The Economics of Electricity Markets

14Managing Interlocational Price Risk

In Chapter 13, we implicitly assumed that network constraints could be ignored. This allowed us to focus on the problem of intertemporal hedging of wholesale spot prices. In this chapter, we reintroduce the potential for network constraints and explore what instruments we might require for hedging geographic variation of wholesale spot prices.

14.1 The Role of the Merchandising Surplus in Facilitating Interlocational Hedging

In Chapter 13, we introduced the concept of the hedge trader. A hedge trader purchases hedge contracts from generators and loads. We assumed that the individual generators and loads seek to achieve a perfect hedge. The traders seek to create portfolios that are independent of the spot price. Now let us generalise these ideas to the case of a system with network congestion.

In the presence of network congestion, there is a third set of factors that can affect the overall market outcomes – those factors that affect the state of the network. We might label the factors that affect network capability as . As long as there is uncertainty in the network capability, there can arise uncertainty in price and dispatch, even if every generator and load has a certain cost function and/or utility function.

As before, let us start by looking at the payout on the set of all hedge contracts in the entire market. Let us assume, without ...