Financial Transmission Rights (FTRs) help generators and load-serving entities hedge congestion-related risk. Transmission congestion causes a divergence between wholesale power prices where it is generated and the trading hubs where it is delivered and sold. Because the congestion, and therefore the risk, varies over time it is particularly important to variable renewables. That uncertainty increases investor risk which potentially slows deployment. James Kim at Lawrence Berkeley National Laboratory summarises his co-authored paper reviewing FTR design in the U.S., and looks at alternative FTR designs that will better serve wind generation. The research shows that there are “wind FTR” designs that are almost as effective for wind plants as the standard fixed-volume FTR is for fossil-burning plants. Kim notes that as variable generation grows the congestion problem will intensify, so a solution is needed now for the generators, the investors, and ultimately a rapid transition.

Most wind power capacity in the United States is in the wind-rich central region. Here, transmission congestion causes a divergence between wholesale power prices where it is generated and the trading hubs where it is delivered and sold. This price difference is called “locational basis” (or just “basis”). Because the basis varies over time, it can unpredictably affect a wind plant’s revenue, which increases investor risk and potentially slows deployment.

Financial Transmission Rights (FTRs)

U.S. wholesale power markets offer a financial product, called a financial transmission right (FTR), that helps generators and load-serving entities hedge congestion-related basis risk. Conventional FTRs, however, are structured around an unvarying contract capacity, which is not particularly suited to power generators with varying output. New FTR designs are therefore needed to support continued investment in wind power.

A new study from Berkeley Lab appearing in The Energy Journal, evaluates the basis and basis risk facing different generating technologies under various types of FTRs. The study analyses the generation-weighted locational basis between generator nodes and common trading hubs for thermal and wind plants operating within three central U.S. markets, using historical nodal pricing and generation data.

The primary contributions of the research are (1) an empirical comparison of the basis and basis risk-facing wind energy and other generation types, (2) an empirical assessment of the effectiveness of conventional fixed-volume FTRs at hedging the basis risk-facing wind and other generation types, and (3) an evaluation of the effectiveness of alternative FTR designs at improving the ability of wind generators to hedge their basis risk.

Key findings

Key findings include:

• Wind plants typically face a larger and more negative basis than do thermal generators, and hence are more negatively impacted by congestion due in part to the negative correlation between wind generation and wholesale power prices.
• Though most thermal generators can effectively hedge basis risk by purchasing conventional fixed-volume FTRs, fixed-volume FTRs do not effectively hedge basis risk for variable wind generation.
• More-effective hedging mechanisms—for example, an FTR whose volume varies with wind plant output—may be required to support those generators most impacted by congestion, and to promote continued investment in variable generation resources in congested markets.

Evaluation of “Basis” across technologies

In the central U.S., wind generators face a greater absolute basis than other generator types, and it is growing with increasing wind deployment.

There is, however, heterogeneity in the basis faced by individual wind and non-wind plants. The 2019 plant-level basis per unit of generation tends to be more negative and clustered for wind plants than for non-wind plants (Figure 1). A negative basis, most prevalent for wind plants in the panhandle of Texas and Oklahoma in SPP, indicates that production-weighted wholesale power prices are lower at plant nodes than at the nearest trading hubs.

Residual Basis: effectiveness of fixed-volume FTRs

An annual fixed-volume FTR can nearly eliminate basis for most conventional generators, but is less effective at reducing the average basis for wind plants (Figure 2). It is not surprising to find that the payout of an annual fixed-volume FTR eliminates the basis for generators whose production is nearly constant, such as a coal plant, since the payout of the FTR is, by design, nearly equal to the generation-weighted basis faced by the plant.

On the other hand, the payout of the fixed-volume FTR does not match the generation-weighted basis of a wind plant, whose volume varies significantly throughout the year, depending on the weather. While the fixed-volume FTR does reduce wind’s basis by $1–5/MWh, it still leaves wind generators with $1.8–3.5/MWh of “residual basis” on average. Though the fixed-volume FTR is not equally effective at minimising the basis facing thermal and wind generators, it does a respectable job of minimising volatility in the residual basis across all generator types.

Wind FTR: an alternative to a fixed-volume FTR

For wind plants, the effectiveness of FTRs can be enhanced across all markets through the introduction of a “wind FTR” whose volume varies with the hourly ISO-wide aggregate wind profile (Figure 3). In all three markets, the wind FTR (labelled “Wind” in Figure 3) reduces wind’s residual basis to less than $1/MWh with a similarly-sized monthly standard deviation; this reduction is most impressive in SPP, given its initial or unhedged basis of $8/MWh with a $5/MWh monthly standard deviation. Overall, the wind FTR is almost as effective for wind plants as the fixed-volume FTR (labelled as “Annual” in Figure 3) is for non-wind plants. The wind FTR is not a perfect hedge, however, since individual plant-level profiles are heterogeneous and will deviate from the market-wide aggregate wind profile, leaving some degree of volume mismatch.

A fixed-volume FTR with more granular time periods, such as a monthly (rather than annual) FTR with on-peak or off-peak periods (labelled as “Month+Peak” in Figure 3), can also be modestly more effective than an annual fixed-volume FTR for wind, but not nearly as impactful as the wind FTR. The lack of a significant reduction in the residual basis relative to that provided by the annual fixed-volume FTR, however, suggests that basis may be driven by widespread, correlated wind events where congestion increases with greater wind production in ways that are more variable than captured by coarse seasonal and time-of-day trends. As a result, simply revising the existing annual fixed-volume FTR design to have greater (but sill fixed) temporal granularity is not likely to be effective in resolving the inherent basis risk issue facing variable generation resources.

Conclusion: implications for the design of FTRs with high VRE penetration

Thermal generators are less-impacted by locational basis, and many can use the fixed-volume FTRs that are available in each of the three markets examined to effectively hedge their basis risk. The variable nature of wind generation, on the other hand, is not a good match for the fixed-volume FTR, leading to substantial residual basis and ongoing residual basis risk. The inability of conventional FTRs to hedge this risk makes them less attractive to wind plants and perhaps less effective at distributing congestion rents.

Continued investment in variable resources in congested markets may require improved hedging mechanisms to manage basis risk. Reforms to FTR markets, including the introduction of new FTR hedging products whose volume varies with wind generation, could create a more effective hedge for those resources most impacted by congestion.

“Rethinking the Role of Financial Transmission Rights in Wind-Rich Electricity Markets in the Central U.S.” was authored by James Hyungkwan Kim, Mark Bolinger, Andrew D. Mills, and Ryan Wiser, all of the Electricity Markets and Policy Department at Berkeley Lab

Register for a free webinar with the authors on February 7, 2023, at 10 am PT / 1 pm ET. Registration link: https://lbnl.zoom.us/webinar/register/WN_9jQWnS9IS_GVhUwAf5Ptig(link is external).

We appreciate the funding support of the Wind Energy Technologies Office within the U.S. Department of Energy’s Office of Energy Efficiency and Renewable Energy.

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James Hyungkwan Kim is an Energy Economist titled Energy Policy Project Scientist in the Electricity Markets and Policy Department at Lawrence Berkeley National Laboratory

This article is published with permission