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U.S. Financial Transmission Rights: Theory and Practice

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  • Sun, Junjie

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.

Suggested Citation

  • Sun, Junjie, 2005. "U.S. Financial Transmission Rights: Theory and Practice," Staff General Research Papers Archive 12266, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genres:12266
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    File URL: http://www2.econ.iastate.edu/papers/p3909-2005-03-24.pdf
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    References listed on IDEAS

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    1. 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.
    2. Lyons, Karen & Fraser, Hamish & Parmesano, Hethie, 2000. "An Introduction to Financial Transmission Rights," The Electricity Journal, Elsevier, vol. 13(10), pages 31-37, December.
    3. 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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    6. 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, March.
    7. 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.
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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, Springer;Society for Computational Economics, vol. 30(3), pages 291-327, October.
    2. Somani, Abhishek, 2012. "Financial risk management and market performance in restructured electric power markets: Theoretical and agent-based test bed studies," ISU General Staff Papers 201201010800003479, Iowa State University, Department of Economics.
    3. Pollitt, Michael G., 2012. "Lessons from the history of independent system operators in the energy sector," Energy Policy, Elsevier, vol. 47(C), pages 32-48.

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    Keywords

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

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