Example: NordPool
The NordPool

 The Nordic Power Exchange (NordPool) is the world’s first multinational exchange for
trade in electric power contracts. The Energy Act of 1990, formed the basis for
deregulation in the Nordic countries.
 During the 1990s, the Nordic countries created a framework for a common electric
power market based on open competition. The countries that integrate the market are
Norway, Finland, Sweden and Denmark
NordPool – Market Structure
Nord Pool Zones and Capacity
Typical Load Curves
Nord Pool – Market Structure
Nord Pool – Market Organization

• The real-time market to serve as a tool for system operators to balance

generation with load at any time during real-time operations, and to provide a
price for participants’ power imbalances.
• Clearing services for financial electricity contracts – Nordic Electricity Clearing
House ASA (NECH).
• Contracts for differences.
• An hour-ahead spot market for physical contracts (Elbas).
• A day-ahead spot market for physical contracts (Elspot).
• A financial derivatives market trading futures and option contracts (Eltermin,
Eloptions).
• Zonal prices (market splitting)
NordPool – Market Organization
Example – ELSPOT Prices
Nord Pool – Real Time (Balancing) Market

The real-time market has two main objectives:

• To serve as a tool for system operators to balance generation to load
at any time during real-time operations.
• To provide a price for participants’ power imbalances.
Bids in the real-time market are submitted to the transmission system
operators (TSO) after the spot market has closed. Bids may be posted or
changed close to the operational time, in accordance with agreed rules.
Real-time market bids are for upward regulation (increased
generation/reduced consumption) and downward regulation (decreased
generation/increased consumption).
Nord Pool – Spot (day-ahead) Market

Nordic market participants trade power contracts for next-day physical

delivery at the Elspot market;.
Trading is based on an auction trade system. The spot concept is based on
bids for purchase and sale of power contracts of one-hour duration that
cover all 24 hours of the next day. Three bidding types are available,
namely hourly bids, block bids, and flexible hourly bids.
The Elbas Market for Finland and Sweden provides continuous power
trading 24 hours a day, covering individual hours, up to one hour prior to
delivery (2 hours in eastern Denmark). The Elbas market is based on hourly
contracts, and it supplements the Elspot and the national Nordic regulating
power markets.
Nord Pool – Financial Markets

 The financial market for price hedging and risk management consists of markets
for futures, forwards, options and contracts for differences. By trading power
derivatives at the Nordic Power Exchange, Exchange Members can hedge
purchases and sales of power with a time horizon of up to four years.
 Futures and forward contracts are traded continuously, much as in other
commodity markets.
 Options were introduced as tradable products at the Nordic Power Exchange in
late 1999. They were launched to satisfy market demand, and represent an
important element in the expanded product line of the Nordic Power Exchange.
Options, combined with futures or forward positions, offer valuable strategies for
managing power market risk. These are standardized products with clearly defined
specifications and terms.
NordPool – Contracts for Differences

 Market participants that use financial market derivatives contracts to

hedge spot market prices, remain exposed to the risk that the System
Price will differ from the actual area price of their spot purchases or
sales.
 To overcome this potential price differential risk, a new forward contract
product – Contracts for Difference (CfD) – was introduced for trading on
the Nordic Power Exchange in November 2000.
 The System Price is the reference price for forward and futures contracts
traded at the Nordic Power Exchange, as well as non-exchange
contracts.
Nord Pool – Clearing Services

 In addition to clearing all contracts traded on the Nordic Power Exchange,

Nord Pool Clearing ASA clears financially settled electricity contracts
traded on Nordic OTC and bilateral markets.
 These markets have a high level of activity, and Nord Pool Clearing
currently clears a substantial proportion of the standardized financial
contracts traded on them.
 Once a non-exchange-traded contract is registered for clearing, Nord Pool
Clearing assumes counterparty responsibility for clearing and settling it.
 To be accepted for clearing, a bilateral market financial electricity contract
must conform to the standardized products traded via Nord Pool.
USA - PJM
PJM – Market Structure
Region Covered by PJM
PJM Market Organization

 PJM operates:
• a day-ahead energy market,
• a real-time energy market,
• a daily capacity market, monthly and multi-monthly capacity markets,
• a regulation market,
• and the monthly Financial Transmission Rights (FTRs) auction market.
 PJM introduced nodal energy pricing with market-clearing prices in April 1998
and nodal market-clearing prices based on competitive offers in April 1999. PJM
implemented a competitive auction-based FTR market in May 1999. Daily
capacity markets were introduced in January 1999 and were broadened to
include monthly and multi-monthly markets in mid-1999. PJM implemented the
day-ahead energy market and the regulation market June 2000.
PJM Market Organization

• PJM currently calculates and posts LMPs for more than 1,750
buses located in its covered zone
• The PJM control area and an additional 600 buses located
outside the PJM control area. LMPs are also calculated for
aggregate load buses and the PJM eastern and western hubs.
• PJM’s two-settlement system consists of two markets – a day-
ahead market and a real-time balancing market. Separate
accounting settlements are performed for each market.
Financial Markets in PJM Zone

• The principal risk management instruments available to participants in the

energy markets today are
• Bilateral, physical or financial contracts
• The versatile futures and options contracts listed on the New York
Mercantile Exchange (NYMEX)
• The Financial Transmission rights (FTRs) traded in PJM.
• The NYMEX provides financially settled monthly futures contracts for on-peak
and off-peak electricity transactions based on the daily floating price for each
peak day of the month at the PJM.
• Additional risk management and trading opportunities are offered through
options on the PJM monthly futures contract.
Example – The APX Power UK
APX Power UK

 Established in 2000 as Britain’s first independent power exchange, APX Power UK

(formerly UKPX) offers an anonymous market place for integrated trading, clearing
and notification for spot and prompt power contracts and a trading platform for
cleared forwards contracts. APX Power UK is the cornerstone of the UK spot market
and is used by members on a 24/7 basis for the majority of their within day
balancing requirements.
 The APX UK Power Auction is a Day-Ahead auction, where trading takes place on
one day for the delivery of electricity the next day. Market members submit their
orders electronically, after which supply and demand are compared and the market
price is calculated for each hour of the following day.
 UK Half Hour 15:30 Auction offers Members an opportunity to trade half hour
contracts in a local Day-Ahead auction. This auction provides Members with the
opportunity to balance their physical portfolios and optimise their generation
portfolio to the half hour delivery period at the day-ahead stage.
APX Power UK

 The spot market is used for balancing and trading purposes and consists of half
hourly products of electricity as well as discrete standardised blocks made up of the
individual half hours.
 APX Power UK’s base and peak load day products, weekend products and
combination blocks are listed on EuroLight for trading clearing and notification by
APX Power UK.
 The OTC Bilateral facility allows Members to have their OTC Bilateral trades cleared,
settled and nominated by APX using the EuroLight®platform. There is no need for
individual credit arrangements between parties as existing collateral held with APX
is utilised.
 EuroLight® is the trading platform used for all APX spot markets, (except the Power
NL Intraday market). The system is used for trading, settlement and notification .
APX Power UK Spot Products

APX Power UK offers Contract Period Covered Hrs Opens for Trading
physical electricity products 6 blocks/day,
for trading on its 24/7 block 1 begins
4 Hrs block 4 Rolling 7 days
electronic platform, 23:00; block 6
EuroLight. The spot market ends 23:00
is used for balancing and
trading purposes and 12 blocks/day,
49 1/2 Hrs prior
block 1A begins
consists of half hourly 2 Hrs block
23:00; block 6B
2 to start of
delivery
products of electricity as ends 23:00
well as discrete
standardised blocks made
24 blocks/day,
up of the individual half block 23 begins 48 Hrs prior to
hours. All Spot products 1 Hr block 1
at 23:00; block start of delivery
traded on the EuroLight 22 ends 23:00
platform are automatically
cleared and notified
48 periods/day,
providing a fully integrated 1/2 Hr 1 begins
49 1/2 Hrs prior
and efficient solution for Half hour block 0.5 to start of
00:00; 1/2 Hr 48
delivery
members. to end 00:00

.
APX Power UK Prompt Products

Contract Period Covered Hrs Opens for Trading

APX Power UK’s
base and peak
load day products, Rolling 2 weekends,
Weekend base 23:00 Fri – 23:00 Sun 48
weekend products open at any time

and combination
blocks are listed
on EuroLight for Base 23:00 – 23:00 24 Rolling 7 days

trading, clearing Peak 07:00 – 19:00 12 Rolling 7 days

and notification by
APX Power UK. In Extended peak 07:00 – 23:00 16 Rolling 7 days

addition, APX
Power UK lists Off peak
23:00 – 7:00 + 19:00
12 Rolling 7 days
– 23:00
base and peak
week products.
Blocks 3 + 4 07:00 – 15:00 8 Rolling 7 days

Overnight 23:00 – 07:00 8 Rolling 7 days

APX Power UK

Contract details

All contracts are for the constant and continuous flow of one Megawatt (MW) of
electricity per hour for the period of the contract.

There are two contract types:

· Base Load – Standardized contracts for a constant flow of one Megawatt of electricity
per hour for the period 23.00 to 23.00 daily.

· Peak Load – Standardized contracts for a constant flow of one Megawatt of electricity
per hour for the period 07:00 to 19:00 for each of the days Monday to Friday

Futures contracts of both types covering Seasons, Quarters, Block Months and Weeks will
be listed. In addition, Contracts are listed covering Base Load Day, Peak Load Day and
Weekend periods. Spot contracts covering Half Hour periods and Four Hour Block periods
are listed from two days out up to half an hour before Gate-Closure.
Real Time Market- Higlights

 Effective from 1st April 2020.

 Real Time Market will be a half hourly market
 Price discovery mechanism will be double sided closed auction
with uniform price.
 MCP and MCV will be discovered for each 15 minute block.
 RTM would be financially and physically binding.
 Bidding and scheduling at Regional periphery.
 Any entity will be able to participate in the Real Time Market.
 Once NOAR is in place, RTM to be brought closer to delivery.
Timelines
Gate Closure

 The Real-Time Market commences with the end of the right to revision of schedule or
declared capability and ends with gate closure. Gate Closure refers to the time after which
bids submitted to the Power exchange cannot be modified.
Right to Recall

 Any revision in schedule made in odd time blocks shall become effective from 7th time
block onwards, and any revision in schedule made in even time blocks shall become
effective from 8th time block onwards, counting the time block in which the request for
revision has been received to be the first one.

 As explained in the figure above, the revision in schedule made in any odd time block (T1,
i.e. from time block 2200 - 2215 Hrs.) shall be effective from 7th time block, i.e. 2330-2345
Hrs. onwards. Further, any revision in schedule made in the immediate next time block
(even time block) i.e. T2, shall be effective from 8th time block i.e. 0000-0015 Hrs. onwards
Right to Revision

 Once the real time market commences for any specific half-hour
delivery period, the revision in schedule for that half hour (two time
blocks) shall not be permitted.

 4 time blocks in between Gate closure and Start of delivery period.

 The right to revision of schedule for the remaining time blocks of the
day for which the RTM is yet to commence, would still be available with
the Discom and the generator.

 Revision of schedule in 4 Time blocks available to : Wind and Solar

Generator; And System Operator.
Time Line for Power Exchanges

 All the entities participating in the Real-Time Market i.e. after the right to revision of
schedule or declared capability ends for a specified half an hour may place their bids and
offers in the Power Exchanges for purchase and sale of power

 The NLDC shall assess and communicate the margin in each transmission corridor before
the trading for RTM closes for a specified duration.

 Once the auction has ended, the power exchange shall run the optimization/engine and
clear the market considering the available transmission margins.

 The power exchange shall immediately communicate to the NLDC the cleared
transaction/volume. The NLDC, using this information will communicate the schedule to
the RLDCs/SLDCs to incorporate in the schedule.

 These schedules will be communicated to the respective RLDCs and SLDCs. The LDCs shall
in turn incorporate the schedules and inform the respective generators and discoms.
THANK YOU