Forward electricity market
European Union Electricity Market Glossary

 

 


 

 

Competitive and liquid forward electricity markets are essential for market participants to hedge their short-term (e.g. day-ahead) price risks and uncertainties. 

 

ACER/CEER Annual Report on the Results of Monitoring the Internal Electricity Market in 2014, November 2015 (p. 175, 176) underlines the fact that different types of participants may expect different benefits from forward markets:




Liquidity in European forward markets

 

The level of competition and liquidity across forward markets in Europe determines whether market participants are able efficiently to hedge the short-term price risks.

 

A variety of forwards, futures, options, swaps, contracts for differences, etc. have been developed and are traded on various platforms.

 

However, in most markets (with the Nordic market as the main exception), the majority of forward trades are brokered rather than being conducted on exchanges.

 

Additionally to the volumes traded through exchanges and brokers, vertically integrated parties will self-supply, relying on internal hedges to protect their positions.

 

Other parties will engage in longer-term bilateral contracts arranged without support of exchanges or brokers.

 

Therefore, the publicly available information on the volumes traded in forward timeframes does not fully reflect the reality.

 

The cross-border access to forward markets depends on the market design.

 

In Europe, two forward market designs have emerged.

 

The first design, implemented in the Nordic and Baltic countries and within Italy, relies mainly on the market and a variety of products developed through the various market platforms.

 

This design contains a set of hedging contracts for a group of bidding zones, and these contracts are linked to a hub (or system) price, which represents either a physically unconstrained DA price, as in the case of the Nordic and Baltic areas, or some sort of an average DA price within this group of zones, as in the case of the Italian area (multi-zone hub).

 

In this design, market participants can hedge the bidding zone price risk by combining a forward product in order to hedge the hub price, with a contract for differences which covers the difference between the hub price and the bidding zone price.

 

Examples of contract for differences are the Electricity Price Area Differentials (EPADs) in the Nordic market or financial TRs (FTRs) within Italy.

 

Contracts for differences are particularly needed when the hub and bidding zone prices are not suf ciently correlated.

 

The second design, implemented in nearly all Member States in Continental Europe, is based on a set of hedging contracts for each bidding zone which are linked to the day ahead clearing price of this bidding zone (single-zone hub).

 

These contracts may be sufficient to hedge the price risk of market participants.

 

However, some market participants located in a given bidding zone may want to use a hedging contract of a neighbouring bidding zone in order to hedge their exposure to risk.

 

This could be a sufficient hedge if prices in the two zones are highly correlated.

 

Otherwise, they would need an additional hedging tool to cover the price differential between the two zones.

 

In this context, the second design gives an additional and specific role to TSOs.

 

They are responsible for calculating long term capacities in a coordinated way and for auctioning (either physical or financial) transmission rights (PTRs or FTRs), enabling market participants to hedge against the specific risk of short-term zonal price differentials.

 

It is worth mentioning that in Continental Europe the pending establishment of the Single Allocation Platform for allocating long term transmission rights will replace the current local or regional ones.

 

ACER/CEER Annual Report on the Results of Monitoring the Internal Electricity Market in 2014, November 2015 (p. 175, 176)

 

a)  Established players will see forward markets as an additional tool for managing their risk. They usually hold various forms of physical options (including generation units, permanent or semi-permanent customer bases, etc.), which can act as hedging instruments to protect against future price changes; 



b)  New entrant generation businesses will be looking to lock long-run prices in to cover for their fixed-cost exposure to investment sunk costs; such players will look for hedging instruments which lock in prices over the investment timeframe (up to 15 years or even more); 


 

c)  New entrant supply businesses will be looking to lock in wholesale prices, for instance up to two years ahead, to match the expected revenues from their projected customers base; and 


 

d)  Commodity traders will see forward energy products as part of a larger risk management portfolio. Their core business is speculation – taking market positions and profit from fluctuations in the price of the underlying assets – and they contribute to the liquidity in forward markets. 


 

According to the ACER/CEER Annual Report on the Results of Monitoring the Internal Electricity Market in 2015, September 2016 (p. 33), in general, the liquidity of forward markets in Europe remained low in 2015, with the main exceptions being Germany, the Nordic area, France and Great Britain.

 

The highest growth in the same period was recorded in the French forward market.

 

The persistence of high absolute values of assessed risk premia in the valuation of long term transmission rights and of Electricity Price Area Differentials (EPADs) point to different problems in the markets for these products, which are crucial for effcient cross-border trading.

 

For instance, transmission right prices reflect inefficiencies such as lack of market coupling, the presence of curtailments in combination with weak firmness regimes, and periods of maintenance reducing the offered capacity, which dampen the value of transmission rights.

 

Also the Commission Staff Working Document of 30.11.2016 Accompanying the document Report from the Commission Final Report of the Sector Inquiry on Capacity Mechanisms {COM(2016) 752 final} SWD(2016) 385 final (p. 35) underlines the importance of the the cross-border access to forward markets in the context of a limited number of liquid forward markets in Europe.

 

The said Commission Staff Working Document of 30.11.2016 refers, however, to the fact that the cross-border access to forward markets depends on the market design.

 

In most of Europe the cross-border access to forward markets is based on transmission rights, either Physical Transmission Rights (PTRs) or Financial Transmission Rights (FTRs), issued by Transmission System Operators (TSOs), which enable market participants to hedge short-term price differentials between two neighbouring bidding zones.

 

In the Nordic and Baltic markets and within Italy, cross-border access to forward markets is based on contracts which cover the difference between the relevant "hub" price (which represents the forward price reference for a group of bidding zones) and each specific bidding zone price.

 

Examples of these contracts are the EPADs in the Nordic and Baltic markets or FTRs within Italy.

 

The so-called Winter Energy Package establishes the uniform legal framework for the EU forward electricity markets.

 

According to the Article 8 of the Proposal for a Regulation of the European Parliament and of the Council on the internal market for electricity (recast), 30.11.2016, COM(2016) 861 final 2016/0379 (COD) TSOs are required to issue long-term transmission rights or have equivalent measures in place to allow for market participants, in particular owners of generation facilities using renewable energies, to hedge price risks across bidding zone borders.

 

The said Article 8 of the draft Regulation envisions that the long-term transmission rights must be:

 

- firm,  

 

- allocated in a transparent, market based and non-discriminatory manner through a single allocation platform,

 

- transferable between market participants.

 

The draft Regulation stipulates, moreover, that subject to compliance with treaty rules on competition, market operators are free to develop forward hedging products including for the long-term to provide market participants, in particular owners of generation facilities using renewable energies, with appropriate possibilities to hedge financial risks from price fluctuations.

 

The EU Member States must not restrict such hedging activity to trades within a Member State or bidding zone.

 

Commission Staff Working Document of 30.11.2016 Accompanying the document Report from the Commission Final Report of the Sector Inquiry on Capacity Mechanisms {COM(2016) 752 final} SWD(2016) 385 final (p. 40) argues that the maximum price in any forward market is constrained by the maximum prices charged in the balancing market, which functions as an implicit price cap for electricity prices in forward markets.

 

Some EU Member States already have no price caps in the balancing market, yet have not experienced prices reflecting the value of lost load (VOLL) even when there has been scarcity. 

 

This can be the case when the balancing price, while not being subject to a cap, does not reflect the full cost of the services used to balance the market or the full cost of the unmet consumer demand (represented by VOLL). 

 

Member States should therefore ensure that balancing market rules, even in the absence of an explicit price cap, do reflect the full costs of balancing and do not implicitly constrain electricity prices in forward markets.

 

 



Last Updated on Friday, 24 March 2017 14:20
 

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