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U.S. Financial Transmission Rights: Theory and Practice

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  • Sun, Junjie
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    Abstract

    This paper reviews both theoretical and empirical studies of financial transmission rights (FTRs) in the major U.S. wholesale power markets. Although the current literature hold more negative views about FTRs, this paper presents a simple illustrative 2-stage model to study the competitive behaviors of electricity generators and load serving entities (LSEs) and analyzes the welfare effects of FTRs in the restructuring U.S. wholesale power market framework. The analysis focuses on a competitive two-node electricity network model where there is one generator and one LSE in each node with linear marginal cost and demand function, supervised by an independent system operator (ISO). In the first-stage of modelling, a no-rights benchmark model is developed to solve for the optimal quantity of power production and consumption and derive the locational marginal price for each node, which serve as the building blocks to solve for the optimal FTR hedge positions in the second-stage model. Once a stochastic parameter shock is introduced, the second-stage model shows that the acquisition of optimal FTRs by the risk averse generators and LSEs increases and in general strictly increases the social welfare compared with the case where there is no FTRs available. This result provides a counterexample to the somewhat negative views about FTRs held by other economists in the literature and provides some economic explanations to the fact that FTRs are widely adopted as a financial hedge instrument in the major U.S. wholesale power markets.

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    File URL: http://www.econ.iastate.edu/sites/default/files/publications/papers/p3909-2005-03-24.pdf
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    Bibliographic Info

    Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12266.

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    Date of creation: 24 Mar 2005
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    Handle: RePEc:isu:genres:12266

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    Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
    Phone: +1 515.294.6741
    Fax: +1 515.294.0221
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    Web page: http://www.econ.iastate.edu
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    Related research

    Keywords: financial transmission rights; locational marginal price; security-constrained economic dispatch; independent system operator; congestion rent;

    This paper has been announced in the following NEP Reports:

    References

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    1. Hogan, William W., 2003. "Transmission Market Design," Working Paper Series rwp03-040, Harvard University, John F. Kennedy School of Government.
    2. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
    3. Bessembinder, Hendrik, 1991. "Forward Contracts and Firm Value: Investment Incentive and Contracting Effects," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(04), pages 519-532, December.
    4. Cardell, Judith B. & Hitt, Carrie Cullen & Hogan, William W., 1997. "Market power and strategic interaction in electricity networks," Resource and Energy Economics, Elsevier, vol. 19(1-2), pages 109-137, March.
    5. Brian T. Kench, 2004. "Let's Get Physical! Or Financial? A Study of Electricity Transmission Rights," Journal of Regulatory Economics, Springer, vol. 25(2), pages 187-214, 03.
    6. Deng, Shi-Jie & Oren, Shmuel & Meliopoulos, A.P., 2010. "The inherent inefficiency of simultaneously feasible financial transmission rights auctions," Energy Economics, Elsevier, vol. 32(4), pages 779-785, July.
    7. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    8. Lyons, Karen & Fraser, Hamish & Parmesano, Hethie, 2000. "An Introduction to Financial Transmission Rights," The Electricity Journal, Elsevier, vol. 13(10), pages 31-37, December.
    9. Steven Stoft, 1999. "Financial Transmission Rights Meet Cournot: How TCCs Curb Market Power," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 1-23.
    10. Rosellón Juan, 2003. "Different Approaches Towards Electricity Transmission Expansion," Review of Network Economics, De Gruyter, vol. 2(3), pages 1-32, September.
    11. Bushnell, James, 1999. "Transmission Rights and Market Power," The Electricity Journal, Elsevier, vol. 12(8), pages 77-85, October.
    12. Shmuel S. Oren, 1997. "Economic Inefficiency of Passive Transmission Rights in Congested Electricity Systems with Competitive Generation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 63-83.
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    Cited by:
    1. Junjie Sun & Leigh Tesfatsion, 2007. "Dynamic Testing of Wholesale Power Market Designs: An Open-Source Agent-Based Framework," Computational Economics, Society for Computational Economics, vol. 30(3), pages 291-327, October.

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