IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 22, NO.
2, MAY 2007
Negotiating Bilateral Contracts in Electricity Markets
Sameh El Khatib, Student Member, IEEE, and Francisco D. Galiana, Fellow, IEEE
Abstract—In mixed pool/bilateral electricity markets, partic-
ipants can sign forward bilateral contracts several months in
advance of its delivery. In addition, generators may sell to and
loads may buy from the pool at the spot price through the day-
ahead or balancing markets. Forward bilateral contracts have the
advantage of price predictability in comparison with the uncertain
spot price. However, the risk is that such a contract commits
the partners to a price that may be disadvantageous compared
to the spot price. Here, we propose a systematic negotiation
scheme through which a generator and load can reach a mutually
beneficial and risk tolerable forward bilateral contract, either
physical or financial. Under this approach, the generator and load
respond rationally to a stream of bilateral bids/counter-bids and
offers/counter-offers considering their respective benefits while
accounting for the risks incurred by the prediction uncertainty in
the pool spot price and other market parameters over the length
of the contract. Each negotiating party can choose its own defi-
nition of risk which can be influenced by regret, value-at-risk or
dispersion from the mean. Numerical tests show that this flexible
negotiating approach can be readily put into practice.
Index Terms—Contract negotiation, forward bilateral contracts,
market uncertainty, pool/bilateral electricity markets, regret, risk/
benefit analysis, value-at-risk.
I. INTRODUCTION
N THE restructured power industry, load-serving entities
I and generation companies trade through both bilateral con-
tracts and the power pool [1]–[4] and [5].
A bilateral contract is an agreement between two parties to
exchange electric power under a set of specified conditions such
as MW amount, time of delivery, duration, and price [6]. Bilat-
eral contracts can take the form of futures or forward contracts,
where the former are generally traded in an exchange [7], and
can be traded continuously up until their time of delivery. In
contrast, forward contracts are typically negotiated directly be-
tween the load and generator with the terms of the contract re-
maining fixed until the time of delivery [8].
Furthermore, a bilateral contract can be either physical or fi-
nancial; the former meaning that all the power transacted bi-
laterally must be self-generated and self-consumed at a pair
of specified network buses [9], [10]. In comparison a contract
is financial if the power transacted need not be self-generated
and self-consumed but could be transferred up to the short-term
market-clearing time to another entity such as the pool [5]. Such
a contract can be interpreted as a contract for difference that
simply guarantees the difference between the contract price and
Manuscript received March 7, 2006; revised October 6, 2006. This work was
supported by the Natural Sciences and Engineering Research Council, Canada,
and the Fonds québécois de la recherche sur la nature et les technologies. Paper
no. TPWRS-00131-2006.
The authors are with the Department of Electrical and Computer Engineering,
McGill University, Montreal, QC H3A 2A7, Canada (e-mail: sameh.elkhatib@
mail.mcgill.ca; francisco.galiana@mcgill.ca).
Digital Object Identifier 10.1109/TPWRS.2007.894858
0885-8950/$25.00 © 2007 IEEE
553
the pool price and has no direct physical transmission implica-
tions [11], [12].
Bilateral contracts are used in electricity markets to hedge
against pool price volatility; however, if improperly chosen, a
contract may actually worsen the benefit since, the eventual
random spot price at market-clearing time, may end up being
either too high or too low compared to the contract price.
Beyond spot price volatility [13], there exist other sources of
risk associated with engaging in a bilateral contract, principally,
random generator, and network-forced outages [14], load fore-
cast errors, and fuel price uncertainty [15]. The negotiation of a
bilateral contract will therefore converge only if both sides can
find a pool/bilateral mix that provides an acceptable compro-
mise between risk and benefit. The literature contains a wealth
of approaches to deal with risk/benefit tradeoff, typically as part
of portfolio management [16], [17] and [18]. There is also a vast
body of literature dealing with the broader issues of negotiation
and decision-making under uncertainty [19], [20].
In the area of electricity markets, the use of bilateral contracts
to manage the risks associated with nodal price fluctuations due
to transmission congestion is analyzed in [21] and [22]. In [23],
the authors use stochastic optimization to determine the optimal
price and quantity of retail electricity contracts. The risk is then
measured as a term in the objective function that the retailer mini-
mizes to limit its exposure to the volatile spot market. Schmutz et
al. [24] determine the value-at-risk from a portfolio of contracts
using fuzzy set theory and scenario construction; Bjorgan et al.
[25] also begin with a portfolio of potential contracts and develop
a technique based on Pareto-optimality to manage the tradeoff
between expected value and standard deviation of the portfolio
profit; Marzano et al. [26] express the portfolio management
problem as a dual dynamic program optimization which allows
for price dynamics over time. The pool/bilateral tradeoff problem
has been addressed in terms of game-theory [27] and stochastic
optimization [28]. The optimal pricing of forward contract prices
has also been studied in [29] through an equilibrium model. In
[29], an optimum forward price is determined by minimizing a
global objective function of the expected profits and variances
of the generators and retailers, while meeting the condition of
zero net supply of forward contracts. The authors conclude that
forward contract prices will generally exceed expected spot
prices when the demand expected value or volatility are high, a
result that is tested by simulated and real data.
The main innovation of this work is to propose a scheme
for a generator/load pair to negotiate a mutually beneficial and
risk-tolerable bilateral forward contract, or to conclude that it
is not in their mutual interest to enter into such an agreement.
In contrast to [29], we do not seek a common forward price that
meets a market equilibrium condition based on the optimization
of a global objective function. In this work, during each bilat-
eral negotiation session, we allow the parties wide flexibility to
choose their own risk/benefit measures, under the assumption
554
that, in general, each negotiating party may have a unique in-
terpretation of what risk and benefit imply. The focus of our
paper is therefore not on predicting how the market might be-
have under a common risk aversion rule and optimum forward
positions, but rather on analyzing bilateral negotiation schemes
between two specified participants, each of which is free to se-
lect its risk aversion and benefit preferences.
The scope of this paper is restricted to forward bilateral con-
tracts, either physical or financial, between a generator and load
pair. The model assumed by the negotiation process is that the
contract is to be delivered in a market where no single partici-
pant can affect the spot price and where transmission congestion
and losses as well as their associated risks are not considered.
The sources of risk that affect the negotiated contract are uncer-
tainty in the spot price, fuel costs, load revenue factor and de-
mand. Risk can be measured by any of several well-established
approaches, namely, standard deviation [25], value-at-risk [13],
[30], [31], or regret [32]–[35].
II. BASIS OF RISK/BENEFIT ASSESSMENT APPROACH
There is no unique way to define and assess risk and benefit.
Not only are the tolerance threshold to risk and its relation to
benefit subjective but so are their definitions, in other words,
the quantities that are deemed to constitute risk and benefit may
vary from one person to another.
In this paper we consider three approaches to assess the risk
of a projected bilateral contract: 1) based on the notion of regret,
under which the negotiating partner is influenced by the prob-
ability that the profit will not be sufficiently close to the best
possible (ideal) value, in other words what it could have earned
if the market parameters had been predicted exactly at the time
of contract negotiation; 2) based on the notion of value-at-risk,
under which the negotiating partner is influenced by the min-
imum profit it can earn with a given probability; and 3) based
on the notion of dispersion of the profit under which the negoti-
ating partner is influenced by the probability that the profit will
deviate excessively from its mean value.
The benefit of a bilateral agreement can also be measured
in various ways. One approach is through the expected rate of
return, in other words the expected value of the ratio of profit
to cost, a measure that can be applied in conjunction with any
of the three risk measures. However, when risk is measured via
regret, the benefit can also be defined by the ratio of the expected
value of the actual and ideal profits.
Whether or not one of the above risk/benefit measures stands
out over any other is a subject of research and even controversy
in decision-making [36], [37]. Decisions based on one risk mea-
sure will in general not agree with the conclusions reached when
using a different measure. The results section illustrates the type
of discrepancies that can occur under various choices of risk
measures. As this paper is not intended to debate what consti-
tutes a reasonable risk preference, the proposed bilateral nego-
tiation approach has been designed to be implemented under
any of the risk/benefit definitions proposed in the literature. We
also note that during a negotiation different risk/benefit mea-
sures (including a mix of the above three) may be used by each
party according to how it is influenced by market uncertainty.
IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 22, NO. 2, MAY 2007
III. BILATERAL CONTRACT CHARACTERIZATION
Whether physical or financial, a bilateral contract is typically
negotiated weeks or months prior to its delivery and includes the
following basic specifications: 1) starting date and time ( ); 2)
ending date and time ( ); 3) constant megawatt (MW) amount
over the length of the contract, GD; 4) constant price in dollar
per megawatt hour ($/MWh) over the length of the contract, ;
and 5) range of hours when the contract is to be delivered.
In a more general form, the MW amount GD and price
could be time-varying over the contract duration. This gener-
alization is, however, not pursued in this paper which aims at a
simpler negotiation that can be implemented by the two parties
independently without the need for complex calculations or the
intervention of a mediator.
IV. UNCERTAIN MARKET PARAMETERS
The uncertain market parameters considered here are the
power plant efficiency and fuel cost coefficients , the load
revenue factor , and the spot prices and load demand levels at
periodic time intervals, respectively,
and . The time interval index is
defined by sub-dividing the contract length into nc
intervals of equal duration (typically one hour).
Each of the above scalar parameters can be a random variable
with a discrete probability density function (pdf) defined over
a finite range. The spot price pdf’s estimated by the generator
and load may be different. In addition, the pdf’s of the time-
dependent parameters, and , may vary over the contract
duration to model growing uncertainty with time.
V. GENERATOR RISK AND BENEFIT
A. Generator Profit
Consider a generator with capacity and cost function
, being the generator MW output at time . The gen-
erator must decide whether or not to sign a bilateral contract
GD at a fixed price considering that at every time interval
, the generator could also sell power to the pool
through the short-term market. At time , at the uncertain spot
price , the amount sold to the pool depends on whether the
contract is physical or financial as shown next.
1) A1-Generation Dispatch With Physical Contracts: Since
for this type of contract the generator is obliged to self-generate
its bilateral commitment, the level GD imposes a hard constraint
on the lower generation limit
(1)
The generation dispatch at market-clearing under a physical
contract is denoted by . If, as an example,
the generator incremental cost takes the form with
, then
if
if
if
(2)
2) A2-Generation Dispatch With Financial Contracts: Since
with a financial contract the generator is not obliged to self-gen-
EL KHATIB AND GALIANA: NEGOTIATING BILATERAL CONTRACTS IN ELECTRICITY MARKETS
erate its bilateral commitment, the amount GD does not impose
a constraint on the lower generation limit
(3)
The generation dispatch at market-clearing under a financial
contract is denoted by . Again if, as an example, the
generator incremental cost takes the form with
then
if
if (4)
if
3) A3-Generation Profit With Physical Contract:
With a physical contract, the generation profit is equal
to what it collects from the power sold to the pool,
, and from the power sold bilaterally,
GD, minus its generation cost
(5)
4) A4-Generation Profit With Financial Contracts: The gen-
eration profit with financial contracts is equal to what it collects
from its sale to the pool plus the compensation from the load for
differences in the pool and bilateral prices minus its total gener-
ation cost
(6)
Observe that the second expression for the generator profit
with financial contracts in (6) has the same form as the gen-
erator profit with physical contracts in (5), the distinction
being in the dispatched value of . In particular, in (6), for
some time intervals, the profit due to the pool component,
may be negative, something that cannot
occur in (5) with physical contracts.
555
B. Generator Ideal Profit
The ideal profit is the maximum that the generator can earn
by adjusting its bilateral contract amount GD under the ideal
assumption that the uncertain market parameters and are
exactly known at contract negotiation time. The ideal profit is
needed when the negotiating generator bases its risk on the no-
tion of regret, in other words, if the generator is swayed by the
extra profit it could have earned had it exactly predicted the un-
certain market parameters at contract negotiation time.
Denoting the generic profit of a generator with either physical
or financial contracts by , the ideal generator
profit can be found numerically for any and , as explained in
Section VIII, from
(7)
In calculating the ideal profit in (7), the contract price is
known either as a bid from the load or as a proposed counter-
offer by the generator during a negotiation session. Note also
that if the contract is physical then the upper limit on GD is
while if the contract is financial then is self-specified by
the generator.
C. Generator Worst Profit
The generator worst profit is the minimum it would earn
after committing to a specific contract if the uncertain
parameters materialized at their most disadvantageous
values. The worst profit is needed when the generator calculates
its risk based on the notion of value-at-risk, in other words,
if the generator decision at the time of contract negotiation is
swayed by the probability that it will be uncomfortably close
to the worst-case scenario.
The worst profit for a given can be found by numer-
ically solving
(8)
D. Generator Risk
The risk to a generator of embarking on a bilateral agreement
can be measured in several ways. Here, we examine three alter-
natives all of which fit into the proposed negotiation scheme.
D1-Generator Risk Based on Regret: The difference be-
tween the ideal profit and the actual profit
defines regret. The generator risk is defined
as the probability that the regret exceeds a fraction of the
absolute value of the ideal profit, where is a self-specified
measure of the generator tolerance to such regret (the greater
the tolerance the higher )—see (9), shown at the bottom of
the page.
(9)
556 IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 22, NO. 2, MAY 2007

D2-Generator Risk Based on Value-at-Risk: The risk here A. Load Profit

is defined as the probability that the profit will be uncomfort-
ably close to its minimum—see (10), shown at the bottom of
the page, where is a self-specified measure of the generator
tolerance to such proximity.
D3-Generator Risk Based on Dispersion From the Mean:
The risk here is defined as the probability that the profit will de-
viate below its mean value by an excessive amount—see (11),
shown at the bottom of the page, where is a self-specified
measure of the generator tolerance to such dispersion and where
is the mean value of the profit. An alternative mea-
sure of risk with the same interpretation is through the standard
deviation of the profit , in which case the risk can
be defined as the ratio of the standard deviation to the absolute
mean
(12)
E. Generator Benefit
If the risk is measured in terms of regret, the benefit can be
the expected value of the ratio of the actual and ideal profits
(13)
In addition to its contract GD at the price , the load can
also buy power throughout the contract length in the short-term
market at the spot prices , . If the demand at
time is with revenue , then the load profit is
(15)
What this equation shows is that the load profit under a phys-
ical contract [first form in (15)] is the same as under a financial
contract [second form in (15)]. This is logical since, in contrast
to the generator, the load, irrespective of whether it signs a phys-
ical or a financial contract, always consumes the same amount
of power.
B. Load Ideal Profit
Synonymous with the generator analysis, the load ideal profit
is the maximum that it would earn by adjusting its bilateral con-
tract amount GD assuming that the uncertain market parameters
, and are known at contract negotiation time. The ideal load
profit is found by numerically solving

An alternative measure of the generator benefit valid for any

of the three forms is the rate of return, that is, the expected value
of the ratio of the profit to the cost (16)

If the contract is physical, then while if the

(14) contract is financial then is self-specified by the load.

C. Load Worst Profit

The load worst profit is the minimum earned under a specific
VI. LOAD RISK AND BENEFIT
contract if the uncertain parameters materi-
The load must also decide on a bilateral price and amount alize at their most disadvantageous values. This is required when
through its own risk/benefit analysis. Note that although the the load decision at contract negotiation time is swayed by the
symbols and GD used here are the same as in the generator probability that it is too close to the worst case scenario. The
case, the two risk/benefit analyses are conducted independently, worst profit for a given can be found by numerically
one by the load and the other by the generator. Thus, the corre- solving
sponding and GD values differ, except when and if load and
generator reach an agreement through the negotiation described
(17)
in Section VII.

(10)

(11)
EL KHATIB AND GALIANA: NEGOTIATING BILATERAL CONTRACTS IN ELECTRICITY MARKETS
D. Load Risk
1) D1-Load Risk Based on Regret: Load regret is the differ-
ence between the ideal profit and the actual
profit . The load risk is the probability that
the regret exceeds a self-specified fraction of the absolute
value of the ideal profit—see (18), shown at the bottom of the
page.
2) D2-Load Risk Based on Value-at-Risk: Here, risk is the
probability that the profit will be too close to its minimum—see
(19), shown at the bottom of the page.
3) D3-Load Risk Based on Dispersion From the Mean: Risk
here is the probability that the load profit will deviate below its
mean value by an excessive amount—see (20), shown at the
bottom of the page, where is the mean value of
the profit. As in the generator case, a similar risk measure can
be defined as the ratio of the standard deviation to the absolute
mean
(21)
E. Load Benefit
If the risk is measured in terms of regret, the benefit can be
the expected value of the ratio of the actual and ideal profits
(22)
Alternatively, for any of the three risk definitions, the load
benefit can be expressed by the rate of return, namely the ex-
pected value of the ratio of the profit to its payment to the pool
and to the generator supplying GD
(23)
VII. NEGOTIATING A BILATERAL CONTRACT
First, it is assumed that both parties have agreed on the po-
tential contract start and end times. The bilateral negotiation
557
Fig. 1. Generator and load risk for the initial proposed price of 35 $/MWh.
approach for and GD contains two basic elements: 1) each
participant chooses its definition of risk and benefit as well as
the extreme limits beyond which it is not ready to compromise
(these limits are affected by the type of risk measure used but
they all are typically less than one) and 2) the participants en-
gage in an iterative negotiation process under which one partic-
ipant offers or bids a contract price and a corresponding range
of GD. The receiving party conducts a risk/benefit analysis for
the current which leads: a) to a new counter offer or bid; b) to
an agreement on a specific value of ; or c) to conclude
that there is no possibility of agreement. These steps are now
described in more detail.
A. Risk/Benefit Analysis
For a proposed contract price the risk/benefit analysis by
either generator or load consists of two steps:
1) Compute the respective risk and benefit versus the bilateral
contract amount GD over its feasible range. The various
substeps are detailed in Section VIII.
2) Identify the acceptable set of GD that meets the risk/benefit
criteria (e.g., Fig. 1). If no acceptable GD range is found,
the analysis rejects the proposed price .
B. The Iterative Negotiation Process
i) The iterative negotiation process can be initiated by either
the load or the generator.
(18)
(19)
(20)
558
ii) The participant initiating the process proposes a contract
price that meets its risk/benefit criteria over a broad ac-
ceptable GD range. This price is a compromise between
the participant’s desire to maximize its benefit within its
risk criterion, yet granting enough flexibility to the other
party to accept this proposal or to respond with a reason-
able counter proposal.
iii) The participant receiving the proposal runs its own risk/
benefit analysis and identifies its own acceptable range of
GD. Then it responds in three possible ways:
a) if the two ranges overlap, it accepts the proposal at the
value of GD in the overlapping set that maximizes its
benefit;
b) if the two ranges do not overlap, it rejects the pro-
posal and counter-proposes with a new bilateral price
(higher if a generator and lower if a load) over a new
acceptable range of GD that overlaps or comes closer
to overlapping the range originally proposed;
c) if the two ranges do not overlap and a sufficient
number of iterations have gone by without finding an
overlapping range of GD, the negotiation is halted.
VIII. NUMERICAL COMPUTATION OF RISK AND BENEFIT
We now describe a typical numerical scheme used by a ne-
gotiating participant when searching for an acceptable range of
GD that meets its specified risk and benefit criterion. The partic-
ular scheme described below corresponds to a generator when
risk is based on regret, but a similar scheme applies to the load
and when the risk is measured based on value-at-risk or disper-
sion from the mean.
1) Specify or consider a value of proposed by the load.
2) Divide the random parameters into a discrete set of
samples. From the respective pdf’s, identify a probability
for each sample, . incremental generation cost (20 $/MWh), the results are
3) Divide the generation capacity range into a
discrete set of GD samples.
4) For each sample of the random variables , solve (7)
over all GD samples to obtain the generator ideal profit
. are both 25%. The steps of this negotiation are as follows.
5) For each sample of GD:
i) for all samples of calculate the profit
from (5) if the contract is phys-
ical and from (6) if the contract is financial;
ii) from (9), calculate the generator risk by summing the
probabilities of all samples meeting the regret
inequality. Similarly, from (13) or (14), find the benefit.
6) Identify the range of GD for which the desired maximum
regret and minimum benefit are satisfied.
IX. BILATERAL NEGOTIATION EXAMPLES
Two negotiation examples are presented here. In the first, both
parties use regret as their risk measure, while in the second, the
common risk measure is dispersion from the mean.
The data used in both examples are given in Tables I and II.
Several simplifying assumptions are made about the contract
type and the degree of uncertainty.
• The spot price remains constant over time for the entire
length of the contract. This spot-price level is uncertain but
IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 22, NO. 2, MAY 2007
TABLE I
ASSUMED GENERATOR PARAMETERS
TABLE II
ASSUMED LOAD PARAMETERS
can be modeled as a uniformly distributed random variable.
Both generator and load use the same probability distribu-
tion to model the spot-price uncertainty.
• The demand and generator incremental cost also remain
unchanged over the length of the contract, but they are
known constants.
• Both load and generator use the rate of return (ratio of the
profit to the cost), as the benefit measure.
• The contract is physical. However, in this example, since
the minimum spot price (30 $/MWh) is greater than the
identical to the case with a financial contract.
A. Negotiation Example Measuring Risk Based on Regret
Here, the maximum risks accepted by the generator and load
1) After experimenting with several contract prices and their
corresponding risk/benefit, the load submits a “reasonable”
initial value of 35 $/MWh. From Figs. 1 and 5, the corre-
sponding acceptable GD range is [60, 100] MW.
2) Upon receiving the load proposal, the generator finds its
own risk/benefit for the proposed bilateral price of 35
$/MWh. From Figs. 1 and 4, the generator then identifies
its own acceptable GD range of [0, 35] MW. Since this
interval does not overlap the proposed [60, 100] MW,
there is no agreement at this price.
3) The generator therefore seeks a counter-offer whose cor-
responding acceptable GD range overlaps the current pro-
posed range. After some trials, the generator counter offers
with a higher bilateral price at 43 $/MWh. From Figs. 2
and 4, this higher counter offer yields a new acceptable
GD range of [56, 100] MW which overlaps the current pro-
posed range of [60, 100] MW.
4) Upon receiving the generator counter-offer of 43 $/MWh
over [56, 100] MW, the load calculates its risk/benefit for
EL KHATIB AND GALIANA: NEGOTIATING BILATERAL CONTRACTS IN ELECTRICITY MARKETS 559

Fig. 2. Generator and load risk for the counter-proposed price of 43 $/MWh. Fig. 4. Generator benefit for three bilateral prices.

Fig. 5. Load benefit for three bilateral prices.

Fig. 3. Generator and load risk for the agreed-to bilateral price of 39 $/MWh.

that price. From Figs. 2 and 5 this analysis yields a new

acceptable GD range of [0, 7] MW (restricted by the ben-
efit), which still does not overlap the [56, 100] MW range
submitted by the generator. Thus, at this price, there still is
no agreement.
5) The load now counter-bids with a new lower bilateral price,
which as seen in Figs. 3 and 5, at 39 $/MWh yields a new
acceptable GD range of [40, 100] MW thus overlapping
the [56, 100] MW interval submitted by the generator.
6) Upon receiving the load counter-bid of 39 $/MWh over
[40, 100] MW, the generator calculates its risk/benefit for
this price. As shown in Figs. 3 and 4, this analysis yields a
new GD range of [30, 44] MW which now does overlap the Fig. 6. Generator and load risk based on dispersion from the mean for the
[40, 100] MW interval proposed by the load. The generator agreed-to bilateral price 39 $/MWh found using regret as the risk measure.
then halts the negotiation by accepting the latest bilateral
price and by choosing the value of which as
seen in Fig. 4 maximizes its benefit within the overlapping The parties can also evaluate the negotiated contract position
interval. ( , ) from another risk perspec-
The shape of the risk curves versus GD is not always intuitive, tive such as dispersion from the mean. Then, as indicated in
but where possible we have verified their correctness through Fig. 6, the risk would be 29% for the generator and 22% for
independent means, namely, numerically and analytically. The the load. This evaluation could be done at the end of the process
breaks in the curves are due to the various events characterizing or during each negotiation step. It can serve to ensure that the
the possible relative locations of the random parameters with position reached with one risk criterion is not radically different
respect to each other (e.g., the event that versus the event from the position that would be reached with an alternative risk
that ). criterion.
560 IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 22, NO. 2, MAY 2007

Fig. 7. Generator and load risk for the bilateral price of 34 $/MWh.

Fig. 9. Generator and load risk for the bilateral price of 38 $/MWh.

Fig. 8. Generator and load risk for the bilateral price of 42 $/MWh.
Fig. 10. Generator benefit for three bilateral prices.

B. Negotiation Example Measuring Risk Based on Dispersion

From the Mean
Here the maximum risks accepted by the generator and load
are both 10%. The steps of this negotiation are:
1) The load submits a price of 34 $/MWh. From Figs. 7 and
11, the acceptable GD range is [53, 100] MW.
2) From its own risk/benefit curves (Figs. 7 and 10), at this
price and amount range, the generator cannot meet its risk/
benefit criteria and counter offers with a higher price of 42
$/MWh. From Figs. 8 and 10 the corresponding acceptable
GD range of [60, 100] MW overlaps the current proposed
range of [53, 100] MW.
3) The load calculates its own risk/benefit (Figs. 8 and 11)
and concludes that, at this price and range, it cannot meet Fig. 11. Load benefit for three bilateral prices.
its risk/benefit criteria, countering with a lower price of 38
$/MWh. From Figs. 9 and 11, the corresponding accept-
ableGD range of [58, 100] MW overlaps the current pro- choosing the value of , which maximizes
posed range of [60, 100] MW. its benefit within the overlapping interval.1
4) From its own risk/benefit curves at the current offer (Figs. 9 As in the first example, the parties can also analyze the ne-
and 10), the generator finds an acceptable GD range of [65, gotiated contract position ( , )
100] MW which now does overlap the proposed [58, 100] from another risk perspective such as regret. Then, as indicated
MW interval. The generator therefore halts the negotiation 1At a lower level of benefit, the parties could have reached an agreement in
by accepting the latest bilateral price of 38 $/MWh and fewer steps however their aim here is to secure the highest possible benefit.
EL KHATIB AND GALIANA: NEGOTIATING BILATERAL CONTRACTS IN ELECTRICITY MARKETS 561

expected rate of return. In addition, each party can self specify

how the uncertain parameters such as spot price, fuel price and
demand should be modelled, typically through a probability
distribution.
The various steps of this iterative negotiation process have
been detailed and illustrated through examples in which the load
and generator converge to a mutually satisfactory bilateral con-
tract after three bargaining sessions.

La Mancha for his valuable comments and C. G. Quilez from the
University of Sevilla for her help in the numerical testing of the
Fig. 12. Generator and load risk based on regret for the agreed-to bilateral price
negotiation scheme.
of 38 $/MWh found using dispersion from the mean as the risk measure.
in Fig. 12, the risk would be 35% for the generator and 15% for
the load.
Some notable observations on the negotiation process are as
follows.
a) Increasing the uncertainty range of any parameter usually
increases risk and decreases the probability of a negoti-
ated agreement. On the other hand, under perfect knowl-
edge of the input parameters, the parties cannot come to
an agreement since, without uncertainty, each party would
know precisely whether a profit is possible or not.
b) Unimodal nonuniform distributions of the uncertain pa-
rameters tend to decrease risk and increase the probability
of a negotiated agreement.
c) The presence of several simultaneous sources of uncer-
tainty such as spot price and fuel costs increases risk and
decreases the probability of a negotiated agreement.
d) If no agreement is possible, other than halting the negotia-
tion, one or both parties may opt to increase their tolerance
to risk by increasing or by increasing the maximum tol-
erable risk.
e) The effect of time-varying spot prices and demand levels
is also to increase risk compared to the case where these
parameters are uniform across the length of the contract.
X. CONCLUSIONS
In mixed pool/bilateral markets, the spot price, system de-
mand and fuel costs at pool market-clearing are uncertain at the
time of negotiating a bilateral contract, typically several months
in advance. Thus, although bilateral contracts are useful hedging
instruments against the volatility of the spot market, the bilateral
contract amount and price must be systematically negotiated in
order for both buyer and seller to meet their acceptable stan-
dards of risk and benefit.
We have developed an iterative approach through which a
generator and load can negotiate a bilateral contract described
by its time of delivery, duration, amount, and price. The ap-
proach is very flexible, allowing the negotiating parties to self-
specify their risk/benefit measures, as well as the corresponding
acceptable thresholds. Risk can be defined based on the notions
of regret, value-at-risk, or dispersion from the mean, while ben-
efit can be described in several ways including expected profit or
ACKNOWLEDGMENT
The authors thank A. J. Conejo from the University of Castilla
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Sameh El Khatib (S’03) received the B.Eng. and
M.Eng. degrees in electrical engineering in 2002 and
2005, respectively, from McGill University, Mon-
treal, QC, Canada, where he is currently working
toward the Ph.D. degree.
His research interests include power system eco-
nomics, portfolio management, and congestion man-
agement.
Francisco D. Galiana (F’93) received the B.Eng.
(Hons.) degree from McGill University, Montreal,
QC, Canada, in 1966 and the M.S. and Ph.D. degrees
from the Massachusetts Institute of Technology,
Cambridge, in 1968 and 1971, respectively.
He spent some years at the Brown Broveri
Research Center, Baden, Switzerland, and held a
faculty position at the University of Michigan, Ann
Arbor. He joined the Department of Electrical and
Computer Engineering, McGill University, in 1977,
where he is currently a Full Professor.