UNIT I POWER SYSTEM FUNDAMENTALS 1.

Introduction
For nearly a hundred years, from the late 19 th century to the end of the 20 th century, the electricity supply industry operated as a regulated monopoly. During the nineties decade, many electric utilities and power distribution companies in many parts of the world ha e been forced to change their ways of doing business, from traditional ertically integrated mechanisms to open mar!et systems. "his can be specifically obser ed in #weden, $ngland, %olumbia, &ustralia, 'orway, Finland and many other parts of the world. "he reasons for introducing change ha e been many and ha e differed o er regions and countries. &mong the de eloping countries, the main issues ha e been a high demand growth coupled inefficient system management and irrational tariff policies, among others. "his has affected the a ailability of financial resources to support in estments in augmenting generation and transmission capacities. (n such circumstances, many utilities were forced to restructure or deregulate their power e)isting power sectors under pressure from international funding agencies. (n de eloped countries, on the other hand, the main moti e force has been to pro ide customers with electricity at lower and cheaper prices and to offer them a greater choice in purchasing economic electrical energy. *eforms ha e been underta!en by introducing commercial incenti es in generation, transmission, distribution and retailing of electricity, with, in many cases, large resultant efficiency gains.

1.1 Regul tion

*egulation means that the go ernment has set down the laws and rules that put limits on and define how a particular industry or company can operate. 'early all the industries in all nations world+wide are regulated to some e)tent, e en if it is only with laws that constrain them to do business under fair or fully disclosed business practices, or to operate their facilities within recommended safety guidelines. *egulation of electric utilities is not the only way a go ernment can control the electric power industry within its ,urisdiction. "he another popular way is either to own and operate the power distribution company directly, as a go ernment or municipal utility, or to set up an agency or administration that pro ides some or all of the electric power industry functions, thereby ha ing a hand in fashioning what the local power industry is and how it operates. 1.1.1 T!e Origin l Need "or Regul tion -oth go ernments and business fa ored utility regulation during the early history of the industry. .ften, they ehemently disagreed on the details of what and how

regulation would be implemented, but from the beginning, both groups recogni/ed that it was necessary. From the perspecti e of the businessmen running the early utilities, regulation brought se eral important benefits. a. (t legitimi/ed the electric utility business. 0o ernment franchises and regulation clearly implied to a possibly s!eptical public that ci ic leaders thought electricity was a good thing. b. (t ga e utilities recognition and limited support from the local go ernment, in appro ing *ight+of+way and easements, and by generally cooperating with them as they e)panded their embryonic companies. c. (t assured a return on in estment, regulated as that might be. d. (t established a local monopoly. $arly utility leaders could focus on building up their systems and the 1uality of them, without ha ing to worry about competitors undercutting prices to gain mar!et share, etc. -eyond the reason discussed abo e, and perhaps most important for both go ernment and business, regulation offered an acceptable, ris!+free way to finance the creation of an electricity supply industry. &t the dawn of the electric era, go ernment leaders were not about to in est large amounts of public capital in a new and untried technology, no matter how attracti e it appeared. *egulation too! care of that+the businessmen would ris! their money, not the go ernment2s. "rue, the go ernment was guaranteeing them a fair return on their in estment, but only through regulated rates. (f electric technology didn2t wor!, or if this new energy source didn2t sell in the mar!etplace, then the businessmen lost money, not the public. Wit!out utilit& regul tion nd go)ern+ent %'on%or%!i' or ( c,ing o" electric utilitie%- uni)er% l electric %&%te+ re c!ing ll !o+e% nd (u%ine%%e%- nd t!e in"r %tructure to %u''ort it- .ould ne)er ! )e (een (uilt.

1.1.# $! r cteri%tic% o" Regul ted Electric Utilit& Structure *egulated electric utilities pro ided the industry with stable growth and good ser ice for more than a century. "he !ey characteristics of the *egulated $lectricity (ndustry are as follows3 a. Mono'ol& Fr nc!i%e3 .nly the local electric utility can produce, mo e or sell commercial electric power within its ser ice territory. b. O(lig tion to Ser)e3 "he utility must pro ide ser ice to all electric consumers in its ser ice territory, not ,ust those that would be profitable. c. Regul tor& O)er%ig!t3 "he utility2s business and operating practices must conform to guidelines and rules set down by go ernment regulators. d. Le %t*$o%t O'er tion3 "he utility must operate in a manner that minimi/es its o erall re enue re1uirements 4amount it must bill its customer base5. e. Regul ted R te%3 "he utility2s rates 4prices5 are set in accordance with go ernment regulatory rules and guidelines.

f. A%%ured R te o" Return3 "he utility assured a fair return on its in estment, it conforms to the regulatory guidelines and practices. 1.1./ Structure o" Regul ted Electricit& Su''l& Indu%tr& & typical structure of a ertically integrated electric utility or regulated electricity supply industry is shown in figure 1.1

Figure 1.1 #tructure of a *egulated (ndustry (n figure 1.1, the money flow is unidirectional, i.e. from the consumers to the electric company. #imilarly, the information flow e)ists only between the generators and the transmission system. 1.1.0 Pro(le+% .it! Regul tion "he most common argument for the deregulation is the inefficiency of regulation. *egulation has two fundamental problems3 415 (t cannot pro ide a strong incenti e to suppliers as cheaply as can a competiti e mar!et, and 425 *egulatory bodies themsel es do not ha e proper incenti es. 6ell+trained regulators could pro ide much better regulation. -ut for go ernment to pro ide competent regulation, the political process would need to change. "he first problem, that of incenti es pro ided by regulators is more susceptible to analysis. T!e Regul tor1% Dile++ "ruly competiti e mar!ets do two things at once7 they pro ide full+powered incenti es 415 to hold price down to marginal cost, and 425 to minimi/e cost. *egulation can do one or

the other but not both. (t must always ma!e a trade+off because suppliers always !now the mar!et better than the regulators. Regul tion in Pr ctice %ompetition can hold a erage prices down to long+run costs while putting full strength pressure on cost minimi/ation. &t best, regulation does a decent ,ob of both but does neither 1uite as well as competition. -ut the 1uestion arises that how does regulation wor! in practice8 *egulation tends to err in the direction of dri ing prices down toward cost. (n fact, most regulators belie e this is their entire ,ob and would implement pure cost+of+ser ice 4%.#5 regulation213 if they could. Fortunately, it2s ,ust too much bother to read,ust rates continuously, so the result is roughly a price cap 425 that gets reset about e ery four years. (n practice, regulation has typically done a passable ,ob world+wide and could do much better if the effort spent deregulating were spent impro ing regulation.

1.# Deregul tion

"he success of pri ati/ation of the airline, telecommunications, gas industries has moti ated the deregulation and restructuring of the electricity supply industry. (n 1999, the :; became one of the pioneers in pri ati/ing its ertically integrated electricity industry. 'orway and %alifornia followed in 1990 and 199< respecti ely. "he success of energy pri ati/ation in the :; and 'orway has encouraged other countries worldwide to follow the trend. %ountries that had undergone energy deregulation include &rgentina, &ustralia, -ra/il, %hile, #pain, 'ew =ealand, (ndia etc. Deregul tion or (etter ter+ 4re*regul tion5 i% re*%tructuring o" t!e rule%regul tion% nd econo+ic incenti)e% t! t go)ern+ent% %et u' to control nd dri)e t!e electric 'o.er indu%tr&. 1.#.1 $ondition% "or Deregul tion6 Lo.er gener tion econo+ie% o" %c le "ueled t!e dri)e "or de*regul tion .ne force that led to the de+regulation of electric power was the change in generation economies of scale that occurred throughout the 19902s. :ntil about 1990+199>, really cost+ competiti e generation could be achie ed only by building truly monstrous coal, natural gas, or nuclear power plants. (t was difficult enough for a monopoly franchise holder to finance such power behemoths. 'o one could en ision how competing companies, each with only a segment of the mar!et, could afford to do so. -ut the situation changed beginning in the 19902s. "echnology from other areas of engineering led to more efficient small turbines and generators. #maller generators could nearly match the efficiency of the enormous units, particularly if they were run on natural gas, rather than coal. #imultaneously, the price of natural gas declined 1 ?erfect cost+of+regulation assures that, no matter what, suppliers will reco er all of their costs but no more. "his includes a normal rate of return on their in estment. ?erfect %.# regulation holds prices down to long+run costs but ta!es away all incenti es to minimi/e cost. # ?rice+cap regulation sets a cap on the supplier2s price according to some formula that ta!es account of inflation and technical progress, and it ne er changes the formula. & perfect 4 ery+

long+term5 price cap must always allow prices that are well abo e long+run cost to a oid accidentally ban!rupting suppliers. %onse1uently, prices will be too high. "hus, in many instances, it was possible to build new power plants that could pro ide energy at a lower price than what customers were paying for that coming from the e)isting old, giant power plants. &t this point, a great many industrial and commercial users of electricity began to build and operate their own plants to produce power cheaper than they could buy it from the utilities and also sell the e)cess power to small customers. 1.#.# Re %on% "or Deregul tion @any changes in technology, business, energy usage, and politics led to the worldwide trend toward electric industry de+regulation a. T!e need "or regul tion c! nged6 @ore fundamental than any one of the many articulated reasons for change, was the fact that the basic needs for regulation of electric utilities had largely abated long before the end of the 20th century. First, the original need for regulation which was to pro ide relati ely ris!+free financing of electric system de elopment, passed into unimportance decades ago. #econd, the omnipresent electric system created, was paid for, decades ago. 6hile utilities continue to borrow money, so that they can add to and re+new their systems, that does not represent the same le el of ris! and in estment as compared to that e)isted in the initial era. b. Pri) ti7 tion6 (n many of the countries where electric utility de+regulation first occurred 4e.g. &rgentina, $ngland5, the go ernment was also pri ati/ing the electricity supply industry. ?ri ati/ation means the go ernment sells its state+owned electric utility business to pri ate in estors. :sually the moti e, as in $ngland, was the go ernment2s firm con ictions that pri ati/e industry could do a better ,ob of running the power industry. "he push for pri ati/ation, and the accompanying political perspecti e, nearly always led to fa oring de+regulation. Deregulation does not ha e to be a part of pri ati/ation efforts. "he deregulation to free up the rules nearly always accompanies pri ati/ation. c. $o%t i% e8'ected to dro'6 %ompetition breeds inno ation, efficiency, and lower costs. @any people belie e that competition will bring about significant decrease in cost. .thers ehemently disagree. .ne thing that seems certain is that customer alue will impro e, whether price, itself, goes down or not. d. $u%to+er "ocu% .ill i+'ro)e6 Deregulation promotes customer focus on the part of suppliers, and increases customer choice. &lthough monopoly franchise utilities ha e an obligation to ser e all customers, that does not promote the same type of focused, pro+ acti e attention to customer needs that competition does. & monopoly+franchise utility listens to its customers when they e)plain their needs, and then responds. & competiti e electricity supply company anticipates their needs and responds in ad ance of their articulating them. e. Encour ge% Inno) tion6 "he regulatory process and the lac! of competition ga e electric supply utilities no incenti e to impro e on yesterday2s performance or to ta!e ris!s on new ideas that might increase customer alue. & competiti e electricity supply industry will pro ide rewards to ris! ta!ers and encourage the use of new technologies and business approaches

:nder deregulated en ironment, the electricity supply industry will always try to inno ate something new for the betterment of ser ice and in turn sa e its costs and ma)imi/e the profit. -y means of this, the utility will try to ensure that it will maintain its customer base in spite of competition.

1./ Ri%, M n ge+ent in Electricit& Su''l& Indu%tr&

*is! management is complicated in a restructured electricity mar!et. @o ing from regulated mar!ets with no or ery low price uncertainty, the electricity mar!ets are now facing liberali/ation and restructuring. $lectricity prices are no longer determined by the regulator, but by the mar!et. $)perience from the 'ordic and %alifornia electricity mar!ets demonstrates that the prices may e)hibit e)treme olatility. &n electricity mar!et player therefore needs ris! management procedures. $lectricity can be traded as any commodity on power e)changes li!e 'ord ?ool and (ndian $nergy $)change 4($A5. Bowe er, compared to the financial mar!ets, many electricity mar!ets lac! li1uidity, ha e tremendous olatility, e)hibit non+normal price distributions, and ha e mar!et incompleteness. (n particular, transmission constraints and the non+storability of electricity present complications. -ecause of the specific electricity mar!et characteristics, the ris! management ideas de eloped for the financial mar!ets are not directly applicable to the electricity mar!et. *is! is the e)posure to uncertainty, i.e. the degree of uncertainty of future net returns. "he term ris! management is used to describe any !ind of action that controls or changes the ris!. "his may be an increase or decrease in ris!. *is! management can generally be defined as changing the ris! to meet the decision ma!er2s attitude toward ris!. "he ob,ecti e of ris! management is to ensure that contract positions, trades, insol ency, and operations do not e)pose the company to losses leading to financial default. *is! management in the electricity mar!et is a relati ely new area that has been introduced after the restructuring of the electricity industry. @ar!et players face new uncertainties such as price uncertainty. "he price of electricity depends on supply and demand, and the price formation is complicated by the fact that electricity is non+ storable and that supply must e1ual demand in real+time. @anagement of different types of ris! as well as management of the total electricity portfolio1 puts great re1uirements on e)pertise. $ffecti e ris! management will gi e the mar!et player information about uncertainty in future net benefits. 1./.1 Di""erent T&'e% o" Ri%,% "he strategic, mar!et, and technical ris!s are the three main sources of ris!s for the players in the electricity mar!et Str tegic ri%, is often called political ris! and it is associated with changes in regulations and legislation. For e)ample there may be changes in energy legislation, changes in concessions for power plants, new rules for e)portCimport to foreign countries, changes in the domestic interest rate le el, changes in the currency rate, and sol ency problems in important customer groups.

M r,et ri%, is the dominating ris! and is associated with changes in prices resulting from uncertainties in supply and demand of electrical energy. "he supply of electricity is influenced by many conditions. "he main components of mar!et ris! are price, basis 4spot price minus futures price5, olume, counter+party, and li1uidity ris!. ?rice ris! is associated with uncertainty in future price. -asis ris! is due to the price difference between the spot price of the asset to be hedged and the futures price of the contract used. (f the asset to be hedged and the asset underlying the futures contract are the same, the basis should be /ero at the e)piration of the futures contract. Dolume ris! is associated with uncertainty in the future olume. %ounter+party ris! is associated with the counterpart being uncertain payer or supplier. Ei1uidity ris! is the ris! that a firm may not be able to, or cannot easily, unwind or offset a particular position at or near the pre ious mar!et price, because of inade1uate mar!et depth. Tec!nic l ri%, is associated with outages of generation and transmission facilities. Distribution companies will be e)posed to this ris!. "echnical ris! does not affect the electricity mar!et and the contract portfolio e)tensi ely because outages ha e short duration and occur infre1uently. 1./.# Source% o" Electricit& M r,et Ri%,% "he ma,or sources of electricity mar!et ris!s e)perienced by mar!et players are3 a. Su''l& S!ort ge6 & supply shortage could cause electricity prices to increase sharply, where a shortage in supply could be created due to unpredicted high temperatures or generation outages. 6hen supply is in shortage, mar!et participants would compete to reach scarce resources, utilities would do their best to fulfill nati e pea! load obligations and suppliers would try to a oid blac!outs. "hese reasons along with pressure from state regulators and politicians are all significant factors that moti ate prices to increase sharply in a olatile electricity mar!et. b. De" ult%6 "he default of participants could cause traders to doubt the creditworthiness of their counterparties and their ability to deli er the contracted power. & ma,or default may lead to widespread effect and se ere price run+up. ?articipants in electricity mar!et operations should recogni/e the potential ris!s and disseminate their resources among a ailable hedging alternati es to increase their chance for sur i al in this competiti e and restructured mar!et. c. Tr n%+i%%ion $on%tr int%6 :nder constrained situations, transmission line loading relief and curtailments could cause run+up in prices. (n addition, a constrained situation could reduce the ability of transmission pro iders to transfer power, which in turn could force mar!et participants to re1uest more power from the hourly spot mar!et, and contribute to price spi!es. d. Price In"or+ tion6 (nade1uacy in realistic and timely price information is another source of ris! in electricity mar!ets, especially at times when mar!ets ha e ma,or e ents such as outages of large generation units, defaults and other factors that could cause price spi!es. (f a participant 4buyer5 is under pressure to find a replacement power, and does not ha e any ade1uate information on what others are paying for power, the participant may get o ercharged for its purchase of

power. "his fact would necessitate price signals in electricity mar!ets to help reduce ris!s associated with price olatility. e. L c, o" E8'erience6 @ar!et participant2s lac! of e)perience could be another source of ris!s in electricity mar!ets. "he ine)perience may lead participants to pay higher prices than necessary7 for e)ample, a successful trader or a buyer who would need energy during the ne)t month could decide either to buy later from the spot mar!et or to sign a bilateral contract now. 1././ Met!od% to 9 ndle:T c,le Electricit& M r,et Ri%,% 29edging Electricit& Ri%,%3 "he management of an electricity business company must assess its ris! e)posures and establish rules for the contract portfolio that is consistent with the ris! profile of the company. Furthermore, all ris!s should be understood, measured, and controlled. &ppropriate ris! measures and tools are therefore important. (n finance, portfolio management has the ob,ecti e to in est in a combination of assets that gi es the highest e)pected return sub,ect to the in estor2s ris! profile. (n the electricity mar!et this means buying and selling the contracts that gi e the company the lowest purchasing price or highest selling price based on a chosen ris! preference. .ne of the strategies to reduce the ris! in finance is to di ersify, but this option is limited in electricity mar!ets 4assuming a single agent5. "he company must e aluate its total portfolio of contracts and acti ities and calculate how a single contract contributes to the total ris!. *is! hedging can be done by modifying physical generation plans, or by using financial contracts. &s most ris! management is done by utili/ing financial deri ati es, we e)plain the basic types here. "he two basic building bloc!s are forward and option contracts. Forward+based products include spot contracts 4physical contracts5, forwards, futures, and swaps. .ption+based products include options, caps, floors, and collars, as well as hybrids, and options on futures, forwards, and swaps. . S'ot $ontr ct3 "he spot contract is normally an hourly contract, but can be e en shorter, li!e the half+hourly spot contract. "he spot contract is not traded on a continuous basis, but through an auction conducted once a day. "he spot contract is a contract gi ing the buyer the obligation to recei e a specified amount of @6s of electricity o er the period, and the seller the obligation to deli er the same amount of power at a specific geographical location that might be anywhere in the transmission networ! or at a single hub. (. For. rd ( %ed $ontr ct6 "he electricity forwards and futures are normally traded on a continuous basis which is also the case for forwards in most of the traditional financial mar!ets. "heir reference price is the spot price. & forward contract commits the buyer to purchase 4and the seller to deli er5 an asset at a specified time in the future at a pre+arranged price. "hey can be pri ately negotiated between two parties or traded at an e)change. "hey often in ol e deli ery of the underlying asset.

c. Future ( %ed $ontr ct6 Futures are standardi/ed forward contracts, traded on organi/ed e)changes. "he main difference between the futures and forwards is the daily mar!ing to mar!et and settlement of futures. Forwards are settled when the contracts reach their due dates. d. S. '%6 $lectricity swaps are financial contracts that enable their holders to pay a fi)ed price for underlying electricity, regardless of the floating electricity price, or ice ersa, o er the contracted time period. "hey are typically established for a fi)ed 1uantity of power referenced to a ariable spot price at either a generator2s or a consumer2s location. $lectricity swaps are widely used in pro iding short+ to medium+term price certainty up to a couple of years. "hey can be iewed as a strip of electricity forwards with multiple settlement dates and identical forward price for each settlement. $lectricity locational basis swaps are also commonly used to loc! in a fi)ed price at a geographic location that is different from the deli ery point of a futures contract. "hat is, a holder of an electricity locational basis swap agrees to either pay or recei e the difference between a specified futures contract price and another locational spot price of interest for a fi)ed constant cash flow at the time of the transaction. "hese swaps are effecti e financial instruments for hedging the basis ris! on the price difference between power prices at two different physical locations. e. O'tion ; %ed $ontr ct%6 "he power industry had been utili/ing the idea of options through embedded terms and conditions in arious supply and purchase contracts for decades, without e)plicitly recogni/ing and aluing the options until the beginning of the electricity industry restructuring in the :.;., the :.#. and the 'ordic countries in the 1990s. "he emergence of the electricity wholesale mar!ets and the dissemination of option pricing and ris! management techni1ues ha e created electricity options not only based on the underlying price attribute 4as in the case with plain anilla electricity call and put options5, but also other attributes li!e olume, deli ery location and timing, 1uality, and fuel type. -asically, a counterpart of each financial option can be created in the domain of electricity options by replacing the underlying of a financial option with electricity. Bere, we describe a sample of electricity options that are commonly utili/ed in ris! management applications in generation and distribution sectors. "hese options usually ha e short+ to medium maturity times such as months or a couple of years. .ptions with maturity times longer than F years are usually embedded in long+term supply or purchase contracts, which are termed as structured transactions. 4i5 Pl in $ ll nd Put O'tion%6 $lectricity call and put options offer their purchasers the right, but not the obligation, to buy or sell a fi)ed amount of underlying electricity at a pre+specified stri!e price by the option e)piration time. "hey ha e similar payoff structures as those of regular call and put options on financial securities and other commodities.

"he underlying of electricity call and put options can be e)change+traded electricity futures or physical electricity deli ered at ma,or power transmission inter+ties, li!e the ones located at %alifornia+ .regon -order and ?alo Derde in the 6estern :.#. power grid. "he ma,ority of the transactions for electricity call and put options occur in the ."% 4o er+the+counter5 mar!ets. $lectricity call and put options are the most effecti e tools a ailable to merchant power plants and power mar!eters for hedging price ris! because electricity generation capacities can be essentially iewed as call options on electricity, particularly when generation costs are fi)ed. 4ii5 $ ll (le nd Put (le For. rd%3 "wo interesting types of electricity deri ati es termed as callable forward and putable forward are introduced to mimic the interruptible supply contracts and the dispatchable independent power producer contracts. (n a callable forward contract, the purchaser of the contract longs one forward contract and shorts one call option with a purchaser+selected stri!e price. "he seller of the forward contract holds opposite positions and can e)ercise the call option if the electricity price e)ceeds the stri!e price, effecti ely canceling the forward contract at the time of deli ery. "he purchaser gets an interruptibility discount on the forward price, which is e1ual to the option premium at the time of contracting continuously compounded to the deli ery time. (n a putable forward, the purchaser longs one forward contract and one put option with a seller+selected stri!e price. "he seller holds the corresponding short positions. "he purchaser e)ercises the put option if the electricity price drops below the stri!e price at the maturity time, effecti ely canceling the forward contract. &t the time of contracting, the purchaser needs to pay a capacity a ailability premium o er the forward energy price, which e1uals the put option price at that time, continuously compounded to the maturity time. .ne ariation of the callable forwards is proposed by adding an earlier notification date for e)ercising the call option in a callable forward before the contract matures. "his emulates an interruptible ser ice contract with early notification. 4iii5 S.ing O'tion%6 $lectricity swing options are adopted from their well+ !nown counterparts in the natural gas industry. &lso !nown as fle)ible nomination options, swing options ha e the following defining features. First, these options may be e)ercised daily or up to a limited number of days during the period in which e)ercise is allowed. #econd, when e)ercising a swing option, the daily 1uantity may ary 4or, swing5 between a minimum daily olume and a ma)imum olume. Bowe er, the total 1uantity ta!en during a time period such as a wee! or a month needs to be within certain minimum and ma)imum olume le els. "hird, the stri!e price of a swing option may be either fi)ed throughout its life

or set at the beginning of each time period based on some pre+specified formula. East, if the minimum+ta!e 1uantity of any contract period is missed by the buyer, then a lump sum penalty or a payment ma!ing up the seller2s re enue shortfall needs to be paid 4i.e., ta!e+or+pay5. ". Tolling $ontr ct%6 "olling is one of the most inno ati e structured transactions embraced by the power industry. & tolling agreement is similar to a common electricity supply contract signed between a buyer 4e.g., a power mar!eter5 and an owner of a power plant 4e.g., an (??5 but with notable differences. For an upfront premium paid to the plant owner, it gi es the buyer the right to either operate and control the scheduling the power plant with the (#. or simply ta!e the output electricity during pre+specified time periods sub,ect to certain constraints. (n addition to inherent operational constraints of the underlying power plant, there are often other contractual limitations in the contract on how the buyer may operate the power plant or ta!e the output electricity.

1.0 Fin nci l Tr n%+i%%ion Rig!t%

.pen access to, efficient utili/ation of, and ade1uate in estment in transmission networ!s are critical for the electricity wholesale mar!ets and retail competitions to be wor!able and efficient. (ntuiti ely, rights are re1uired for using transmission networ!s and rules are needed for rationing transmission usage when networ!s become congested. "here are two ma,or proposals for using financial instruments as transmission rights in the :.#.3 4a5 the point+to+point financial transmission rights 4F"*s5 and 4b5 the flowgate rights 4F0*s5 as outlined in the #tandard @ar!et Design 4#@D5 put forth by the Federal $nergy *egulatory %ommission 4F$*%5. F"*s and F0*s are electricity deri ati es, with their alues deri ed from the networ! transmission capacity. (n an electricity mar!et such as the ?G@ that employs locational mar!et price 4E@?5, a point+to+point F"* is specified o er any two locations in the power transmission grid. &n F"* entitles its holder to recei e compensation 4or pay5 for transmission congestion charges that arise when the grid is congested. "he congestion chargeCpayment 4or, payoff5 associated with one unit of F"* is e1ual to the difference between the two locational prices of one unit of electricity resulting from the re+dispatch of generators out of merit order to relie e transmission congestion. "he primary mar!ets for the F"* trading are auctions held by the independent system operators 4(#.s5 of power mar!ets. &n F"* option offers the right to the F"* settlement without the obligation to pay when that settlement is negati e. Bence the settlement of an F"* option e1uals to the positi e part of the corresponding two+sided point+ to+point F"*.

1.< $onge%tion M n ge+ent in $o+'etiti)e Electricit& M r,et

1.<.1 Introduction "ransmission congestion occurs when there is not enough transmission capability to support all re1uests for transmission ser ices, and in order to ensure reliability, transmission system operators must re+dispatch generation or, in the limit, deny some of these re1uests to

pre ent transmission lines from becoming o erloaded. (n other words, transmission congestion does not refer to deli eries that are simply held up or delayed 4as in traffic congestion57 it refers to re1uests for deli eries 4transactions5 that cannot be physically implemented as re1uested. %ongestion could pre ent system operators from dispatching additional power from a specific generator. Bistorically, ertically integrated utilities managed this condition by constraining the economic dispatch of generators with the ob,ecti e of ensuring security and reliability of their own andCor neighboring systems. $lectric power industry restructuring has mo ed generation in estment and operations decisions into the competiti e mar!et but has left transmission as a communal resource in the regulated en ironment. "his mi)ing of competiti e generation and regulated transmission ma!es congestion management difficult. "he difficulty is compounded by increases in the amount of congestion resulting from increased commercial transactions and the relati e decline in the amount of transmission. 1.<.# Re %on% o" $onge%tion6 %ongestion could be caused for arious reasons, such as transmission line outages, generator outages, changes in energy demand and uncoordinated transactions. 1.<./ E""ect% o" $onge%tion6 %ongestion can introduce physical and financial ris!s that participants ha e to manage. "he magnitude of these ris!s depends largely upon the pricing and settlement arrangement in the mar!et and how closely these rules are related to congestion management. Further, congestion may result in pre enting new contracts, infeasibility in e)isting and new contracts, additional outages, monopoly of prices in some regions of power systems and damages to system components. 1.<.0 I+'ort nce o" $onge%tion M n ge+ent "ransmission congestion has a specific meaning for electrical systems. (t can be defined as the condition where desired transmission line+flows e)ceed reliability limits. Following this definition, congestion management can be defined as the actions ta!en to a oid or relie e congestion. @ore broadly, congestion management can be considered any systematic approach used in scheduling and matching generation and loads in order to manage congestion. "he first responsibility of the transmission #ystem .perator 4#.5, whether it is a large (ndependent #ystem .perator or a small utility control area, is to maintain system reliability. "his in ol es de eloping generation and load schedules that can be balanced in real time. "he #. must ma!e sure that the scheduled flows do not e)ceed a ma)imum for any lin! on the system. #cheduling generators and loads must carefully consider any transmission lin! that could potentially become constrained. "his consideration includes not only the current flows on the system2s lines and e1uipment, but it also must consider the post+ contingency capacity. For any lin! the transmission system must pro ide enough capacity that any single contingency within the system 4and any credible multiple contingency5 could be handled.

&lthough the transmission system operates according to the physical laws of power flow, the economic implications for congestion management are e1ually important. "ransmission congestion can be easily managed by curtailing generators and loads. Bowe er, arbitrarily restricting generators and loads can ha e significant economic costs. Figures 1.2 and 1.F portray an e)ample of why this is the case.

Figure 1.2 ?ower flow with no constraints

Figure 1.F ?ower flow with constraints (n Figure 1.2, there is no congestion. "he 200 @6 load can be ser ed with a ailable power at H20 per @6B. Bowe er, in Figure 1.F, while the same generation source offers power at H20 per @6B, the a ailable transfer capability has been reduced to 1>0 @6, less than the desired transfer of 200 @6. 'ow the remaining >0 @6 of power must be transferred o er a different facility and purchased from a second generator that charges HI0 per @6B. "hus for the >0 @6 increment, the cost of power purchased by the customer has doubled. "he a erage cost to the customer for 200 @6B has increased from HI,000 to H>,000 or by 2>J. "his e)ample illustrates why transmission congestion and conse1uently congestion management is potentially important from an economic standpoint. 1.<.< Princi'le% o" $onge%tion M n ge+ent6 (n principle, congestion can only be relie ed physically by reducing generation or increasing consumption on the surplus side of the bottlenec! and, con ersely, by increasing generation or reducing consumption on the shortfall side. Depending on which time phase one is in, different methods can be used for managing congestion. "hese methods should be based on the following principles3 1. $conomic efficiency and promotion of competition, 2. @a)imi/ing of the amount of capacity a ailable and the use made of it, F. "ransparency to networ! users on a nondiscriminatory basis, I. $fficient #ystem .peration 1.<.= $onge%tion M n ge+ent Met!od% (n liberali/ed electricity mar!et all the 0enerating %ompanies and Distribution %ompanies ma!e the transactions ahead of time, but by the time of implementations there may be congestion in some of the transmission lines. Bence (ndependent #ystem .perator has the responsibility to relie e congestion so that the system is maintained in secure state. .ne of the reasons why a specific congestion management method is used is that it should be economically efficient in the short run and pro ide correct incenti es for in estment 4networ! capacity, production capacity and e en location of consumption5 in the long run. %ongestion may be alle iated through arious ways. &mong the technical solutions we ha e out+aging of congested lines, operation of F&%"# de ices and operation of transformer tap changers. &mong the non technical solutions we ha e mar!et based and non mar!et based methods of %ongestion @anagement. 'on mar!et based methods are those where no form of mar!et mechanism is used to allocate the scarce transmission capacity but use other reasonable criteria. "hese include sharing of capacity on a pro rata basis where users share in proportion to their re1uirements, first come first ser e and preference for certain types of contracts. "he non mar!et based methods for congestion management do not send any signals for in estment and ha e no measure of the alue of the congested line. @ar!et based methods are based on mar!et

mechanisms and hence gi e an indication of the alue of the scarce resource of transmission capacity. "hese methods are briefly discussed below. 1.<.=.1 Nod l nd >on l 'ricing (n the nodal pricing scheme e ery bus in the grid is treated as a /one. "he locational marginal price 4E@?5 for each bus is determined by the (#. by carrying out an economic dispatch with the flow limits. "he E@? becomes the price and payment that buyers pay and the generators recei e respecti ely. "he mar!et is settled with the networ! constraints hence congestion does not arise. "his method of congestion management is practiced by the ?G@ in the :#&. (n =onal pricing system buses with similar E@?s are aggregated into /ones. "he mar!et is first settled constraint free. $ach /one will ha e a price for energy that buyers can pay and sellers recei e. (n the case that congestion occurs the (#. recei es supplementary bids for increase and decrease of generation. "he most e)pensi e supplemental bid for increase of generation becomes the price for that /one and the cheapest supplemental bid for decrease of generation becomes the price for that /one. (n this way the (#. earns congestion rent o er the congested lines. (n case that there is no congestion the /onal prices will be the same. "he %alifornia mar!et migrated from this congestion management mechanism to the /onal pricing method. 1.<.=.# Re*di%' tc!ing (n this method of congestion management the mar!et is settled without the constraints of the transmission system being applied. (f congestion occurs the (#. re+ dispatches the generation in such a way that congestion is gotten rid of. "his will entail the (#. purchasing power from high price areas. "he generators in the low price areas will be commanded to regulate downwards. #ince the (#. in essence is buying power at a high price and selling it at a lower price he incurs a cost. "he net cost incurred by the (#. is an indication of the congestion charge and is a signal for in estment. "he (#. directly commands generators to up regulate or down regulate without the use of the mar!et. 1.<.=./ $ounter tr ding %ounter trading is a modified form of re+dispatching the difference being that up and down regulation power is obtained from the mar!et. "he generators submit bids for up and down regulation on the balancing mar!et. #imilar to the re+dispatch the (#. will incur net cost in the purchase of regulation power since he has to use more e)pensi e power for up regulation. #weden uses this form of congestion management. %ounter trading may be iewed as a special type of re+dispatching. (n this thesis we shall use these methods for clearing congestion. 1.<.=.0 M r,et S'litting (n mar!et splitting the mar!et is first settled without constraints applied. (f the resulting schedules cause congestion on some line4s5 the mar!et is then split and settled separately with the transfer limit applied. "he (#. purchases power from the low price area and sells it in the high price area. "he (#. thus ma!es a profit. 'orway uses this congestion management method. 1.<.=.< Auctioning

(n auctioning the a ailable capacity of a normally constrained path is auctioned by the (#. recei ing bids from parties willing to use the path. "he lowest marginal bid accepted becomes the price for transmission on the path. "wo forms of auctioning are in use i.e. implicit and e)plicit. 1.<.=.= Lo d curt il+ent -y managing load, congestion can also be effecti ely relie ed. "he benefits result from reduced pea! demand and reduced pressure on both electricity generation and distribution systems. "he amount of curtailed load should be as small as possible and the price in the congested area should fall as much as possible. 6hile there are many different !inds of curtailment algorithms, a parameter termed as willingness+to+pay+to+a oid+ curtailment was introduced in which is regarded as a highly effecti e instrument in setting the transaction curtailment. 1.<.=.? FA$TS Fle)ible &% transmission systems 4F&%"#5 is a new technology de eloped in recent two decades, and it has been widely put in practice in the world. F&%"# is defined by the ($$$ as a power electronic+based system and other static e1uipment that has the ability to enhance controllability, increase power transfer capability. F&%"# could be connected either in series or in shunt with the power system or e en in a combined pattern to pro ide compensation for the power system. Dariable series capacitors, phase shifters and unified power flow controllers as the most used F&%"# de ices can be utili/ed to change the power flow which result in many benefits li!e losses reduced, stability margin increased etc. Due to such features of F&%"#, integrating it into the congestion management becomes more and more popular. & summary of congestion management methods is shown in figure 1.I.

Figure 1.I #ummary of %ongestion @ethods

1.= A) il (le Tr n%"er $ ' (ilit&

(n a deregulated power system, the information about the transfer capability will help the energy mar!eters in reser ing the transmission ser ices. For secured and economic

supply of electric power, long distance bul! power transfers are essential, but the power transfer capability of a power system is limited. "o operate the power systems safely and to gain the ad antages of bul! power transfers, computations of transfer capability is essential. "ransfer capability plays a ital role in liberali/ed electricity mar!et. &ll the transmission lines are utili/ed significantly below their physical limits due to arious constraints. -y increasing the transfer capability the economic alue of transmission lines can be impro ed and also there will be an increase in o erall efficiency as more energy trading can ta!e place between the competing regions operating with different price structures. "he power system should be planned and operated such that these power transfers are within the limits of the system transfer capability. A) il (le Tr n%"er $ ' (ilit& 2AT$3 is a measure of the transfer capability remaining in the physical transmission networ! for further commercial acti ity o er and abo e already committed uses. @athematically, &"% is defined as the "otal "ransfer %apability 4""%5 less the "ransmission *eliability @argin 4"*@5, less the sum of e)isting transmission commitments 4which includes retail customer ser ice5 and the %apacity -enefit @argin 4%-@5. Tot l Tr n%"er $ ' (ilit& 2TT$3 is defined as the amount of electric power that can be transferred o er the interconnected transmission networ! in a reliable manner while meeting all of a specific set of defined pre+ and post+contingency system conditions. Tr n%+i%%ion Reli (ilit& M rgin 2TRM3 is defined as that amount of transmission transfer capability necessary to ensure that the interconnected transmission networ! is secure under a reasonable range of uncertainties in system conditions. $ ' cit& ;ene"it M rgin 2$;M3 is defined as that amount of transmission transfer capability reser ed by load ser ing entities to ensure access to generation from interconnected systems to meet generation reliability re1uirements. 1.=.1 A) il (le Tr n%"er $ ' (ilit& Princi'le% & ailable "ransfer %apability 4&"%5 is a measure of the transfer capability remaining in the physical transmission networ! for further commercial acti ity o er and abo e already committed uses. &s a measure bridging the technical characteristics of how interconnected transmission networ!s perform to the commercial re1uirements associated with transmission ser ice re1uests, &"% must satisfy certain principles balancing both technical and commercial issues. &"% must accurately reflect the physical realities of the transmission networ!, while not being so complicated that it unduly constrains commerce. "he following principles identify the re1uirements for the calculation and application of &"%s. a. ATC calculations must produce commercially viable results. ATCs produced by the calculations must give a reasonable and dependable indication of transfer capabilities available to the electric power market. "he fre1uency and detail of indi idual &"% calculations must be consistent with the le el of commercial acti ity and congestion. b. ATC calculations must recognize time-variant power flow conditions on the entire interconnected transmission network. In addition, the effects of simultaneous transfers and parallel path flows throughout the network must be addressed from a reliability viewpoint. *egardless of the desire for commercial

c.

d.

e.

f.

simplification, the laws of physics go ern how the transmission networ! will react to customer demand and generation supply. $lectrical demand and supply cannot, in general, be treated independently of one another. &ll system conditions, uses, and limits must be considered to accurately assess the capabilities of the transmission networ!. ATC calculations must recognize the dependency of ATC on the points of electric power in ection, the directions of transfers across the interconnected transmission network, and the points of power e!traction. All entities must provide sufficient information necessary for the calculation of ATC. $lectric power flows resulting from each power transfer use the entire networ! and are not go erned by the commercial terms of the transfer. "egional or wide-area coordination is necessary to develop and post information that reasonably reflects the ATCs of the interconnected transmission network. &"% calculations must use a regional or wide+area approach to capture the interactions of electric power flows among indi idual, subregional, *egional, and multiregional systems. ATC calculations must conform to #orthern American $nergy "eliability Council %#$"C&, "egional, subregional, power pool, and individual system reliability planning and operating policies, criteria, or guides. &ppropriate system contingencies must be considered. The determination of ATC must accommodate reasonable uncertainties in system conditions and provide operating fle!ibility to ensure the secure operation of the interconnected network.

1.=.# I+'ort nce o" AT$ A%%e%%+ent (n the open access or deregulated en ironment all the participants 4producers and buyers of electrical energy5 desire to produce or consume large amounts of energy and may force the transmission system to operate beyond one or more transfer limits. "his !ind of operation leads to congestion of the system. "herefore accurate determination of a ailable transfer capability is essential to ensure the system security and reliability while ser ing a wide range of bilateral and multilateral power transactions. "he following reasons show the need of &"% computations (t gi es the amount of ma)imum additional power transfer between the specified interfaces. (t ensures the secure operation of the system. .n the basis of &"% computation firm and non+firm reser ation of transmission ser ices can be made. (n a deregulated open access mar!et it can be used as tool for transmission pricing. "he limits or binding constraints for &"% can be used in power system planning and networ! e)pansion.

1.? Screening $ur)e%

#creening cur es can be used to identify the fi)ed and ariable costs for a gi en generating unit as a function of the capacity factor. %apacity factor is the percentage of the hours in the year that a generator ser es a load and is determined by the load. & screening cur e plots the average cost vs the capacity factor. "he two types of screening cur es are3 a. %apacity -ased and b. $nergy -ased. %apacity+based screening cur es plot the a erage cost for using the capacity of the plant and are represented with the cur e ACCapacity = FC + cf VC . "his type of screening cur es can be used to determine optimal in estment le els in different generating technologies based on the optimal durations a certain technology should ser e each operating mode. "hese cur es can be used to compare generation costs between different generating technologies. Figure 1.> shows a typical capacity+based screening cur e.

Figure 1.> %apacity+-ased #creening %ur e From figure, it can be seen that the capacity+based screening cur e is formed by a fi)ed component and a ariable component. "he fi)ed component is the in estment cost. :sually, the in estment cost is annuali/ed either o er the plant life of the planning period. "he ariable component is the ariable operating cost whose biggest and most significati e part is the fuel cost. #ince in estment plans range from ten to thirty years, the annuali/ed fuel cost has to be le eli/ed to ta!e into account the effects of inflation. "he uniform le eli/ed annual e1ui alent of the fuel cost is
41 + a 5 1 n 1+ i i 41 + i 5 LA fc = fc 4i a 5 41 + i 5 n 1
n

where LAfc is the le eli/ed annual fuel cost, fc is the fuel cost in the first year, a is the inflation rate, i is the present worth rate and n is the number of years of the le eli/ation. $1uation 415 transforms an inflation series into annuities. $nergy+based screening cur es show the a erage cost of the energy produced by a generating unit. "hey are represented by the cur e AC Energy = cf +VC . $nergy+based screening cur es are ery useful when assessing alternati es technologies 4nuclear, wind, solar or the li!e5 in electricity mar!ets. "he capacity factors for alternati e technologies are
FC

technical dependent rather than mar!et dependent. "his is because their ariable costs are usually below the mar!et price so they run whether they are technically capable. "o assess the economics of alternati e technologies, the a erage cost of energy is compared with the a erage price of the mar!et.

Figure 1.< $nergy+-ased #creening %ur e Figure 1.< shows a typical energy+based screening cur e. (t is worth mentioning that when comparing se eral technologies using either the capacity+based or the energy+based screening cur es, both cur es intersect at the same point, that is, at the capacity factor at which one generating unit becomes more economical than the other.

Review Questions for University Exams 1. 6hat do you understand by ?ower #ystem $conomics8 'ower (ystem $conomics deals with a. economic aspects including economic theory in the electricity market, b. market design and interactions in liberalized electricity markets, c. behavior of involved market participants, regulatory and public policy implications, and technical restrictions. 2. 6hat do you understand by regulation8 $)plain the need of regulation. F. $)plain in brief the characteristics of a regulated electricity supply industry. I. Draw and e)plain the structure of a regulated electric utility structure. >. Discuss the problems associated with regulation. &lso e)plain *egulator2s Dilemma. <. 6hat do you understand by the term Deregulation8 $)plain the conditions that led to deregulation in power sector. K. $)plain in detail the arious reasons that cause the electricity supply industry to mo e towards deregulation. 9. 6hat do you understand by *is! @anagement in electricity mar!et8 &lso e)plain the importance of ris! management. 9. $nlist the arious ob,ecti es of *is! @anagement.

10. Eist and e)plain the arious types of ris!s in ol ed in the liberali/ed electricity mar!et. 11. Describe the arious sources that causes ris!s in open electricity mar!et. 12. $)plain arious methods or financial deri ati es of mitigating or handling ris!s in power mar!et. 1F. 6hat do you understand by the term Financial "ransmission *ights in electricity mar!et8 1I. Define congestion in power transmission system. 6hy it occurs8 1>. $nlist the arious ill+effects of congested transmission networ!. 1<. $)plain the concept and importance of congestion management in competiti e electricity mar!et. 1K. .n what principle does the congestion management methods are based8 $)plain 19. Describe the arious methods of handling or tac!ling congestion in transmission grid. 19. $)plain the term & ailable "ransfer %apability in deregulated power system. 20. 6rite short notes on the following3 a. "otal "ransfer %apability 4""%5. b. "ransmission *eliability @argin 4"*@5. c. %apacity -enefit @argin 4%-@5. 21. Eist and e)plain arious principles that identify the re1uirements for the calculation and application of & ailable "ransfer %apability. 22. Describe arious principles that & ailable "ransfer %apability must satisfy while balancing technical and commercial issues associated with transmission ser ice re1uests. 2F. 6hy & ailable "ransfer %apability &ssessment is important in open access power system8 2I. 6hat do you understand by screening cur es8 $)plain with neat diagrams the capacity+based screening cur e and energy+based screening cur e.