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Financial

Chapter 3: Electricity financial markets.pdf

Market types

OTC (over-the-counter):

  • bilateral arrangements between generators and retailers, or

  • arranged with the assistance of brokers that post bid (buy) and ask (sell) prices on behalf of their clients

  • rely on the credit worthiness of electricity market counterparties

ASX:

  • electricity derivative products: futurres and options

  • Participants (licensed brokers) buy and sell contracts on behalf of clients that include

  • generators,
  • retailers,
  • speculators such as hedge funds, and banks and other financial intermediaries

Financial market instruments

Forward contracts An agreement to exchange the NEM spot price in the future for an agreed fixed price.

  • Called swaps in the OTC markets: OTC swap settlements are typically paid or received weekly in arrears (after the spot price is known) based on the difference between the spot price and the previously agreed fixed price.

  • Called futures on the ASX: ASX electricity futures and options settlements are paid or received daily based on mark-to-market valuations. ASX futures are finally cash settled against the average spot price of the relevant quarter.

Options A right, without obligation, to enter into a transaction at an agreed price in the future (exercisable option) or a right to receive cash flow differences between an agreed price and a floating price (cash settled option). The buyer pays a premium to the option seller.

  • Cap: A contract through which the buyer earns payments when the pool price exceeds an agreed price. Caps are typically purchased by retailers to place a ceiling on their effective pool purchase price in the future.

  • Floor: A contract through which the buyer earns payments when the pool price is less than an agreed price. Floors are typically purchased by generators to ensure a minimum effective pool sale price in the future.

  • Swaptions / futures options: An option to enter a swap or futures contract at an agreed price and time in the future.

  • Asian options: An option through which the payoff is linked to the average value of an underlying benchmark (usually the NEM spot price) during a defined period.

  • Profiled volume options for sculpted loads: A volumetric option that gives the holder the right to purchase a flexible volume in the future at a fixed price.

SWAP (OTC)

A swap is a financial derivative contract between two parties who agree to exchange cash flows or other financial instruments over a specified period.

In electricity markets, swaps are often used to manage price risk associated with fluctuations in electricity prices.

Electricity swaps allow market participants, such as generators, retailers, and other stakeholders, to hedge against the volatility of electricity prices. For example, a generator may enter into a swap agreement to fix the price at which they sell electricity, providing predictability in revenue.

CAP

A cap is a financial instrument that sets a maximum limit on the price of a commodity, such as electricity, within a specified period.

It provides protection against price spikes beyond a predetermined level.

In electricity markets, participants can purchase price caps as a risk management strategy (pay premium in all intervals). If the market price exceeds the cap, the cap holder receives compensation for the difference.

Caps are often used by electricity consumers or retailers to limit their exposure to extremely high prices during periods of peak demand or supply shortages.