Hedging Strategy and Electricity Contract Engineering - IFOR
Hedging Strategy and Electricity Contract Engineering - IFOR
Hedging Strategy and Electricity Contract Engineering - IFOR
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2.7 <strong>Electricity</strong> contracts 23<br />
tions. St<strong>and</strong>ardized contracts are normally cleared at a power exchange, meaning<br />
that the exchange takes the counterparty risk, 13 why these contracts have<br />
to be simple to assure a correct risk assessment <strong>and</strong> have to be well defined to<br />
avoid any legal uncertainty.<br />
2.7.1.1. The spot market<br />
The spot market is actually a day-ahead market, but still called a spot market. 14<br />
A pure spot market would not be possible in the electricity market, since the<br />
ISO needs advanced notice to verify that the schedule is feasible <strong>and</strong> lies<br />
within the transmission constraints. Further, not all power plants can alter their<br />
output within minutes, why also the generation side needs some respite. 15<br />
The spot is normally an hourly contract, but can be even shorter, like the<br />
half-hourly spot contract traded at the Amsterdam Power Exchange. The spot<br />
contract has physical delivery <strong>and</strong> is the underlying of most derivatives. The<br />
spot is not traded on a continuous basis, since the pricing mechanism is an<br />
auction, conducted once per day.<br />
The spot contract is a contract giving the buyer the obligation to receive one<br />
MW of electricity over the period, <strong>and</strong> the seller the obligation to deliver the<br />
same amount of power at a specific geographical location. Depending on how<br />
the market is set-up <strong>and</strong> how the ISO is managing the grid, this specific location<br />
can be anywhere in a grid or it can be a single hub in the grid. In any case, the<br />
exact location of the supply <strong>and</strong> the dem<strong>and</strong> has to be communicated to the ISO<br />
so that he can manage the power system. In Figure 2.6 the load curve of a spot<br />
contract is visualized.<br />
2.7.1.2. The futures market<br />
The electricity futures are normally traded on a continuous basis, which is also<br />
the case for most traditional financial markets. The future has the spot price<br />
13 Counterparty risk is also called credit risk, which is defined in Chapter 3.3.<br />
14 The definition of a spot market is a market for immediate or very near delivery<br />
15 The operational flexibility will be explained in more details in Chapter 4
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