Hedging Strategy and Electricity Contract Engineering - IFOR

24 The electricity market
Power
Power
1 MW
1 MW
t
t+ 1
Spot
Time
T
Future
T
1 2
Time
Fig. 2.6: Load curve of spot and futures contract.
as underlying and there are both financially and physically settled contracts,
depending on the power exchange. Futures are normally used to assure a fixed
price of sold or bought electricity in the future. There are in Europe futures
with up to a year of average spot price as underlying and they are traded up to
three years in advance.
The physically settled future obligates the buyer to receive a constant power of
1 MW over the period T 1 T 2 and the seller to deliver the same amount at a
specified price, the so-called delivery price K , as illustrated in Figure 2.6. The
location is determined by the underlying spot contract’s specifications.
To facilitate for financial players to trade in the futures market and hence increase
liquidity, many power exchanges have chosen financially settled futures,
meaning that no electricity is delivered. Instead, the same profit and loss profile
is achieved through a cash payoff given by the difference between the average
spot price during the period
1
T 2 T 1
T 2
T 1
S and the delivery price K as illustrated
in Figure 2.7. 16 The players that need to receive or deliver physical
energy will have to cover their physical demand or supply in the spot market.
The payoff of the financial settled future however assures that the actual price
for buying or selling electricity in combination with the future will be exactly
the delivery price K .
16 Since the shortest future typically has a period of a full day, i. e. 24 spot contracts, the
payoff is given by the difference between the average spot price and the delivery price
and not as in traditional financial markets between the spot price and the delivery price.