BASICS OF COMPETITIVE MARKETS FOR ELECTRICITY AUCTIONS - INTENT AUCTIONS - COMPONENTS. Basic Definitions Transactions Futures
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1 BASICS OF COMPETITIVE MARKETS FOR ELECTRICITY Basic Definitions Transactions Futures 3/6/2003 copyright 1996 Gerald B. Sheble' 1 AUCTIONS - INTENT Open Exchange on a Common Product Open Knowledge on Price (Valuation) Price Discovery Costs Private (competitive edge) Minimize Surplus Profits Fair, Independent Valuation 3/6/2003 copyright 1996 Gerald B. Sheble' 2 AUCTIONS - COMPONENTS Players Suppliers Buyers Risk Takers (insurance) Infrastructure Objects Contracts Payoff Strategies 3/6/2003 copyright 1996 Gerald B. Sheble' 3
2 EXCHANGE FLOOR C o m m u n i c a t i o n Floor Brokers Prices and Volume Floor Traders C FCM F CM F CM F CM o m m u n i c Clearing Corporation a Pool Operators Trade Advisors t i o n Clients (Trading Public) 3/6/2003 copyright 1996 Gerald B. Sheble' 4 KINDS OF MARKETS Two-Party Direct Placement Direct Over the Counter Expert Trader Open Outcry Multiple Trades Announce Bids Exchange of Bids Fix Contract Trade 3/6/2003 copyright 1996 Gerald B. Sheble' 5 COMMODITIES Trading by Standards Contracts must specify: Price, Contract Length (Horizon), Quantity, Place of Delivery, Quality 3/6/2003 copyright 1996 Gerald B. Sheble' 6
3 TYPES OF COMMODITY CONTRACTS TRADED Cash Contracts Spot Contracts Forward Contracts Option Contracts Futures Contracts Straight, Monthly Options Swap Contracts Market Contracts 3/6/2003 copyright 1996 Gerald B. Sheble' 7 MAJOR TRADING OBJECTIVES Hedging - defense mechanism against loss and/or supply shortages. Speculation - investment risk with a chance for profit. Arbitrage - crossing of sales (purchases) between markets. 3/6/2003 copyright 1996 Gerald B. Sheble' 8 MARKETS COMMONLY OPERATED Cash Chicago Board of Trade Chicago Mercantile Futures New York Mercantile Exchange Swaps Industrial Banks 3/6/2003 copyright 1996 Gerald B. Sheble' 9
4 CASH MARKET Spot and forward contracts Price of transactions reflect current system conditions. Forward market, same, but transactions occur at some future time. Link between the cash market and the futures market 3/6/2003 copyright 1996 Gerald B. Sheble' 10 FUTURES MARKET Improved market efficiency due to reduced search costs Creates competition Contracts are between individuals and the exchanges Contracts follow a standard format Price and number of contracts are negotiated in the "ring" Contracts are settled at the end of the day 3/6/2003 copyright 1996 Gerald B. Sheble' 11 REASONS FOR NOT TAKING DELIVERY Inefficiency Due to Transportation Sufficient Inventories Trader's Lack of Storage to Make or Take Delivery Engagement for Price and Quantity Protection 3/6/2003 copyright 1996 Gerald B. Sheble' 12
5 MORE REASONS FOR NOT TAKING DELIVERY Discrepancy Between Timing Requirements of the Trader Excessive Storage, Insurance and/or Financing Costs 3/6/2003 copyright 1996 Gerald B. Sheble' 13 OPTIONS MARKET Allow flexibility in exercising the right to activate a contract or cancel it. Claims to buy are "call" options. Claims to sell are "put" options. Redistribute the risk from those wishing to avoid it to those willing to accept it. Contribute to price stability, increase supply when prices rise and increase demand when prices fall. 3/6/2003 copyright 1996 Gerald B. Sheble' 14 CLEARING HOUSE/SWAP MARKET Contract position closed with an exchange of physicals or financial substitution Trader can find another buyer (seller) on the exchange who will accept (make) delivery and end trader's delivery obligation Acceptor of obligation compensated through a price discount or a premium on commodity 3/6/2003 copyright 1996 Gerald B. Sheble' 15
6 OPTIMAL MIX Spots Options Forwards Futures Contracts Physical Inventories 3/6/2003 copyright 1996 Gerald B. Sheble' 16 OPTIMAL MIX DEPENDS ON The business objectives of the trader, such as hedging The constraints imposed by the different contracts The costs of the different contracts Management of Portfolios- Financial Engineers 3/6/2003 copyright 1996 Gerald B. Sheble' 17 OPTION JARGON I Price actual market value or equilibrium price at which one would buy or sell the option. Strike Price: fixed price to buy (sell) the underlying asset Formula value or intrinsic value Call option: asset-strike price Put option: strike-asset but not less than zero. 3/6/2003 copyright 1996 Gerald B. Sheble' 18
7 OPTION JARGON II Gross profit - Payoff In-the-money: Call: price >strike price Put: price <strike price Out-of-the-money: Call: price < strike Put: price > strike Maturity - Expiration Date 3/6/2003 copyright 1996 Gerald B. Sheble' 19 OPTION JARGON III Cash Settlement: financial trade instead of asset trade. European options: exercised only at expiration. American options are exercisable anytime. 3/6/2003 copyright 1996 Gerald B. Sheble' 20 HOCKEY-STICK DIAGRAMS CALL Profit Diagram shows gross payoff or net profit (vertical) as a function of asset price (horizontal Profit/option ($) Holder Price at Expiration ($) Seller 3/6/2003 copyright 1996 Gerald B. Sheble' 21
8 HOCKEY-STICK DIAGRAMS PUT Profit Diagram shows gross payoff or net profit (vertical) as a function of asset price (horizontal Profit/option ($) Holder Seller Price at Expiration ($) 3/6/2003 copyright 1996 Gerald B. Sheble' 22 RISK ASSESSMENT AND MANAGEMENT Risk included within contracts Risk of markets Risk of equipment Risk of supplies Risk of delivery LOLP/EUE (costs) at each load bus TPLAN, TRELSS 3/6/2003 copyright 1996 Gerald B. Sheble' 23 RISK/ECONOMICS Contract Incentives Spot Prices Loss Of Load Probability Margin Requirements Auction Formulation Market Interactions Financial Commitments 3/6/2003 copyright 1996 Gerald B. Sheble' 24
9 AUCTION MARKET STRUCTURES Basic Mechanisms Bidding Risk Management 3/6/2003 copyright 1996 Gerald B. Sheble' 25 AUCTIONS - IMPLEMENTATION Actual Historical Growth Based on Need to Function Analysis Experimental Economics (Floor) Experimental Economics (Laboratory) Game Theory (very simple) 3/6/2003 copyright 1996 Gerald B. Sheble' 26 CENTRALIZED MATCHING AUCTIONS STANDARD MECHANISMS Single Auctions English Dutch First Price Sealed Bid Second Price Sealed Bid Double Auctions First Price Sealed Bid etc. 3/6/2003 copyright 1996 Gerald B. Sheble' 27
10 COMPUTERIZED TRADING Primary Sealed Bid Double Auctions Duration Bind At Closing Optimization by Price Decoupling 3/6/2003 copyright 1996 Gerald B. Sheble' 28 COMPUTERIZED EXCHANGE Auction Mechanism Contract Evaluation Player Player Player 3/6/2003 copyright 1996 Gerald B. Sheble' 29 AUCTION ON SUPPLY AND DEMAND CURVE Demand Supply st bid 2nd bid 3rd bid 4th bid 3/6/2003 copyright 1996 Gerald B. Sheble' 30
11 SURPLUS PROFITS Central agent keeps surplus profit may or may not show prices may keep inventory based on expected trends may play more than one contract Ring split profit by rule (1/2) list put and call prices for exchanged contracts 3/6/2003 copyright 1996 Gerald B. Sheble' 31 CENTRALIZED MATCHING AUCTIONS Reliability Adequacy Security Obligation to Serve Coordination Valuation 3/6/2003 copyright 1996 Gerald B. Sheble' 32 INTERCHANGE BROKERAGE Heuristics Economy A (Economic Dispatch) Economy B (Unit Commitment) Florida Coordination Group Hourly Bids Optimal Power Flow Security Constrained Dispatch Expert System Rules on Operation 3/6/2003 copyright 1996 Gerald B. Sheble' 33
12 NEW BUSINESS ENVIRONMENT NERC Standards (reliability & security) ICA/ISO/RTG Coordinator (present & future) GENCO Supplier (ancillary & main) DISTCO Buyer (ancillary & main) TRANSCO Transportation (ancillary & storage) EMA Markets (cash, futures & planning) ESCO Services (quality & reliability) BROCO Marketers (market & broker) 3/6/2003 copyright 1996 Gerald B. Sheble' 34 GENCO PARADIGM Fuel Contracts Fuel Inventory Other Market Players (GENCOs Generation or 3/6/2003 copyright 1996 Gerald B. Sheble' 35 MULTIPLE-PERIOD INVENTORY FLOW MODEL B u y Market Price + Transaction Cost Initial Stock Period i Holding Cost Market Price - Transaction Cost Sell 3/6/2003 copyright 1996 Gerald B. Sheble' 36
13 INTERCONNECTION OF FUTURES AND CASH MARKETS F u t u r e s M a r k e t F u t u r e O p t i o n C a s h M a r k e t S p o t F o r w a r d P e r i o d i 3/6/2003 copyright 1996 Gerald B. Sheble' 37 SEGMENTATION OF RESERVE MARGINS AND ACTUAL PRODUCTION Reserve Margin Future Option Actual Production Spot Forward 3/6/2003 copyright 1996 Gerald B. Sheble' 38 MULTIPLE MARKET COORDINATION Time Line into Future Cash Market Futures Market Planning Market Swap Market Independent System Operator Generation Producer Distribution Owner 3/6/2003 copyright 1996 Gerald B. Sheble' 39
14 GENCO Real/Reactive Power, etc. Price Quotations Contract Types Base Load Load Following Reserve Contingent etc. 3/6/2003 copyright 1996 Gerald B. Sheble' 40 ESCO Real/Reactive Power, etc. Price Quotations Contract Types Base Load Load Following Reserve etc. 3/6/2003 copyright 1996 Gerald B. Sheble' 41 LaGrangian Relaxation Unit Commitment Update Lambda for each Time Period H=1 H=2... H=T Gen 1,...Gen N Gen 1,...Gen N Gen 1,...Gen N P1,P2,... P1,P2,... P1,P2,... Check Conservation of Energy for all Time Periods No Satisfied? Yes Stop 3/6/2003 copyright 1996 Gerald B. Sheble' 42
15 LaGrangian Relaxation Auction (GENCOs & ESCOs) Update Lambda for each Time Period H=1 H=2... H=T Co 1,...Co N Co 1,...Co N Co 1,...Co N P1,P2,... P1,P2,... P1,P2,... Check Conservation of Energy for all Time Periods No Satisfied? Yes Stop 3/6/2003 copyright 1996 Gerald B. Sheble' 43 Multiple Round Auction (GENCOs & ESCOs) Post Matched Bids for each Time Period Co1 Co2... CoN Strategy Update Strategy Update Strategy Update P1/Q1,...,PT/QT P1/Q1,...,PT/QT P1/Q1,...,PT/QT Check Operating Rules (PF++) for all Time Periods Yes Any matches? No Firm Contracts Yes Another Round? No STOP 3/6/2003 copyright 1996 Gerald B. Sheble' 44 LaGrangian Relaxation Auctions Give model data to central authority number of parameters (e.g. 32) Bid is not disclosed Central authority matches unit commitment power flow security constrained dispatch Central authority posts matched 3/6/2003 copyright 1996 Gerald B. Sheble' 45
16 LaGrangian Relaxation Auctions Pros Centralized Data One Set of Programs Looks Like Old Environment Cons Audit of Data Incentive for New Programs Correction of Bugs Responsibility for Equipment Constraints One-Shot Bidding Contingencies TRANSCOs, etc. 3/6/2003 copyright 1996 Gerald B. Sheble' 46 AUCTION SEQUENTIAL INTERPLAY Phase I EMA Markets (cash, future & planning) GENCO generation (may buy short & ancillary) ESCO distribution (may sell short & ancillary) 3/6/2003 copyright 1996 Gerald B. Sheble' 47 AUCTION SEQUENTIAL INTERPLAY Phase II EMA Markets (cash, future & planning) TRANSCO transmission (ancillary & reliability) ESCO distribution (may sell short & ancillary) 3/6/2003 copyright 1996 Gerald B. Sheble' 48
17 AUCTION MANAGEMENT with Transmission Impacts Matching of Sealed Bids Adjust Matched Bids for Transmission Equipment Usage Ancillary Services Losses Frequency Regulation Voltage Support Stranded 3/6/2003 copyright 1996 Gerald B. Sheble' 49 PROPOSED BUSINESS ENVIRONMENT Energy Mercantile Association (EMA) Regional Transmission Group (RTG) Independent System Operator (ISO) Independent Contract Administrator (ICA) Reliability Corporation (NERC++) Market Research and Development (FERC++) 3/6/2003 copyright 1996 Gerald B. Sheble' 50 TRANSMISSION Price Quotations Availability Capability 3/6/2003 copyright 1996 Gerald B. Sheble' 51
18 AUCTION SIMULTANEOUS INTERPLAY EMA Markets (cash, future & planning) GENCO generation (may buy short & ancillary) ESCO distribution (may sell short & ancillary) TRANSCO transmission (ancillary & reliability) 3/6/2003 copyright 1996 Gerald B. Sheble' 52 MULTIPLE MARKET COORDINATION Time Line into Future Cash Market Futures Market Planning Market Swap Market Independent System Operator Generation Producer Transmission Owner Distribution Owner 3/6/2003 copyright 1996 Gerald B. Sheble' 53 EMA (ICA/ISO/RTG/POOLCO) Market coordinator Implement the cash market contracts Perform contingency and state estimation analyses Maintaining voltage stability Compute amount of available reserves Monitor reactive power flow 3/6/2003 copyright 1996 Gerald B. Sheble' 54
19 PROPOSED RTG/POOLCO FUNCTION INDEPENDENT CONTRACT ADMINISTRATOR (ICA) Imbedded system operation treated as social welfare costs: Reactive power flow Voltage Stability Losses Transient Stability Dynamic Stability 3/6/2003 copyright 1996 Gerald B. Sheble' 55 RELIABILITY CORPORATION (NERC) Assess reliability of power services Oversee operation of power system Record of power systems operation and planning Forward guidelines to RTG for implementation Develop a set of guidelines to be followed in emergencies, 3/6/2003 copyright 1996 Gerald B. Sheble' 56 MANAGEMENT (Golden Rule) Users who aggravate the behavior of power system should be penalized Those who improve the behavior of power system should be rewarded Charge for social welfare costs according to contract impact Debit/credit system for aggravating the behavior of the power system 3/6/2003 copyright 1996 Gerald B. Sheble' 57
20 SUMMARY Trading fits the energy marketplace with total change of Communication and Control philosophy Players can purchase or sell energy depending on needs Players can determine when to purchase energy and when to sell excess energy 3/6/2003 copyright 1996 Gerald B. Sheble' 58 SUMMARY Contracts with standard regulations to mutually benefit all parties Contracts governed by an energy commodity market Formal guideline could be drafted for an efficient and fair deregulated marketplace Operating principles and guides are main restriction to implementation 3/6/2003 copyright 1996 Gerald B. Sheble' 59 NEW YORK MERCANTILE EXCHANGE ELECTRIC FUTURES TRADING UNIT: 1000 MWHrs TRADING HOURS: same as gas TRADING MONTHS: same as gas PRICE: dollars and cents per 1000 MWHr 3/6/2003 copyright 1996 Gerald B. Sheble' 60
21 NEW YORK MERCANTILE EXCHANGE ELECTRIC FUTURES MINIMUM PRICE FLUCTUATION: same as gas MAXIMUM DAILY PRICE FLUCTUATION: same as gas LAST TRADING DAY: same as gas? EXERCISE OF OPTIONS: same as gas? OPTION STRIKE PRICES: same as gas 3/6/2003 copyright 1996 Gerald B. Sheble' 61 NEW YORK MERCANTILE EXCHANGE ELECTRIC FUTURES DELIVERY: COB and Palo Verde DELIVERY PERIOD: same as gas (during peak period of working days) ALTERNATE DELIVERY PROCEDURE: same as gas EXCHANGE OF FUTURES FOR, OR IN CONNECTION WITH PHYSICALS (EPP): same as gas (swap) 3/6/2003 copyright 1996 Gerald B. Sheble' 62 NEW YORK MERCANTILE EXCHANGE ELECTRIC FUTURES QUALITY SPECIFICATIONS: same as gas? (transmission specifications in effect at time of delivery) CUSTOMER MARGIN REQUIREMENTS: same as gas 3/6/2003 copyright 1996 Gerald B. Sheble' 63
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