MODULE 1

TRADITIONAL POWER INDUSTRY

 The electric power industry has been operated as a vertically
integrated regulated monopoly that owned the generation,
transmission and distribution facilities.
 It has also been a local monopoly, in the sense that in any area one
company or government agency sold electric power and services to
all customers.
 The regulations are generally imposed by the government or the
government authority.
 These essentially represent a set of rules or framework that the
government has imposed so as to run the system smoothly and with
discipline, without undue advantage to any particular entity at the
cost of end consumer.
 All practical power systems of earlier days used to be regulated by
the government.

Generation

VIU

Transmission

Distribution

Customers
The traditional power industry had several characteristics:
i) Monopoly franchise : Only the national or local electric utility was
permitted to produce, transmit, distribute and sell commercial electric
power within its service territory.
ii) Obligation to serve : The utility had to provide electricity for the needs of
all consumers in its service area, not just those that were profitable.
iii) Regulatory oversight : The utility’s business and operating practices
had to confirm to guidelines and rules set down by government regulators.
iv) Regulated rates : The electric utility’s rates were either set or regulated
in accordance with government regulatory rules and guidelines.
v) Guaranteed rate of return : The government guaranteed that regulated
rules would provide the electric utility with a reasonable or fair profit margin
above its cost.
vi) Least cost operation : The electric utility was required to operate in a
manner that minimized overall revenue requirements.
 However, vertically integrated monopolies could not provide services
as efficiently as competitive firms as in airline, telephone and natural
and gas industries, the electric power industry plans to improve its
efficiency by providing a more reliable energy at least cost to
customers through restructuring.
 A competition is guaranteed by establishing a restructured
environment in which customers could choose to buy from different
suppliers and change suppliers as they wish in order to pay market
based rates.

Restructuring of a power system refers to the process of transforming

the traditional vertically integrated electricity supply industry into a more
competitive, market-oriented structure. It involves separating the
generation, transmission, distribution, and retail sectors to promote
efficiency, competition, and better service for consumers.

UNBUNDLING GENERATION, TRANSMISSION AND DISTRIBUTION

 To implement competition, vertically integrated utilities are required
to unbundle their retail services into generation, transmission and
distribution (Gencos, Transcos and Discos).

 Competition is introduced in the generation activity by allowing other

private participants in this segment. In contrast to the vertically
integrated case where all the generation is owned by the same
utility, there is a scope for private players to sell their generation at
competitive prices. The generators owned by the earlier vertically
integrated utility will then compete with these private generators.

 Generation utilities will no longer have a monopoly, small businesses

will be free to sign contract for buying power from cheaper sources,
and utilities will be obligated to deliver or wheel power over existing
lines for a fee (non- discriminatory).

 The vertically integrated system is steadily restructuring to a more

market based system in which competition will replace the role of
regulation in setting the price of electric power.

 The main objective of electric power restructuring is to significantly

reduce the cost of power charged to small businesses and
consumers.

 The cost of electricity generation will be reduced by driving prices

through market forces and more competition; this task will be
accomplished by creating an open access environment that will allow
consumers to choose a provider (customer choice) for electric
energy.

 On April 24,1996 Federal Energy Regulatory Commission(FERC)

Issued Final rule 888 requiring all public utilities that own, control or
operate facilities for transmitting electric energy in interstate
commerce to file open access non-discriminatory tariffs.

 This rule caused public utilities to functionally unbundle wholesale

generation and transmission services.
  The basic premise of transmission open access is that the
transmission owners/providers treat all transmission users on a
non-discriminatory and comparable basis regarding access to and
use of the transmission system and services.

 In addition FERC issued Rule 889, for the development of an

electronic communication system called Open Access Same Time
Information System (OASIS).

Benefits of deregulation:
The competitive environment offers a good range of benefits for the
customers as well as the private entities. It is claimed that some of the
significant benefits of power industry deregulation would include:
1. Electricity price will go down: It is a common understanding that the
competitive prices are lesser than the monopolist prices. It significantly
reduces the cost of power charged to small business and customers. The
cost of electricity generation will be reduced by driving prices through
market forces and more competition.
2. Choice for customers: The customer will have choice for its retailer.
The retailers will compete not only on the price offered but also on the
other facilities provided to the customers. These could include better
plans, better reliability, better quality, etc. This will provide greater
incentives for short and long term efficiencies than is provided by
economic regulation.
3. Customer-centric service: The retailers would provide better service
than what the monopolist would do.
4. Innovation: The regulatory process and lack of competition gave
electric utilities no incentive to improve or to take risks on new ideas that
might increase the customer value.
5. Under deregulated environment, the electric utility will always try to
innovate something for the betterment of service and in turn save costs
and maximize the profit.
6. Restructuring in electricity industry will create new business
opportunities where new firms selling new products and services will
appear, consumers will have alternatives in buying electricity services, and
new technologies such as metering and telecommunication devices will
develop.

Disadvantages of deregulation
1. Improper implementation or hasty implementation of restructuring
may lead to very high whole sale market prices leading to electricity
crisis like that happened in California in 2000-2001, which
threatened to wreck its economy and caused collateral damage
throughout the West.

2. Employee Uncertainty: Restructuring often causes employees to

panic and wonder how the changes will affect their job security.
When the news gets out that the company is restructuring, some
employees may begin looking for new employment.

3.The stress of the restructuring sometimes takes away from the

staff's focus on their actual work.
STRUCTURAL COMPONENTS OF RESTRUCTURED SYSTEM
The structural components representing various segments of the electricity
market as Generation Companies (GENCOS-G), Power Exchange (PX),
Scheduling Coordinators (SC), Power Marketer(PM), Independent System
Operator (ISO), Ancillary Services (AS), Retail Service Providers (R), and
Distribution Companies (DISCOS-D),TRANSMISSION OWNERS(TO)

PX SC
GENCOS PM ISO RETAILER DISCOS
(R)
AS TO
1.Gencos (Generating Company) and Power Marketers
 Gencos and Power Marketers are the primary and secondary
generation sectors respectively
 Genco is an owner-operator of one or more generators that runs
them and bids the power into the competitive marketplace.
 Open transmission access allows Gencos to access the
transmission network without distinction and competition.

Power Marketer: An agent for generation facilities. It markets power

on behalf of the generators, may arrange transmission or ancillary
services as needed, considered as an intermediary between the
buyer and the seller, and expected to reduce prices for customers.

2.DISCOS (Distribution Company)

 Functions:
o Owns and operates the distribution network (11 kV and

below in many countries).

o Responsible for delivering electricity from the transmission
system to end consumers (residential, commercial, industrial).
o Maintains, upgrades, and expands the distribution
infrastructure.
o In competitive markets it is solely responsible for the physical
infrastructure required to deliver electricity — not for selling
the electricity itself, while separate retailers handle energy
sales.
Retailer

 Functions:
o Acts as an intermediary between the electricity market (or

generators) and the end users.

o Buys electricity in bulk from the wholesale market or directly
from generators.
o Sells electricity to consumers, often offering pricing options,
value-added services, and customer support.
o Competes with other retailers to attract and retain customers,
based on price, service quality, green energy options, etc.
o May bundle services (e.g., energy audits, home automation).

In some places, the local distribution function is combined with retail

function.

In many other cases, however, the Discos does not sell the power. It
only owns and operates the local distribution system, and obtains its
revenue by wheeling electric power through its network.

3. Power Exchange (PX)

 In a restructured power system, power exchange refers to the
market place wherein the electricity is traded or exchanged between
different market participants, such as generation companies,
distribution companies, and consumers.

 This market place permits different participants to sell and buy

energy and other services in a competitive way based on quantity
bids and prices.

 Participants include power marketers, brokers , load aggregators ,

retailers, large industrial customers and co generators.

 PX is a independent, non government and non profit entity which

accepts schedules for loads and generation resources.
 It provides a competitive market place by running an electronic
auction where market participants buy and sell electricity and can do
business quickly and easily.

 Through an electronic auction, PX establishes an Market Clearing

Price (MCP) for each hour of the following day for trades between
buyers (demands) and sellers(suppliers).

 In this market place PX does not deal with small consumers.

 PX manages settlement and credit arrangements for scheduling and

balancing of loads and generation resources.

 It submits balanced demand and supply schedules for successful

bidders to ISO(Independent System Operator) and performs
settlement functions with ISO as well as PX participants such as
UDCs(Utility Distribution Companies), marketers, aggregators etc

 It also submits ancillary service bids to ISO for maintaining system

reliability , adjustment bids(Decremental /Incremental bids are used
to relieve or eliminate congestion on transmission grid)

 PX guarantees an equal and non discriminatory access and

competitive opportunities to all participants.

Electric Service Provider (ESP):

 Broker: An agent for either entities in negotiating contracts to
purchase and /or buy electric energy and other services without
owing any transmission or generation facilities , and at the same
time does not take ownership of the energy purchased or sold for its
agents.
 Load Aggregator: Any marketer, broker, public agency, city, country
or special district, that combines the loads of multiple end-use-
consumers in facilitating the sale and purchase of electric energy,
transmission, and other services on behalf of these customers.

 Retailers: An Electric Service Provider(ESP) that can be

aggregators,brokers and marketers who enters into a direct access
 transaction with an end-use –customer. They compete on the basis
of price and services to reach and sell only electricity or electricity
and other services.
 Cogenerator: An entity that owns a generation unit that produces
electricity and another form of useful thermal energy such as heat or
steam to be used for industrial , commercial, heating or cooling
purposes, and cogeneration is the simultaneous production of both
usable heat or steam and electricity from a common fuel source.

RESTRUCTURING MODELS:

Three major models are being discussed as alternatives to the

current vertically integrated monopoly. The three models are:

1. PoolCo Model
2. Bilateral Contract Model
3. Hybrid Model

PoolCo Model:
 A PoolCo is defined as a centralized market place that
clears the market for buyers and sellers where electric
power sellers/buyers submit bids and prices into the pool
for the amounts of energy that they are willing to sell/buy.

 This pool becomes a centralized clearing market for

trading electricity which would implement competition by
forcing distribution utilities to purchase their power from
the PoolCo instead of trading with generating companies.

 These companies sell power at a Market Clearing Price

(MCP) defined by the PoolCo, instead of a price which
is based on generation cost (as is the case in a
vertically integrated monopoly).

 The final price for spot market power (spot markets is

where market generators are paid for the electricity that
they have sold to the pool and market consumers are
 charged for their electricity consumption.) may exceed
MCP to account for charges that the ISO could obligate
customers to pay for the associated ancillary
services and to cover ISO’s overhead costs.

 PoolCo does not own any generation or transmission

components and centrally dispatches all generating
units within the service jurisdiction of the pool.

 If a power provider bids too high, it may not be able to

sell power. On the other hand, buyers compete for
buying power and if their bids are too low, they may not
be getting any power.

Bilateral Contracts (Direct Access) Model:

 The Bilateral Contracts model has two main

characteristics that would distinguish it from the PoolCo
model.

 These two characteristics are: the ISO’s role is more

limited; and buyers and sellers could negotiate directly in
the market place.

 This model permits direct contracts between customers

and generators without entering into pooling
arrangements.

 Any two contracted parties would agree on contract

terms such as price, quantity and locations, and
generation providers would inform the ISO on how its
hourly generators would be dispatched.

 The ISO would make sure that sufficient resources are

available to finalize the transactions and maintain the
system reliability.
 Hybrid Model:

 The hybrid model combines various features of the

previous two models.
 The hybrid model differs from the PoolCo model,
customers are allowed to sign bilateral contracts and
choose suppliers from the pool.

 The California model is an example of the hybrid model.

 This structure has advantages over a mandatory pool as

it provides end-users with the maximum flexibility to
purchase from either the pool or directly from suppliers.

4. Scheduling Coordinators (SC)

 SCs arrange trading between generators and customers, SC plays
an intermediary between ISO, retailers and customers.
 Each SC submits balanced schedules and provides settlement ready
data to ISO.
 Each SC maintains a year around, 24 hour scheduling center and
provides non emergency operating instructions to generators and
retailers.
 Each SC provides the ISO with its customers demand, supply
schedule and transmission use and ISO runs the information through
a computer program to check for transmission congestion

 If no congestion exists ,ISO will send approval signal to the SC,

otherwise the SC will be advised to sell, buy or trade power to
resolve the situation.

 In this process, the ISO may provide suggested alternatives to the

SC for removing the congestion.

 SC plays a critical role in restructured power systems. In California,

SCs are the only market players for generation dispatch and
responsible for resolving congestion (through adjustment bids).
  This is different from restructuring proposals in New York, New
England and PJM (Pennsylvania ,New Jersey ,Maryland) where ISO
resolves congestion.

 Moreover SCs may negotiate bilateral contract with or between its

participants
 In the day-ahead and hour-ahead markets, SC’s schedule at each
hour must balance the power injected into the system and the power
extracted from the system.
 The ISO is not allowed to adjust individual schedules of SCs’
participants (generators or consumers), only SCs have this power,
with one exception in the case of extreme emergency (such as
severe outages) when the ISO is authorized to change generation
or/and load to secure the system.

Difference between SC and PX:

 Even though PX is seen as SC it has a limited role and trading
functionalities as compared to other SCs

 An SC would have the ability to negotiate with its own generators

and client loads and interact with other SCs. SCs disclose resulting
schedules to its own participants and are not obligated to pass on
any information to other participants which conclude that SCs could
discriminate against some participants.

 This fact is in contrast to the PX which publishes MCP based on non

discriminatory auction results and notifies its participants of these
results.

 The non-discriminatory is guaranteed in the PX while the SC can

price discriminate by matching the next highest willingness to pay for
demand with a slightly lower generation price.

 If SC imposes price discrimination, it could lead to prices which

would be higher than a uniform MCP determined by the PX.
  In the day ahead market, SC participants could trade energy for
reducing congestion and lowering power costs, while PX traders
cannot respond to congestion through bids or trades. This may lead
market participants to avoid PX to prevent possible curtailments in
the future.

5. Independent System Operator (ISO)

 A competitive generation market and retail direct access
necessitated an independent operational control of the grid.
However, the independent operation of the grid was not guaranteed
without an independent entity , the so called Independent System
Operator (ISO).

 An ISO is independent of individual market participants such as

transmission owners, generators , distribution companies and end
users. The basic purpose of ISO is to ensure a fair and a non-
discriminatory access to transmission services and ancillary services
to maintain the real-time operation of the system and facilitate its
reliability requirements.

Role of ISO:

 The primary objective of the ISO is matching electricity supply with

demand as necessary to ensure reliability .

 ISO should control generation to the extent necessary to maintain

reliability and optimise transmission efficiency.
In Order No.888, FERC developed eleven principles as guidelines to
the electric industry restructuring to form a properly constituted ISO,
through which public utilities could comply with FERCs non-
discriminatory transmission tariff requirements :

1. ISO governance should be structured in a fair and non

discriminatory manner.
2. An ISO and its employees should have no financial interest in the
economic performance of any power market participant. An ISO
should adopt and enforce strict conflict of interest standards.

3. An ISO should provide open access to the transmission system and

all services in a non-discriminatory manner.

4. An ISO should have the primary responsibility in ensuring short-term

reliability of grid operations. Its role in this responsibility should be
well defined and comply with applicable standards set by
NERC(North American Electricity Reliability Corporation) and
regional reliability council.

5. An ISO should have control over the operation of interconnected

transmission facilities within its region.

6. An ISO should identify constraints on the system and be able to take

operational actions to relieve these constraints within the trading
rules established by the governing body. These rules should
promote efficient trading.

7. An ISO should have appropriate incentives for efficient management

and administration and should procure services needed for such
management and administration in an open market.

8. An ISOs transmission and ancillary services pricing policies should

promote the efficient use of and investment in generation,
transmission and consumption.

9. An ISO should make transmission system information publicly

available on a timely basis via an electronic information network
(OASIS) consistent with the commissions requirements.

10. An ISO should develop mechanisms to co-ordinate its activities

with neighbouring control areas.
11. An ISO should establish an Alternate Dispute Resolution (ADR)
process to resolve disputes in the first instance.
  An ISO is mainly responsible for maintaining system integrity by
acquiring resources necessary to remove transmission violations,
balance the system in second to second manner and maintain
system frequency at an acceptable level to retain stability.

6.Transmission Owners/Providers
 The basic premise of transmission open access is that the
transmission owners/providers treat all transmission users on a non-
discriminatory and comparable basis regarding access to and use of
the transmission system and services.

 This requirement could be difficult to ensure if the transmission

owners have any financial interests in energy generation or supply.

 A general trend is, therefore to designate an Independent System

Operator (ISO) to operate the transmission system and facilitate
provision of transmission services.

 Maintenance of the transmission system remains the responsibility of

the transmission owners.
7.Ancillary Services
Ancillary services are defined as services which are required to support
the transmission of capacity and energy from resources to loads while
keeping a reliable operation of the transmission system of a transmission
provider in accordance with Good utility practice.
 Ancillary service providers supply the transmission network support
services that are needed for reliable operation of the power system.

 In its order 888, FERC has defined six ancillary services that must
be provided by or made available through transmission providers.

 They are 1. Scheduling Control and Dispatch services

2. Reactive supply and voltage control
3. Regulation and frequency response services
4. Energy imbalance service
5. Operating reserve, spinning and supplemental
reserve services
 6. Transmission constraint mitigation (congestion
management)

 Transmission customers may self-provide these services or buy

them through one of the following methods:

(i) Providers of these services advertise their availability via the

OASIS or commercial exchanges
(ii) ISO provides these services in real time and charges
transmission users.

Market Clearing Price (MCP):

 PX accepts supply and demand bids to determine a

MCP for each of the 24 periods in the trading day.

Computers aggregate all valid (approved) supply bids

and demand bids. Draw the aggregated demand bid
curve and aggregated supply offer curve.

 MCPs are determined at the intersection of

aggregated supply and aggregated demand curves
and all trades are executed at the MCP, in other
words, the MCP is the balance price at the market
equilibrium for the aggregated supply and demand
graphs.

Day-Ahead Market:

 In the day ahead market, participants would bid

supply and demand for the next day’s 24 hours.This
market starts at 6 am and closes at 1 p.m of the day
ahead of the trading day.

 In the day-ahead market and for each hour of the 24-

hour scheduling day, sellers bid a schedule of supply
at various prices, buyers bid a schedule of demand at
various prices, and MCP is determined for each hour.

 Then, sellers specify the resources for the sold

power, and buyers specify the delivery points for the
 purchased power. PX schedules supply and demand
with the ISO for delivery.
 Supply and demand are adjusted to account for
congestion and ancillary services and then PX
finalizes the schedules.

 When the market closes, the ISO announces the final

day ahead schedules.

Hour-Ahead market:
In the hour-ahead market participants perform a similar
bidding process as the day ahead market, where the
hour ahead market begins two hours before the hour of
operation.

This market provides a means for participants to buy

and sell so as to adjust their day ahead commitments
based on information closer to the transaction hour
schedules for minimizing real time imbalances.

In-Elastic Market or Single side auction market:

An inelastic market or Single side auction market

does not provide sufficient signals or incentives to a
consumer to adjust its demand in response to the price,
i.e., the consumer does not have any motivation to
adjust its demand for electrical energy to adapt to
market conditions.

Here supply curves show elasticity, i.e., there are

different price offers for energy for each of the supply
curves, while the demand remains inelastic, i.e.
demand for energy is the same, regardless of the price
of energy (or the inelastic demand shows no price
sensitivity).

Elastic market or Double side auction market :

Both supply and demand show elasticity, i.e., there are

different price offers for energy for each of the supply
and demand .
TRANSMISSION PRICING:

FERC recognized that transmission grid is the key

issue to competition, and issued guidelines to price
the transmission. The guidelines are summarized
such that the transmission pricing would:

(i) meet traditional revenue requirements of

transmission owners

(ii) reflect comparability: i.e. a transmission owner

would charge itself on the same basis that it
would charge others for the same service

(iii) promote economic efficiency

(iv) promote fairness

(v) be practical

Transmission pricing methods:

1. Contract Path Method

2. MW-Mile method

MW –mile method:

 Several ISOs are using a MW-Mile approach

to price transmission.

 The MW-Mile rate is basically based on the

distance between transacted parties (from
the generating source to the load) and flow in
each line resulted from the transaction.
  This approach takes into account parallel
power flows and eliminates the previous
problem that transmission owners were not
compensated for using their facilities.

 This approach does not give credit for

counter-flows on transmission lines.

 The method is complicated because every

change in transmission lines or transmission
equipment requires a recalculation of flows
and charges in all lines.

CONGESTION MANAGEMENT :

The condition where overloads in transmission

lines or transformers occur is called congestion.

Congestion could prevent system operators from

dispatching additional power from a specific
generator.

Congestion could be caused for various reasons ,

such as transmission line outages, generator
outages, changes in energy demand and
un-coordinated transactions.

Congestion may result in infeasibility in existing

and new contracts, additional outages and
damages to system components.

Congestion may be prevented to some extent

(preventive actions) by means of reservations,
rights and congestion pricing.

Also, congestion can be corrected by applying

controls (corrective actions) such as phase shifters,
tap transformers, Switchable VAR capacitors,
re-dispatch of generation and curtailment of loads
and FACTS devices.
 A fast relief of congestion may be possible by
removing congested lines to prevent severe
damages to the system.

INTER-ZONAL/INTRAZONAL CONGESTION

Inter zonal congestion is the occurrence of

congestion between two zones.

Intra zonal congestion is the congestion within the same

zone.

Module 3

Block forwards market:

 On March 31, 1999, the CalPX announced a new product to be introduced

during April and May 1999.

 The new product was the Block Forwards contracts which would improve
the overall efficiency of the California’s electricity market

 The market offers monthly on-peak electricity contracts for delivery

beginning in July and for the following five months.

 Each forward block consists of 16 on-peak hours, from 6 a.m. to 10 p.m.

daily, for each dayof a month, excluding Sundays and certain holidays.

 Contracts are available for each of the following six months, which includes
much of the summer when electrical demand and prices are highest and
most volatile in California.
Transmission Congestion Contracts (TCCs).

 To motivate an efficient expansion of transmission capacity in the

California’s competitive market, Transmission Congestion
Contracts(TCCs) were proposed to deal with congestion in a transmission
grid.

 TCC holder will put a contract for the flow in transmission line.

 If congestion arises in the transmission line , the holder of a contract for

transferring x MW from point a to point b could receive a monetary
compensation equal to x * (Priceb -Pricea).

 i.e A TCC holder is entitled to a payment equal to the difference in spot

prices at the two points on the system, times the quantity of TCC contract
flows that could not be completed as a result of transmission congestion.

 If congestion does not exist, prices at the two locations would be equal,
which would not entitle the holder for any payment.

 TCC holders would be entitled to receive a portion of any congestion

rentals collected by the ISO based upon spot price differentials.

TCC holders use this incentives for the expansion of transmission

capacity.

MODULE 4

ATC (Available Transfer Capability):

NERC defines ATC as a measure of the transfer

capability remaining in the physical transmission
network for further commercial activity over and
above already committed users.

The ATC value is determined based on other

parameters, which are TTC, TRM, and CBM.
 Mathematically, the ATC value between two points
is given as

ATC = TTC - TRM - (ETC + CBM)

where,

ATC - Available Transfer Capability

TTC - Total Transfer Capability between two points
TRM - Transmission Reliability Margin
ETC - Existing Transmission Commitments
CBM - Capacity Benefit Margin

TTC Calculation (Total Transfer Capability).

TTC is the total amount of electric power that can

be transferred from one area to another area over
the interconnected transmission network in a
reliable manner

TRM Calculation(Transmission Reliability Margin):

It is defined as the amount of transfer capability

necessary to provide a reasonable level of
assurance that the interconnected transmission
network will be secure.

TRM accounts for the uncertainty in operating

conditions such as variations in model parameters
(e.g line impedance), load forecasting errors, load
distribution error, variations in generation dispatch
due to component outages , variations in operating
reserves etc

Capacity Benefit Margin (CBM)

CBM is the translation of generator reserve margin
into a transfer capability quantity, determined by
Load Serving Entities.
 Capacity Benefit Margin is defined as that amount
of transmission transfer capability reserved by load
serving entities to ensure access to generation
from interconnected systems to meet generation
reliability requirements.
The transmission capacity preserved as CBM is
intended to be used by LSE only in times of
emergency generation deficiencies."

LSE would get the benefit from CBM by sharing

installed capacity reserves with other parties
elsewhere in the interconnected network.

MODULE V

ELECTRICITY TRADING:

Electricity trading through an exchange started for the

first time in 1996 where electricity futures were traded on
the New York Mercantile Exchange (NYMEX).

The Chicago Board of Trade (CBOT), the Chicago

Mercantile Exchange (CME),Minneapolis Grain
Exchange (MGE) and NYMEX are examples of large
exchanges in the Unites States.

Trading is an activity in which transactions would take

place directly between two participants (i.e., over-the-
counter, OTC) or indirectly through an organized
marketplace or exchange.

Electricity trading has two main components, i.e. physical

trading and financial trading.

PHYSICAL TRADING:
In physical trading of electricity, usually the full value
has to be paid to the seller on the spot or after a short
period of time if the seller knows the buyer very well.

FINANCIAL TRADING:

In financial trading, financial contracts would take place

between traders as agreements that would give certainty
to traders.

DEFINITIONS IN ELECTRICITY TRADING:

LIQUIDITY:

Liquidity is the ability to convert an asset into cash

equivalent to its current market value

HEDGING:

Hedging is an investment taken to limit the risk of

another investment. Ex Investors puts an insurance
policy to protect themselves from losses.

OBJECTIVE OF AN ENERGY TRADING SYSTEM:

The primary objective of an energy trading system

would be to create an accessible facility that would
 enable:

 Participants to discover future prices

 Generating unit owners to allocate supply to feed

the demand

 Sellers to deliver electricity to buyers

 Participants to forecast supply and demand"

 Participants to hedge possible risks.

To implement these objectives, the main trading

system should be composed of many functional
blocks or subsystems.

The main trading system may include information

function (subsystem), analysis function, risk
management function, decision-making function, etc.

DERIVATIVES:

Derivatives is a financial contract or instrument. The

basic derivatives are called plain vanilla which include
forwards, futures, options and swaps.

A forward or futures contract would include an

obligation (do something) to buy or sell a specified
quantity of an asset at a certain future time for a
certain price.

An options contract would include a right (not

obligation ie not forced to buy or sell) to buy or sell a
specified quantity of an asset at a certain future time
for a certain price.

A price swap is defined as an agreement between two

 participants that would negotiate in over-the-counter
(OTC) markets to exchange (swap) certain price risk
exposures over a certain period time.

FORWARD CONTRACT:

Forward contract is an agreement between two parties to

buy or sell a certain quantity of an asset at a certain
future time for a certain price (forward price).

A forward contract, has a specific expiration at which the

asset is delivered and payment is made.

Usually, the contract is held between two financial parties

or between a financial party and one of its corporate
clients.

The buyer of the contract is called long and the seller of

the contract is called short.

This type of contracts is not normally traded on an

exchange. Forwards contracts are traded bilaterally or
OTC between two counter parties.

The agreement would include the amount of commodity,

delivery price, delivery date and time, and delivery
location.

Futures contract:

Futures are standardized contracts which are traded on

and cleared by an exchange.

A futures contract is defined as an agreement between

two parties to buy or sell a certain quantity of an asset at
a certain future time for a certain price.
Even though the definition of futures contract is the same
as that of the forward contract, it differs from a forward
contract in many aspects.

The main differences of the two contracts are:

1.Unlike forward contracts, future contracts are traded in

an exchange.

2. A futures contract would have standardized terms, and

the terms are usually set by the exchange.

3. A futures contract is usually much smaller than a

forward contract.

4. A futures contract has the characteristic of marking-to-

market (daily settling up). The futures price is reset each
day and the holder’s profiles or losses are realized every
day

5. Most futures positions are closed out prior to

expiration - less than1% of future positions would
actually result in the delivery of a commodity.

6. Some futures contracts could call for cash delivery.

7. A futures contract would usually be held between a

participant and the exchange, while a forwards contract
would be between two participants or between a
participant and an establishment such as a bank.

8. In a futures contract, two contracted parties would not

necessarily know each other.

9. The exchange could guarantee that a futures contract

would be honored.

10.In a futures contract, the exact delivery date would

usually not be specified. The delivery date is specified in
 the delivery month and the exchange would specify the
delivery period during the month. The holder of the short
position would have the right to choose the delivery time
during the delivery period.

11. In futures contracts, the exchange would specify the

product’s quality and the location of its delivery.

12.It would be less costly, except for the margin and the
commission , to enter and exit a futures contract. The
commodity would never have to change hands, as long
as a participant would pay its losses or get paid on the
expiration date

13.A margin is required for entering a futures transaction.

14.Futures prices would converge to spot prices at the

expiration of a futures contract.

An options contract would include a right (not obligation)

to buy or sell a specified quantity of an asset at a
certain future time for a certain price.

Call Options (calls): The holder is given the right to buy

the asset by a certain date for a certain price.

Put Options (Puts): The holder is given the right to sell

the asset by a certain date for a certain price

Swaps are the other type of derivatives that market

entities could use for hedging.

A price swap is defined as an agreement between two

participants that would negotiate in over-the-counter
(OTC) markets to certain price risk exposures over a
certain period time.