Financial Transmission Rights in the Nordic electricity market: pros and cons compared to the present system with Contracts for Difference

Background and purpose of the study

The Project Coordination Group (PCG) chaired by the European Energy Regulators has agreed upon five Target Models for forward, day-ahead, intra‐day and balancing markets and capacity calculation as part of its European market integration strategy. The Target Model for the Forward Market dictates that TSOs sell 100 % of forecast available capacity forward in line with forward energy market horizons. Transmission is to be sold as either Financial Transmission Rights (FTRs) or Physical Transmission Rights (PTRs). PTRs are not seen as a real option for the Nordic market since they will reduce available transmission capacities for the implicit Nord Pool Spot auctions and for the market coupling with other areas.

At present, market participants in the Nordic financial market purchase Contracts for Difference (CfD) to hedge against the basis risk when area prices are not equal to the System Price. CfDs are issued by the market players without the TSO’s involvement. This is different from the European target model described above in which TSOs issues FTRs.

The purpose of this study is to further investigate the topic of introducing FTRs issued by the TSOs in the Nordic financial market instead of the current CfDs issued by market players. The study shall describe how FTRs can work in the Nordic financial market and propose a design for FTRs in the Nordic market. The study shall analyze how the introduction of FTRs would impact market actors and TSOs and list pros and cons compared to the present system with CfDs.

Project Structure

The project consists of four Working Packages. The researchers' objective is to combine theoretical knowledge about how market instruments “should” work and impact market participants, with empirical knowledge about how market participants respond to changes in market design and market risks.

Work Package 1: PCG Target Models and earlier debate regarding FTRs

WP1 will describe the PCG Target Models, especially the Target Model for the Forward market. It will also include a summary of  earlier proposals from e.g. the European Federation of Energy Traders (EFET) and earlier debate and research regarding FTRs. Interviews will be held with representatives for the Swedish Energy Markets Inspectorate (EI), the Norwegian Water Resources and Energy Directorate (NVE) and EFET in order to identify key issues.

Work Package 2: Lessons learned from PTRs and CfDs

Explicit auctions and implicit auctions will be compared with regard to market efficiency and allocation of congestion rents. Transaction data for NorNed auctions and the earlier auctions on the German-Danish border will be compared with spot price differences between South Norway-Netherlands and West Denmark-Germany. The purpose of the analysis is to look at issues such as:

• Differences between auction contract prices and price spreads in the spot markets for different contract durations
• Development of these price differences over time
• Number of players in the different auctions and the development over time

The contracts in the explicit auctions are PTRs and not FTRs. However, this analysis will enable us to discuss the potential impact of different FTR designs on the liquidity and the allocation of congestion rents.

WP2 will also include a description of current area price risk management in the Nordic market and current trade in CfDs in order to give a basis for the analysis of possible impacts.

Work Package 3: Description of how FTRs can work in the Nordic electricity market

The findings in WP1 will be used to define a possible design of FTRs.

WP3 will describe the possible impact of such FTRs on the financial market, on the physical market and on the retail market. Analysed issues will include impact on liquidity, product structure, market power and market dynamics.

The usefulness of FTRs as hedging instruments instead of CfDs will be analysed, from both a practical and a theoretical perspective.

An important part of WP3 will be the impact on and incentives for TSOs to allocate increased transmission capacity and to accomplish transmission investments. This analysis includes consequences if TSOs are allowed to trade their position in FTRs before delivery, e.g. due to changes in available transmission capacity. Effects on transmission pricing will also be discussed.

10 interviews with Swedish and Norwegian TSOs, traders, producers, retailers and industrial customers will be carried out.

Work Package 4: Pros and cons compared to the present system of CfDs

The findings in WP3 will be the basis for a discussion of pros and cons with FTRs compared to the present system of CfDs.

Pros and cons for different types and sizes of market actors will be described and summarized.

WP4 will also discuss if and how FTRs will change the behaviour of TSOs.

Research Team

Björn Hagman has long management experience from energy companies and from Nord Pool. Throughout his career, Mr. Hagman has been active in international cooperation and international projects and has acquired a deep knowledge of the European markets. For the past six years, Mr. Hagman has worked as an energy market consultant with special focus on price formation, congestion management and risk management. During 2010 he performed an analysis of the Nordic financial market for NordREG which focused on hedging and trading in CfDs.

Jørgen Bjørndalen Mr. Bjørndalen is Cand. Oecon. from the Norwegian School of Economics and Business Administration (NHH), where he also started his professional career as a research economist in the team that prepared the Norwegian deregulation of the electricity sector back in 1989. After 8 years as a researcher, he started at SKM Energy Consulting in 1996. Since then, he has advised a number of European utilities, TSOs and energy authorities. He covers a broad range of topics, such as energy trading, risk management, price formation, competition analysis, transmission system design (electricity and gas), transmission pricing and regulation (electricity and gas), transmission investments, energy market design, harmonisation and integration of markets, and security of supply. Recently, he has prepared revenue analyses for several interconnection projects, as well as socioeconomic analysis of such projects.

Reference group

• Marie Pålsson, Energy Markets Inspectorate
• Petri Eväsoja, Fortum
• Magnus Thorstensson, Swedenergy
• Håkan Feuk, E.ON
• Jens Norberg, DinEl
• Tania Pinzón, Svenska Kraftnät
• Tobias Johansson, Vattefall
• Bo Lindörn, Oberoende Elhandlare