EBF 301
Global Finance for the Earth, Energy, and Materials Industries

Lesson 12 Introduction

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Overview

This lesson will focus on the electricity market and introduce the major players and common financial instruments in the market. Since electricity cannot be stored in large volumes at a reasonable cost, part of the job of the power grid operator is to make sure that supply and demand balance at every moment. This means that the power grid is making adjustments every single second (or less than a second) as demand changes. Many of these adjustments are automated responses. This gives unique characteristics to the electricity market that is not common in other energy markets. Unlike transportation cost in the oil and gas market, electricity transmission cost is highly volatile. Because of these characteristics, NYMEX futures contracts don’t add much value to the market, and they are not commonly traded, or the traded volume is very low. Consequently, other financial instruments are being used for the purposes of arbitrage and hedging.

We will learn what is called the "energy market" portion of the PJM market model. The energy market is essentially a set of two connected short-term forward markets. The first, called the "day ahead" market, commits generators to be able to produce electricity 24 hours in advance, based on forecasted demand. The second, called the "real-time" market or "hour ahead" market, commits generators to be able to produce electricity one hour in advance, based on an updated demand forecast. You can think about the day-ahead market as setting a schedule of which power plants should be available to produce energy, while the real-time market shifts those schedules around a little bit based on an improved forecast of electricity demand.

Learning Outcomes

At the successful completion of this lesson, students should be able to:

  • explain the basics of the electricity market and its differences comparing to other energy commodity markets;
  • outline electricity market reform;
  • define the RTO’s role in the electricity market;
  • describe the uniform price auction mechanism;
  • be able to recognize the temporal and locational risks in the electricity market;
  • demonstrate the financial instruments being used for arbitrage and hedging purposes:
    • virtual bidding,
    • spark spread,
    • financial transmission rights,
    • contracts for differences.

What is due for Lesson 12?

This lesson will take us one week to complete. The following items will be due Sunday at 11:59 p.m. Eastern Time.

  • Lesson 12 Quiz
  • Lesson 12 activities as assigned in Canvas

Questions?

If you have any questions, please post them to our General Course Questions discussion forum (not email), located under Modules in Canvas. The TA and I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.

Note

The majority of this lesson was modified, with permission, from Penn State's EBF 483, Introduction to Electricity Markets written by Dr. Seth Blumsack.