Energy trading

NOIEMBRIE 2021
 What Do Energy Traders Do?
• The main task of a energy trader is to sell or buy shares of
Primary energy at a given price to make a profit.
• Energy traders use computer software programs and other
analytical tools, such as meteorological data to help
Responsibilities determine which way energy prices might be headed.

• Energy traders use a number of tools to help predict energy

prices. Keeping these tools in shape is one of the key
secondary tasks of an energy trader.
Secondary Tasks • Depending on the size of the energy trading firm and the
energy trader's position, there may be mandatory securities
paperwork that needs to be filed during a sale or purchase.

https://www.youtube.com/watch?v=MRUdfhdP7ls
 Terms (1)
❖Arbitrage refers to the practice of buying an asset then selling it immediately to take advantage of a difference in price.
❖Ask refers to the price at which you can buy an asset or security from a seller. It can be variously referred to as ask, the ask,
or asking price. The ask will be the price you need to pay in order to buy a particular asset: so we usually refer to it as the
'buy' price.
❖Bid in trading and investing, the bid is the amount a party is willing to pay in order to buy a financial instrument. It is the
opposite of an ask
❖Broker is an individual or company that places trades on behalf of a trader e .g TFS.
❖Commodity is a basic physical asset, often used as a raw material in the production of goods or services.
❖Derivative is a financial product that enables traders to speculate on the price movement of assets without purchasing the
assets themselves.
❖Execution In trading, execution is the completion of a buy or sell order from a trader. It is carried out by a broker.
❖Exposure is a general term that can mean three things:
◦ the total market value of your trades at open
◦ the total amount of possible risk at any given point
◦ the portion of a fund invested in a particular market or asset
 Terms (2)
❖A forward contract is a contract that has a defined date of expiry. The contract can vary between different instances, making
it a non-standardized entity that can be customized according to the asset being traded, expiry date and amount being
traded.
❖Futures contracts represent an agreement between two parties to trade an asset at a defined price on a specified date in the
future. They are also often referred to simply as ‘futures’.
❖A hedge is an investment or trade designed to reduce your existing exposure to risk. The process of reducing risk via
investments is called 'hedging'. Most hedges take the form of a position that offsets one or more positions you have open,
like a futures contract offering to sell stock that you have bought. Hedging can come in many forms, however, like buying an
asset that tends to move inversely with the asset you are holding. A hedge that removes all risk from a position – except the
cost of the hedge itself – is referred to as a perfect hedge, but most traders will only hedge against part of their position.
❖In the money is a term that describes an option’s state of ‘moneyness’ – or the underlying asset’s status when compared to
the price at which it can be bought or sold (its strike price).
❖Index In trading, an index is a grouping of financial assets that are used to give a performance indicator of a particular sector.
❖Long When used in trading, long refers to a position that makes profit if an asset’s market price increases. Usually used in
context as ‘taking a long position’, or ‘going long’.
❖A market maker is an individual or institution that buys and sells large amounts of a particular asset in order to facilitate
liquidity
 Terms (3)
❖Open positions Your open positions are the trades you have made that are still able to incur a profit or a loss. When a
position is closed, all profits and losses are realized and the trade is no longer active.
❖An option is a financial instrument that offers you the right – but not the obligation – to buy or sell an asset when its price
moves beyond a certain price with a set time period.
There are two types of option:
◦ Call give the holder the option to buy an asset at or above the strike price
◦ Put give the holder the option to sell an asset at or below the strike price
❖An option spread is a strategy used in options trading. It involves buying and selling multiple options on the same underlying
asset that are almost identical to each other but with a different strike price or expiry.
❖Order In trading, an order is a request sent to a broker or trading platform to make a trade on a financial instrument.
❖OTC stands for over-the-counter, and refers to a trade that is not made on a formal exchange. It is often referred to as off-
exchange trading.
❖A portfolio refers to group of assets that are held by a trader or trading company. Assets in a portfolio can come in many
forms, including stocks, bonds, commodities or derivatives.
❖Position is the financial term for a trade that is either currently able to incur a profit or a loss (an open position) or has
recently been cancelled (a closed position). Positions are the way in which a trader will hope to make a profit.
 Terms (4)
❖ PnL Profit and loss are two terms that are central to trading: the financial returns (or outgoings without returns) from any business
enterprise or trade.
❖Put option Puts are a variety of option that give the purchaser the right, but not the obligation, to sell an asset at a certain price
before the option expires.
❖Quote In trading, the quote is the price at which an asset was last traded, or the price at which it can currently be bought or sold.
❖In trading, short describes a trade that will incur a profit if the asset being traded falls in price. It is also often referred to as going
short, shorting or sometimes selling. Shorting is the opposite of going long, or trading to incur a profit if your market increases in
price.
❖Spread In finance, the spread is the difference in price between the buy (bid) and sell (offer) prices quoted for an asset.
❖Strike In options trading, the strike is the price at which a contract can be exercised, and the price at which the underlying asset will
be bought or sold. It is also known as the strike price.
❖If the option is a call, then when the underlying asset hits the strike price it can be bought. If the option is a put, then hitting the
strike price means the underlying asset can be sold. In order for an option to be exercised, it must reach its strike price before its
expiration date. The more the asset price moves beyond the strike price, the more profit is derived from the option. When the
underlying asset in an option matches its strike price, the option is known as being at the money. When it exceeds the strike price, it
is in the money.
❖A trading floor is the area of a business or an exchange where assets are bought and sold, most commonly associated with stock
exchanges and futures exchanges.
 Terms (5)
❖Trading plan is a strategy set by the individual trader in order to systemize evaluation of assets, risk management, types of
trading, and objective setting. Most trading plans will comprise two parts: long Your personal trading plan will be unique to you,
reflecting your risk appetite, preferred markets and trading style. Making a trading plan means taking your short- and long-term
goals into account, as well as expertise and other factors.-term trading objectives, and the route to achieving them.
❖VaR – value at risk A statistical technique used to measure and quantify the level of financial risk within a firm or
investment portfolio over a specific time frame. Value at risk is used by risk managers in order to measure and control the level
of risk which the firm undertakes. The risk manager's job is to ensure that risks are not taken beyond the level at which the firm
can absorb the losses of a probable worst outcome.
http://financetrainingcourse.com/education/2012/07/value-at-risk-var-case-study-explanation/

❖Volatility -A statistical measure of the dispersion of returns for a given security or market index. Volatility can either be
measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the
higher the volatility, the riskier the security.
❖'Mark To Market - MTM‘ - a measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark
to market aims to provide a realistic appraisal of an institution's or company's current financial situation.
 Who are the Participants in the
Energy Markets?
❖Those with a Physical Interest
• Electric Utilities
• Oil and Gas Producers
• Industrial Oil/Gas Consumers
• Coal Mines
❖Those without a Physical Interest
• Financial Entities Hedge Funds, Banks
• Private Investors via Commodity Indexes
• Local Traders on the Exchanges
 WHY?

❖For utilities (and other entities with a physical interest), the intent is to
manage risk.
❖For those without a physical interest, the intent is to take on risk in
hopes of a reward or arbitrage opportunity.
 Types of Market Participants
Three types of participants in forward markets:
❖ Hedgers – Producers & Suppliers - Intent is protection, to avoid exposure to adverse price
movements
❖ Speculators – Traders - Intent is profit,
✓ willing to take a position in the market,
✓ betting that the price will go up or down.

❖ Arbitrageurs – Producers & Traders - Intent is profit;

✓ Lock in profit by concurrently taking positions in two different markets – cross border trading or
cross commodities trading
✓ Important group for liquid markets and keeping markets in balance
✓ Existence ensures minimal arbitrage opportunities for liquid markets
 Market Maker
❖Market Maker are those companies which undertake to keep a buy and sell order in the order
book at all the time (obligation to quote)
❖Market makers ensure a “basic liquidity”;
❖There can be one or several market maker for one OTC platforms;
❖Minimum requirements are put with regard to the market makers obligation to quote:
✓ Minimum volume
✓ Maximum ask – bid range (spread)
✓ Minimum quotation duration during the day
❖They have granted reduced fees for all the transactions – monthly measurement of
performance
 Relationship between the Physical &
Financial
❖For those with a physical interest in the market, they are naturally short (in need of a
commodity) or naturally long (with an excess of a commodity).
❖Their participation in the market is in direct relationship to their naturally short or naturally
long position.
❖Those with a physical interest will use the market to balance their naturally short or long
position.
❖This takes much of the risk out of the commodity prices and allows the utility to focus on its
core business.
 Physical & Financial
PHYSICAL FINANCIAL

Naturally Short Long Natural

Natural Gas Gas Contract

❖ This utility needs (is short) natural gas; it hedges the price risk by
purchasing (going long) a financial natural gas contract.
❖ May also hedge physical delivery risk by entering into a physical
purchase with index based pricing.
How is Energy Traded?
Buys Sells

Different Markets
✓ Exchange Traded
✓ Over the Counter
 Exchange
▪ An organization formed to provide an orderly market for trading futures and options.
▪ Provides the requisite infrastructure and support to facilitate trading.
▪ Facilitates the shifting of risk between counter-parties and price discovery.
e.g. EU exchange EEX; APX; Nordpool
Exchange structure: Exchange +Clearing House (e.g. ECC) +Trading participants +clearing
members
 Exchange Traded Contracts
❖Product Terms are standardized and non-negotiable (set by the Exchange)
❖Counter-party risk is assumed by the clearing members of the exchange
❖Most contracts are Financially Settled (though a small number may be Physically Delivered)
❖Characterized by generally greater liquidity than Over-the-Counter
❖The trade is between the Exchange and the buyer or seller.
❖The parties buying and selling with the Exchange are required to post a Margin (to mitigate
counterparty credit risk)
 Over-the-Counter (OTC)
❖ All transactions completed outside of a regulated exchange (e.g., EEX)
❖ An OTC deal is negotiated between two counter-parties or with a broker(e.g. TFS, ICAP).
❖ The counter-parties take on credit risk.
❖ The terms of an OTC deal are negotiable and can be customized.
❖The contract can be customized as agreed to by the two parties.
❖ Both parties will be subject to credit risk.
• Some “standardized” bilateral contracts have been developed.
✓ International Swaps and Derivatives Association (ISDA) – Standard agreement for financial trading
✓ Energy Federation European Trading (EFET)- Standard agreement for trading physical power
✓ Edison Electric Institute (EEI) – Standard agreement for trading physical power
✓ North American Energy Standards Board (NAESB) – Formerly GISB (Gas Industry Standards Board) – A standard agreement for trading physical
gas
 Forward Contract
❖An agreement between two counter-parties to buy/sell the commodity in the future at an
agreed upon price.
❖The terms of the contract are negotiable and may be customized.
❖Since forward contracts are not traded on an exchange, each counter-party takes on
credit risk.
❖Forwards can not always be easily liquidated with an off-setting trade.
❖A forward contract is considered “must take” energy.
❖Many forward contracts for electricity are “fixed price” (though they can also be based
upon an index) and are traded in monthly blocks.
❖May be physically delivered or booked out.
 Forward Price Curve = Market
Intelligent in a trading Company
❖A strip of forward prices starting with the prompt month and ending with some point out in the
future. Represents the term structure of forward prices.

❖This is NOT a price forecast! It is the current view of the market on forward prices → Market
signal.
 Natural Gas Forward Curve
As of Close April 17, 2007
Monthly Gas Forward Curve
$10.00
$9.75
$9.50
$9.25
$9.00
$8.75
$8.50
$8.25
$8.00
$7.75
$7.50
$7.25
$7.00
$6.75
$6.50
$6.25
$6.00
Nov-07

Nov-08

Nov-09

Nov-10

Nov-11
May-07

May-08

May-09

May-10

May-11
Defining Derivatives
 Derivatives
A derivative is a financial instrument
Thus a Futures or Option
whose value is based upon the
Contract is a derivative of the
Derivatives underlying physical product/commodity
underlying physical commodity.
(e.g., electricity, natural gas, oil, coal).

Options Futures

Unconditional futures Unconditional futures

transaction – buyer has transaction – buyer and
option to exercise apart seller have the obligation
from that buyer and
seller have the obligation

Physical Commodity:
Electricity or Natural Gas
 Futures Contract
➢A futures contract is a standardized contract to buy or sell the underlying commodity at a given
price, at a specified time.

➢It is traded on a futures exchange and thus is a contract with the exchange.

➢The terms of the contract are non-negotiable and are set by the exchange.
 Call option
What is a call option? - it is an option to buy the underlying at a given price.

Calls set CEILINGS!

• The buyer of a Call option has the right, but not the obligation, to buy the
underlying at a given price - Protects against a higher market price.
• The seller of a Call option has an obligation to sell the underlying at a given
price, at the buyer’s sole discretion.
 What is a Put Option?
•It is an option to sell the underlying at a given price.

• Puts set FLOORS!

 Put Option
• What is a Put Option? It is an option to sell the underlying at a given price.

• Puts set FLOORS!

• The buyer of a Put option has the right, but not the obligation, to sell the underlying at a given
price - Protects against a lower market price.

• The seller of a Put option has an obligation to buy the underlying at a given price at the buyer’s
sole discretion.
 Option Terminology
❖ Exercise and Assignment describe the conversion of the option into the underlying forward contract.
❖ The Option buyer exercises the option.
❖ The Option seller is assigned the option.
❖ A strike price is the price at which the underlying is bought or sold in an options contract. E.g., $50.00/MWh Call
Option $6.50/MMBtu Put Option

Buying (“Long” the Option)

Option Buyer exercises the Option
Involves Choice
Pays Premium
Profitable Underlying Position
Selling (“Short” the Option)
Option Seller is assigned the Option
No Choice
Receives Premium
Unprofitable Underlying Position
 Option Example:
Long Call Option Power
 Specifics

❖Utility ABC is “economically short” generation for

the summer, with a cost of generation of
$65.00/MWh

❖Utility ABC is considering the purchase of a call

option.
Purchase of a $50.00/MWh
Call Option
❖Provides price protection (a cap) for Utility ABC

❖The strike price is below Utility ABC’s cost of

generation (of $65.00/MWh)

❖Utility ABC will pay an option premium ($5.00/MWh)

for the purchase of this option
Purchase a Call Option
What:Buy a $50.00/MWh Call Option for
$5.00/MWh

Why: To provide price protection

 Long a Call Option
Purchase Price
$60.00

$55.00

$50.00

$45.00
Purchase Price ($/MWh)

$40.00

$35.00

$30.00

$25.00

$20.00

$15.00

$10.00

0
00

00

00

00

00

00

00

00

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0.

0.

0.

0.

0.

0.

0.

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00
$2

$3

$4

$5

$6

$7

$8

$9

$1
Underlying Market Price ($/MWh)
 Purchase of a Call Option
Profit and Loss at Expiration
$50.00

$45.00

$40.00

$35.00
Profit / Loss ($/MWh)

$30.00

$25.00

$20.00

$15.00

$10.00

$5.00

$-

$(5.00)

$(10.00)

0
00

00

00

00

00

00

00

00

.0
0.

0.

0.

0.

0.

0.

0.

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00
$2

$3

$4

$5

$6

$7

$8

$9

$1
Underlying Market Price ($/MWh)
 Option Example:
Long Call Option Natural Gas
 Purchase of a $7.00/MMBtu
Call Option

❖Provides price protection (a cap) for Utility ABC’s gas cost

❖The strike price is $7.00/MMBtu
❖Utility ABC will pay an option premium ($0.73/MMBtu) for the
purchase of this option
 Purchase a Call Option
❑What: Buy a $7.00/MMBtu Call Option for
$0.73/MMBtu

❑Why: To provide fuel price protection

 Purchase of a $7.00 Call Option
Purchase Price of Gas
$9.00
$8.50
$8.00
Gas Cost (MMBtu

$7.50
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
.00

.25

.50

.75

.00

.25

.50

.75

.00

.25

.50

.75

.00

.25

.50

.75

.00
$5

$5

$5

$5

$6

$6

$6

$6

$7

$7

$7

$7

$8

$8

$8

$8

$9
Underlying Market Price (MMBtu)
 Purchase of a $7.00 Call Option
Profit and Loss at Expiration

$2.00
Profit / Loss ($MMBtu)

$1.00

$-

$(1.00)

$(2.00)
5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00 8.25 8.50 8.75 9.00
Market Price (MMBtu)
Option Example:
Short Put Option
Natural Gas
Sale of a $6.00/MMBtu Put Option
❖This involves the sale of a put option, which obligates Utility ABC to buy
natural gas at the strike price.
❖The strike price is at Utility ABC’s budgeted natural gas cost of
$6.00/MMBtu).
❖Utility ABC will receive an option premium of $0.20/MMBtu for the sale of
this option.
❖The premium received will offset gas costs.
Sale of a $6.00/MMBtu Put Option
❖This is a “Short Put” since Utility ABC is short natural gas
❖The strike price is at Utility ABC’s budgeted natural gas cost of
$6.00/MMBtu)
❖Utility ABC will receive an option premium of $0.20/MMBtu for the sale of
this option
❖The premium received will offset gas costs
 Sale of a $6.00 Put Option
Purchase Price
$8.00

$7.50
Gas Cost (MMBtu

$7.00
$6.50
$6.00
$5.50

$5.00
$4.50
$4.00
4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00
Underlying Market Price (MMBtu)
 Sale of a $6.00 Put Option
Profit and Loss at Expiration

$3.00
Profit / Loss ($MMBtu)

$2.00

$1.00

$-

$(1.00)

$(2.00)

$(3.00)

$(4.00)
3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00
Market Price (MMBtu)
Option Example:
Long Collar
 Long Collar
Long a Call and Short a Put
❖Combining the Sale of a Put Option with the Purchase of a Call Option

❖The long Call provides a Cap for the purchase price

❖The short Put premium offsets the cost of the Call option

❖Premiums: Buy $7.00 July Call = $0.15/MMBtu

Sell $6.30 July Put = $0.10/MMBtu
Net Premium Cost of $0.05/MMBtu
 Long $7.00 Call and Short $6.30 Put
Purchase Price of Natural Gas
$7.20

$7.00 Gas cost will range from a minimum of

Purchase Price (MMBtu)

$6.35/MMBtu (floor), to a maximum (cap) of

$7.05/MMBtu
$6.80

$6.60

$6.40

$6.20

$6.00
4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00
Market Price (MMBtu)
 Long $7.00 Call and Short $6.30 Put
Profit & Loss at Expiration
$2.00

$1.00
Profit / Loss ($MMBtu)

$-

$(1.00)

$(2.00)

$(3.00)
4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00
Market Price ($/MMBtu)
Option Example:
Long Call and
Short Put Spread
(3-Way)
Long Call and Short a Put Spread
❖Combining the purchase of a Call option with the sale of a higher
strike Put option and the purchase of a lower strike Put option

❖The Call option provides upside price protection

❖The short put option premium offsets the cost of the call.

❖The long put option allows for some participation in a downward

market.
Long Call and Short a Put Spread
❖Upside price protection is fixed

❖Price floats down with the market down to the short put strike price

❖If the market drops below the long put strike, this position will be
above the market (by the difference in the put strike prices), but will
float down, providing some benefit from lower market prices.

❖Premiums:
◦ Buy $7.00 Call = $0.38/MMBtu
◦ Sell $6.00 Put = $0.18/MMBtu
◦ Buy $5.00 Put = $0.11/MMBtu
◦ Net Premium Cost of $0.31/MMBtu
 Long $7.00 Call, Short $6.00 Put & Long
$5.00 Put
Purchase Price of Natural Gas
$8.00

$7.50
Gas Purchase Cost (MMBtu)

$7.00

$6.50

$6.00

$5.50

$5.00

$4.50

$4.00
4.00 4.50 5.00 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50 12.00

Market Price (MMBtu)

 Long $7.00 Call, Short $6.00 Put and
Long $5.00 Put
Profit and Loss at Expiration
$2.00

$1.00
P/L ($MMBtu)

$-

$(1.00)

$(2.00)
4.00 4.50 5.00 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50 12.00

Market Price (MMBtu)

 Option Example:
Long Futures and Long Put (Synthetic Call)
Long Futures and Long Put
❖Upside price protection is fixed

❖Purchasing a put option provides a floor for the

value of the futures contract.

❖This position is a synthetic call option

❖Future price and put option premium:

◦ Long Jan Futures = $7.20/MMBtu
◦ Buy $5.50 Jan Put = $.23/MMBtu
 Long Futures and Long $5.50 Put
Purchase Price of Natural Gas
$7.00

$6.50
Gas Purchase Cost (MMBtu)

$6.00

$5.50

$5.00

$4.50

$4.00
3.50 4.00 4.50 5.00 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50
Market Price (MMBtu)
 Long Futures and Long $5.50 Put
Profit & Loss at Expiration
$3.00

$2.00
P/L ($MMBtu)

$1.00

$-

$(1.00)

$(2.00)
3.50 4.00 4.50 5.00 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50
Market Price (MMBtu)
Hedging Strategies
Hedging Strategies – Part I
Agenda
I. Hedging Strategies for a Naturally Long Utility
1. Sell Forward
2. Sell Call Option
3. Buy Put Option
4. Sell Collar (Sell Call, Buy Put)

II. Hedging Strategies for a Naturally Short Utility

1. Buy Forward
2. Buy Call Option
3. Sell Put Option
4. Buy Collar (Buy Call, Sell Put)
 Long Hedging Example
❖Assume Utility ABC is long energy for a given month at a cost of $18.00/MWh
❖Assume underlying market price for this month = $30.00/MWh
❖Possible Hedges for Utility ABC include:

1. Selling Forward at $30.00/MWh

2. Selling an Out-of-the-Money Call Option with a $35.00/MWh strike price *

3. Buying an Out-of-the-Money Put Option with a $25.00/MWh Strike Price *

4. Selling Call and Buying Put to create a Short “Collar”

* Selling Calls and Selling Puts generates premium revenue and reduces total net delta exposure, but does not provide price
protection.
1. Forward Sale

Forward Sale at $30.00/MWh

Sales Price $30.00/MWh

Cost of Gen $18.00/MWh
Transmission $ 5.00/MWh
Net Margin $ 7.00/MWh
Impacts of a Forward Sale
• Secures revenue
• Avoids uncertainty of spot market
• Provides diversity (assuming some sales in
the spot market)
• Locks in a fixed price – If the market price
increases, this will result in a loss of
opportunity (to sell at a higher price)
2. Sale of a $35.00/MWh Call Option
• This is a “covered Call” since Utility
ABC is long the energy
• The strike price is above Utility ABC’s
cost of generation (of $18.00/MWh)
• Utility ABC will receive an option
premium ($5.00/MWh) for the sale of
this option
Short Call and Long Underlying
What: Own Generation at $18.00/MWh (long underlying)
Sell a $35.00 Call Option for $5.00/MWh (short Call)
(“Covered Call”)

Why: To obtain Premium from the Sale of the Call Option

(Premium can be used to offset overall energy costs)

Note: Assuming gas is the marginal unit, consider

purchasing a daily call option on gas (in order to hedge
the potential fuel cost if and when the option is assigned).
 Risks Associated with
Sale of a Covered Call Option
• Price Risk/Opportunity Loss – The Call will only be
exercised when the market price is higher than
$35.00/MWh (ie: Utility ABC could otherwise be
selling in the daily market at a price > $35.00/MWh on
these days)

• Operations Risk – If a unit fails (or system load is

significantly greater than anticipated), Utility ABC may
be unable to deliver the energy. A standard Call
option is an “FLD” product. If Utility ABC does not
deliver the energy, then they must pay the cost of
replacing it in the market.
 Sale of a Covered Call
Option Sales Price
$50.00

$45.00 Sell at strike price of $35.00/MWh

w hen market is > $35.00/MWh
$40.00

$35.00
Sales Price ($/MWh)

$30.00

$25.00

$20.00
Sell in the market w hen market
$15.00
price is < $35.00/MWh

$10.00

$5.00

$-
00

00

00

00

00

00

00

00

00
0.

5.

0.

5.

0.

5.

0.

5.

0.
$1

$1

$2

$2

$3

$3

$4

$4

$5
Underlying Market Price ($/MWh)
 Sale of a Covered Call Option
Profit and Loss at Expiration
$30.00
Capping Profit at $22.00/MWh
(Market Price of $35.00/MWh)
$25.00

$20.00
Net Profit/Loss ($/MWh)

$15.00

$10.00

$5.00

$-

$(5.00)
Breakeven at $13.00/MWh
Market Price
$(10.00)
00

00

00

00

00

00

00

00

00
0.

5.

0.

5.

0.

5.

0.

5.

0.
$1

$1

$2

$2

$3

$3

$4

$4

$5
Underlying Market Price ($/MWh)
 3. Purchase a $25.00/MWh
Put Option

• The purchase of a Put option provides Utility

ABC with a floor for the sales price of this
energy.
• In return for the option premium ($3.00/MWh),
Utility ABC locks in a minimum sales price (a
floor) of $25.00/MWh for this block of energy.
• This results in an effective price of no less than
$22.00/MWh ($25.00 - $3.00 premium) for this
block of energy.
Purchase of a Put Option and
Long Underlying
WHAT: Long Underlying Generation at $18.00/MWh
Buy a $25.00 Put for $3.00/MWh Premium

WHY: To lock in a floor for the Sales Price of

$25.00/MWh
 Long Put Option and Long Underlying
Sales Price
$60.00

$55.00

$50.00

$45.00
Sales Price ($/MWh)

$40.00
Minimum Sales Price of
$25.00/MWh
$35.00

$30.00

$25.00

$20.00

$15.00
$10.00 $16.00 $22.00 $28.00 $34.00 $40.00 $46.00 $52.00

Underlying Market Price ($/MWh)

 Long Put Option and Long Underlying
Profit and Loss at Expiration
$15.00

$10.00
Net Profit/Loss ($/MWh)

$5.00

$-
00

00

00

00

00

00

00

00

00

00

00

00
8.

0.

2.

4.

6.

8.

0.

2.

4.

6.

8.

0.
$1

$2

$2

$2

$2

$2

$3

$3

$3

$3

$3

$4
Underlying Market Price ($/MWh)
 4. Short Collar
Sell a Call and Buy a Put
❖Combining the Sale of a Call Option with the
Purchase of a Put Option (and the long
underlying) creates a “collar”
❖The long Put provides a floor for the sales
price
❖The short Call limits or caps the sales price,
but offsets the cost of the Put option.
❖Premiums: Buy Put = $3.00
Sell Call = $5.00
 Collar Sales Price
Long $25 Put, Short $35 Call & Long Underlying
$45.00

Sell at cap of
$40.00 $35.00/MWh (when call is
exercised)

$35.00
Sales Price ($/MWh)

$30.00

$25.00

$20.00
Sell at floor of $25.00/MWh (exercising
put) when market is < $25.00/MWh

$15.00

$10.00
$18.00

$20.00

$22.00

$24.00

$26.00

$28.00

$30.00

$32.00

$34.00

$36.00

$38.00

$40.00

$42.00

$44.00

$46.00

$48.00

$50.00

$52.00

$54.00
Underlying Market Price ($/MWh)
 Collar Profit & Loss at Expiration
Long $25 Put, Short $35 Call & Long Underlying
$25.00
Margin ranges from a minimum of $9.00/MWh
(floor), to a maximum (cap) of $19.00/MWh
(with a generating cost of $18.00/MWh)
$20.00
Net Profit/Loss ($/MWh)

$15.00

$10.00

$5.00

$-
$18.00

$20.00

$22.00

$24.00

$26.00

$28.00

$30.00

$32.00

$34.00

$36.00

$38.00

$40.00

$42.00

$44.00

$46.00

$48.00

$50.00

$52.00

$54.00
Underlying Market Price ($/MWh)
Hedging Strategies – Part I
Agenda
I. Hedging Strategies for a Naturally Long Utility
1. Sell Forward
2. Sell Call Option
3. Buy Put Option
4. Sell Collar (Sell Call, Buy Put)

II. Hedging Strategies for a Naturally Short Utility

1. Buy Forward
2. Buy Call Option
3. Sell Put Option
4. Buy Collar (Buy Call, Sell Put)
 Short Hedging Example
❖Assume Utility ABC is “economically short” energy for
a given month, with a cost of generation for the next
block of $60.00/MWh
❖Assume underlying market price for this month =
$30.00/MWh
❖Possible Hedges for Utility ABC include:

1. Purchasing Forward at $30.00/MWh

2. Buying an Out-of-the-Money Call Option with a
$35.00/MWh strike price
3. Selling an Out-of-the-Money Put Option with a
$25.00/MWh Strike Price
4. Buying Call and Selling Put to create a long
“Collar”
1. Forward Purchase

Forward Purchase at $30.00/MWh

Cost of Gen $60.00/MWh

Purchase Price $30.00/MWh
Transmission $ 5.00/MWh
Net Margin $ 25.00/MWh
Impacts of a Forward Purchase

❖ Secures physical supply and transmission

❖ Avoids uncertainty of spot market
❖ Provides diversity (assuming some
purchases in the spot market)
❖ Locks in a fixed price – If the market price
decreases, this will result in a loss of
opportunity (to buy at a lower price)
2. Purchase of a $35.00/MWh
Call Option

❖ Provides price protection (a cap) for Utility

ABC
❖ The strike price is below Utility ABC’s cost of
generation (of $60.00/MWh)
❖ Utility ABC will pay an option premium
($5.00/MWh) for the purchase of this option
Purchase of a Call Option

What: Buy a $35.00/MWh Call Option for

$5.00/MWh

Why: To provide price protection

 Purchase of a Call Option
Purchase Price
$50.00

$45.00

$40.00
Purchase Price ($/MWh)

$35.00

$30.00

$25.00

$20.00

$15.00

$10.00

$5.00

$-
00

00

00

00

00

00

00

00

00
0.

5.

0.

5.

0.

5.

0.

5.

0.
$1

$1

$2

$2

$3

$3

$4

$4

$5
Underlying Market Price ($/MWh)
 Purchase of a Call Option
Profit and Loss at Expiration
$30.00

$25.00

$20.00
Net Profit/Loss ($/MWh)

$15.00

$10.00

$5.00

$-

$(5.00)

$(10.00)
00

00

00

00

00

00

00

00

00
0.

5.

0.

5.

0.

5.

0.

5.

0.
$1

$1

$2

$2

$3

$3

$4

$4

$5
Underlying Market Price ($/MWh)
3. Sale of $25.00/MWh Put
Option

• The sale of a Put option obligates Utility

ABC to purchase energy at the strike price
of $25.00/MWh in return for the option
premium of $3.00/MWh
• When the market is < $25.00/MWh, the Put
will be exercised and Utility ABC will be
obligated to purchase energy at
$25.00/MWh
Comparison of a Forward Purchase
and the Sale of a Put Option
❖Both a forward purchase and the sale of a Put option
involve potential opportunity loss (energy could be
purchased for a lower price on the days the market is
lower than the strike or forward price)

❖The difference is that a forward purchase is “must

take” energy; energy will only be supplied by the Put
option on the days when the market is lower

❖In return for this optionality, a premium is collected

with the sale of the Put option
 Risks of Selling a Put
Option
❖A Put option will only be exercised when the market is
lower than the strike price, resulting in opportunity loss on
the days it is exercised (e.g., Utility ABC could have
purchased in the daily market for a lower price than the
strike price on these days)

❖The strike price is still significantly less than Utility ABC’s

cost of generation for the next block (e.g., $25.00MWh vs.
$60.00/MWh)

❖Selling a Put option has downside risk which is

significantly less in the electricity market than upside risk
(e.g., floor of about $14.00/MWh)
 Sale of a Put Option
WHAT: Next block cost of generation at $40.00/MWh
Sell a $25.00/MWh Put for $3.00/MWh Premium

WHY : To collect premium to offset purchase price of

physical energy. Obligation to buy at $25.00/MWh
is “economically attractive” for Utility ABC given
their cost of generation. Net purchase price is
$22.00/MWh.
 Short Put Option
Purchase Price
$60.00

$55.00

$50.00

$45.00
Pruchase Price ($/MWh)

$40.00
Minimum Purchase Price
of $25.00/MWh
$35.00

$30.00

$25.00

$20.00

$15.00
$10.00 $16.00 $22.00 $28.00 $34.00 $40.00 $46.00 $52.00

Underlying Market Price ($/MWh)

 Short Put Option
Profit and Loss at Expiration
$15.00

$10.00
Net Profit/Loss ($/MWh)

$5.00

$-

$(5.00)

$(10.00)

$(15.00)
00

00

00

00

00

00

00

00

00

00

00

00

00
0.

2.

4.

6.

8.

0.

2.

4.

6.

8.

0.

2.

4.
$1

$1

$1

$1

$1

$2

$2

$2

$2

$2

$3

$3

$3
Underlying Market Price ($/MWh)
 “Clean energy for all Europeans”
PACKAGE

❖Regulation (EU) 2019/941* on risk-preparedness in the electricity

sector and repealing Directive 2005/89/EC
❖Regulation (EU) 2019/942* on establishing a European Union
Agency for the Cooperation of Energy Regulators
❖Regulation (EU) 2019/943* on the internal market of electricity
❖Directive 2019/944** on common rules for the internal market for
electricity and amending Directive 2012/27/EU
* The regulations are directly applicable starting with January 1st, 2020
** The Directive must be transposed into national legislation
 Regulation (EU) 2019/943 on the
internal market of electricity
a) The efficient achievement of the objectives of the energy union, of the climate and
energy framework for 2030, allowing the market to issue signals for increasing energy
efficiency, the share of renewable energy sources, security of supply, flexibility,
sustainability, decarbonisation and innovation;
b) Establishing fundamental principals for the proper functioning of integrated electricity
Regulation objectives
markets, ensuring non-discriminatory access to the market for all electricity suppliers and
customers, to enable consumers, ensure competitiveness on the global market and
disruptive consumption, energy storage and energy efficiency and to facilitate the
aggregation of the distributed demand and supply and to allow market integration and
sectoral integration , as well as remunerating the electricity produced from RES.
c) electricity customers must have the opportunity to participate actively in the market, on
equal basis with other market participants and must be empowered to manage their own
energy consumption. In order to integrate the growing share of energy from E-RES, the
future electricity system should use all available sources of flexibility, in particular demand-
oriented solutions and energy storage and should use digitization, by integrating innovative
technologies into the framework of the electricity system;
d) facilitating the realization of a functional and transparent wholesale market, which will
contribute to a high level of security of electricity supply and provide for mechanisms for
harmonizing the rules for cross-border exchanges of electricity.
The distribution operators cooperate at Union level through the EU DSO entity, to promote the completion and
functioning of the internal electricity market and to promote the optimal management and coordinated
operation of the transmission and distribution systems. The DSOs who wish to participate in the EU DSO entity
have the right to become registered members of the entity.
DSO: EU ROLE
❑ promoting the exploitation and planning of distribution networks in
coordination with the exploitation and planning of transport networks;
❑ facilitating the integration of renewable energy sources, distributed
production and other resources integrated into the distribution network,
such as storage;
❑ facilitating the flexibility of demand and disruptive consumption, as well as
distributing network access to users;
❑ contributing to the digitization of distribution systems, including the
implementation of smart grids and smart metering systems;
❑ supporting the development of data management, cyber security and data
protection in cooperation with competent authorities and regulated entities;
Impact over DSO
❑ When intelligent metering systems have been introduced, ANRE will take
into account differentiated network tariffs per hour, when establishing or
approving the transport and distribution tariffs;
❑ network rates differentiated per hour to reflect the use of the network, in a
transparent, cost-effective and predictable way for the final customer
❑ Distribution tariff methodologies stimulate the ODs to exploit and
develop their networks in the most cost-effective manner, including
through the purchase of services;
❑ ANRE recognizes in the distribution tariffs the relevant costs as eligible and
can introduce performance objectives to stimulate the OD to increase the
efficiency of the network.
 Regulation (EU) 2019/943 on the
internal market of electricity
❑ be organised in such a way as to be non-discriminatory;
❑ Maximize the ability of all market participants to manage imbalances;
❑ Maximise the opportunities for all market participants to participate in cross-
zonal trade in as close as possible to real time across all biding zones;
Day ahead market and
❑ Provide prices that reflect market fundamentals, including the real time value of
energy, on which market participants are able to rely when agreeing on longer-
Intraday markets
term hedging products;
❑ Ensure operational security while allowing for maximum use of transmission
capacity;
❑ Be transparent while at the same time protecting the confidentiality of
commercially sensitive information and ensuring trading occurs in an anonymous
manner;
❑ Make no distinction between trades made within a bidding zone and across
bidding zones;
❑ Be organized in such a way as to ensure that all markets participants are able to
access the market individually or through aggregation;
❑ There shall be no specific network charge on individual transactions for cross-
zonal trading of electricity.
Trade
❑ NEMOs shall allow market participants to trade energy as close to real
time as possible and at least up to the intraday cross-zonal gate
closure time;
❑ NEMOs shall provide market participants with the opportunity to
trade in energy in time intervals which are at least as short as the
imbalance settlment period for both day-ahead and intraday markets;
❑ NEMOs shall provide products for trading in day-ahead and intraday
markets which are sufficiently small in size, with minimum bid sizes
of 500 kW or less, to allow for the effective participation of demand-
side response, energy storage and small-scale renewables including
direct participation by customers;
❑ The imbalance settlement period shall be 15 minutes in all scheduling
areas, unless regulatory authorities have granted a derogation or an
exemption;
❑ Capacity shall be allocated by means of explicit capacity auctions or
implicit auctions including both capacity and energy. Both methods
may coexist on the same interconnection. For intraday trade,
continuous trading, which may be complemented by auctions, shall be
used.
 Regulation (EU) 2019/943 on the
internal market of electricity
❑TSOs shall issue long-term transmission rights or have equivalent
measures in place to allow for market participants, including owners
of power-generating facilities using RES, to hedge price risks across
bidding zone borders;
❑Long-term transmission rights shall be allocated in a transparent,
Forward markets
market based and non-discriminatory manner through a single
allocation platform;
❑market operators shall be free to develop forward hedging products,
including long-term forward hedging products, to provide market
participants, including owners of power-generating facilities using
renewable energy sources, with appropriate possibilities for hedging
financial risks against price fluctuations;
❑MS shall not require that such hedging activity be limited to trades
within a MS or bidding zone.
Technical bidding limits
❑ There shall be neither a maximum nor a minimum limit to the
wholesale electricity price;
❑ NEMOs may apply harmonised limits on maximum and minimum
clearing prices for day-ahead and intraday timeframes. Those limits
shall be sufficiently high so as not to unnecessarily restrict trade, shall
be harmonised for the internal market and shall take into account the
maximum value of lost load;
❑ NEMOs shall implement a transparent mechanism to adjust
automatically the technical bidding limits in due time;
❑ Transmission system operators shall not take any measures for the
purpose of changing wholesale prices;
❑ Regulatory authorities shall identify policies and measures applied
within their territory that could contribute to indirectly restricting
wholesale price formation, including limiting bids relating to the
activation of balancing energy, capacity mechanisms, measures by the
transmission system operators, measures intended to challenge
market outcomes, or to prevent the abuse of dominant positions or
inefficiently defined bidding zones.
 Directive 2019/944 on common rules for the
internal market for electricity
Suppliers are free to set out the prices at which they supply electricity to customers. MS are taking appropriate measures to ensure effective competition between suppliers.
For the purpose of a transitional period where effective competition is established between suppliers in terms of electricity supply contracts and a fully effective, market-based retail pricing for them, MS
can use public interventions in establishing the prices of electricity supply it to the domestic clients and to the micro enterprises that do not benefit from public interventions.

Energy Supply

• Suppliers are free to set the prices at which they supply their electricity to customers. The MS are taking
appropriate measures to ensure effective competition between suppliers.
Market based supply prices • The MS ensure the protection of domestic customers affected by energy poverty and the vulnerable customers,
through social policy or by means other than public interventions in setting electricity supply prices.

• The MS can use public interventions in establishing electricity supply prices to domestic customers and to micro-
enterprises that do not benefit from public interventions.
• Public interventions:
• (a) they are accompanied by a set of measures to ensure effective competition and a methodology for
evaluating the progress made on the respective measures;
• (b) are established on the basis of a methodology that ensures a non-discriminatory treatment of providers;
• (c) are set at a price that exceeds the cost and at a level at which there can be effective competition in terms
of prices;
Public interventions • (d) they are designed to minimize any negative impact on the wholesale electricity market;
• (e) it ensures that all beneficiaries of such public interventions have the opportunity to choose competitive
offers;
• (f) all beneficiaries of such public intervention have the right to have smart meters and are offered such
meters, which are installed without additional initial costs for the client, are directly informed of the
possibility of installing smart meters and are provided with the necessary assistance;
• (g) do not lead to a direct cross-subsidization between customers fed at free market prices and those fed at
regulated supply prices.
 Directive 2019/944 on common rules for
the internal market for electricity
Basic contractual rights – Final customers have the right to conclude with their supplier a contract that specifies fair and transparent general conditions, presented in a simple and
unambiguous language and which does not include non-contractual barriers to the exercise of the clients’ rights, such as: eg excessive contractual documentation. Customers are protected
against incorrect or misleading sales methods.
MS guarantees that the regulations allow suppliers to provide electricity contracts at dynamic prices. MS guarantees end consumers who have a smart meter installed the possibility to
request the conclusion of a supply contract with dynamic prices for at least one supplier and any supplier that has more than 200,000 final customers.

Energy Supply

• No later than 2026, the technical process of switching the supplier should not take more than 24 hours and must be
possible on any business day;
The right to change the supplier • The MS ensures that at least no change commissions are required for domestic customers and small businesses;
and norms regarding commisions • The MS may allow suppliers or market participants involved in the aggregation to collect termination commissions
for change from customers who voluntarily terminate fixed-term supply contracts at fixed prices before their term is reached,
provided that such commissions are made part of a contract that the client voluntarily concluded and clearly
communicated to the client before the conclusion of the contract

• All customers groups (industrial, commercial and households) should have access to the electricity markets to trade
their flexibility and self-generated electricity;
The aggregation contract • Customers should be allowed to make full use of the advantages of aggregation of production and supply over larger
regions and benefit from cross-border competition;
• The MS ensures that, in case an end customer wishes to conclude an aggregation contract, the respective end
customer has this right without the consent of the electricity company.

• MS ensures that at least domestic customers and microentreprises with an expected yearly consumption of below
100,000 kWh have access, free of charge, to at least one tool for comparing the offers of suppliers, including offers
Comparison tools for dynamic electricity price contracts.
• The instruments can be managed by any entity, including private companies and public authorities at bodies
Directive 2019/944 on common rules for
the internal market for electricity
Active customers/ CEC

• MS guarantees to the active customers: (a) entitled to operate either directly or through aggregation; (b) entitled to
sell self-generated electricity, including through power purchase agreements; (c) entitled to participate in flexibility
schemes and energy efficiency schemes; (d) entitled to delegate to a third party the management of the installations
required for this activities, including installations, operation, data handling and maintenance, without that third party
Active customers
being considered to be an active customer; (e) subject to cost-reflective, transparent and non-discriminatory network
charges that account separately for the electricity fed into the grid and the electricity consumed from the grid,
ensuring that they contribute in an adequate and balanced way to the overall cost sharing of the system; (f)
financially responsible for the imbalances they cause in the electricity system.

• MS shall provide an enabling regulatory framework for CEC, ensuring that: (a) participation in a CEC is open and
voluntary; (b) members or shareholders of CEC are entitled to leave the community (C) members or shareholders of
Citizen Energy communities CEC do not lose their rights and obligations as household customers or active customers (d) subject to fair
compensation as assessed by the regulatory authority, relevant distribution system operators cooperators cooperate
with CEC to facilitate electricity transfers within CEC; (e) CEC are subject to non-discriminatory, fair, proportionate
and transparent procedures and charges and to non-discriminatory and cost-reflective network charges

Demand response through
aggregation
• MS shall allow and foster participation of demand response through aggregation. MS shall allow final customers,
including those offering demand response through aggregation, to participate alongside producers in a non-
discriminatory manner in all electricity markets.
• MS shall ensure that regulatory authorities, or their TSO or ODs, act in close cooperation with market participants
and final customers, establish the technical requirements for participation of demand response in all electricity
markets on the basis of the technical characteristics of those markets and the capabilities of demand response. Such
requirements shall cover participation involving aggregated loads.
Directive 2019/944 on common rules for
the internal market for electricity
Electricity markets differ from other markets such as those for natural gas, for example because they involve the trading in a commodity
which cannot currently be easily stored and which is produced using a large variety of generating installations, including through
distributed generation. This has been reflected in the different approaches to the regulatory treatment of interconnectors in the
electricity and gas sectors. The integration of electricity markets requires a high degree of cooperation among system operators, market
participants and regulatory authorities, in particular where electricity is traded via market coupling.

Member States shall ensure that all final customers are entitled to have their electricity provided by a supplier, subject to the supplier's
agreement, regardless of the Member State in which the supplier is registered, provided that the supplier follows the applicable trading
and balancing rules. In that regard, Member States shall take all measures necessary to ensure that administrative procedures do not
discriminate against suppliers already registered in another Member State.

Member States and the Contracting Parties to the Treaty establishing the Energy Community should cooperate closely on all matters
concerning the development of an integrated electricity trading region and should take no measures that endanger the further
integration of electricity markets or the security of supply of Member States and Contracting Parties

The Commission Communication of 15 July 2015, entitled ‘Launching the public consultation process on a new energy market design’,
highlighted that the move away from generation in large central generating installations towards decentralised production of electricity
from renewable sources and towards decarbonised markets requires adapting the current rules of electricity trading and changing the
existing market roles. The Communication underlined the need to organise electricity markets in a more flexible manner and to fully
integrate all market players – including producers of renewable energy, new energy service providers, energy storage and flexible
demand. It is equally important for the Union to invest urgently in interconnection at Union level for the transfer of energy through high-
voltage electricity transmission systems.
Electricity market auction
settings.
A comparison between
Marginal Pricing System (MPS)
and Pay-as-Bid (PAB)
 A comparison between Marginal Pricing
System (MPS) and Pay-as-Bid (PAB)
Key notes:

I. under uniform-price auctions (MPS), all suppliers receive the same market-clearing price
which is set at the offer price of the most expensive resource chosen to provide supply
II. in a pay-as-bid auction (PAB), prices paid to winning suppliers are based on their actual
bids, rather than the bid of the highest priced supplier selected to provide supply
III. some observers advocate a switch from the marginal price system (also called uniform-
price auctions) relied on almost exclusively in all organized wholesale power markets in
the U.S. and Europe, to pay-as-bid auctions.
IV. switch to a pay-as-bid auction may have adverse consequences for market efficiency by
reducing the efficiency of plant dispatch
◦ Pay as bid in day ahead will not solve the problem of Romanian day-ahead market
The goal of economic efficiency in
the production of power
➢ the electric industry’s clear goal has been to provide reliable power as efficiently as
possible

➢ short-run (static) efficiency means:

➢ output is produced by the least-cost suppliers;
➢ it is consumed by those most willing to pay for it, and;
➢ the right amount is produced.
➢ long-run, dynamic efficiency requires: developing the right amount and type of
resources, such as generation facilities, in the right locations.
➢ create this infrastructure -> the system must create price signals that encourage the
right incremental investment.
➢ create this infrastructure -> provide sufficient confidence that the system of pricing and
compensation for power production will afford a reasonable opportunity for investment
recovery given the capital intensity of and multi-year lead times for plant construction.
Price formation on uniform price auctions
(also called marginal price system)
2) it is consumed by those most willing to pay for it, and;

3) the right amount is

produced.

1) output is produced by the least-cost suppliers;

Price formation on pay as bid auctions – same bidding behavior of
generators

• Hypothesis 1: Payments to generators can be significantly reduced because plants that are
ranked left of the marginal plant in the merit order must not necessarily receive the price of the
most expensive generator. This decreases the average cost of electricity for consumers.
• Hypothesis 2: A pay-as-bid auction is more effective in disciplining market power because
generators cannot influence the market price received by all their infra-marginal plants through
strategically withholding capacity.
Price formation on pay as bid auctions – adjusted bidding
behavior with generators having complete information

• Assuming that generators can perfectly predict the MCP (no uncertainty), they have no
incentives to bid less than 60 €/MWh
• the average electricity prices that have to be paid by consumers in both auctions are the same
and the net cost savings of changing from one regime to the other would be zero
Price formation on pay as bid auctions – adjusted bidding
behavior with generators having uncertain information

• pay-as-bid leads to higher overall bids because generators have strong incentives to bid above
marginal costs
• the bids in the pay-as-bid auction differ relatively little in price illustrating each generator’s
attempt to bid close to the MCP
• small forecasting errors can cause situations in which low-marginal-cost bidders are not
dispatched and average electricity prices rise above the system marginal costs
 Conclusions

I. pay-as-bid auctions are unlikely to have any impact on short-run prices in

wholesale electricity markets
II. a switch to a pay-as-bid auction may have adverse consequences for market
efficiency by reducing the efficiency of plant dispatch
III. pay as bid in day ahead will not solve the problem of Romanian day-ahead
market
IV. uniform price mechanism under Romanian generation mix (more than 5000
MW in E-RES) is creating benefits on demand side but is putting pressure on
long-run economic efficiency of base load plants
V. day-ahead mechanism of a uniform price needs to be correlated with all
other electricity market mechanism, for power and ancillary services, in
order to secure long term efficiency on both demand and supply side.