LBNL Report Number
The physical nature of electricity generation and delivery creates special problems for the design of efficient markets, notably the need to manage delivery in real time and the volatile congestion and associated costs that result. Proposals for the operation of the deregulated electricity industry tend towards one of two paradigms: centralized and decentralized. Transmission congestion management can be implemented in the more centralized point-to-point approach, as in New York state, where derivative transmission congestion contracts (TCCs) are traded, or in the more decentralized flowgate-based approach. While it is widely accepted that theoretically TCCs have attractive properties as hedging instruments against congestion cost uncertainty, whether efficient markets for them can be established in practice has been questioned. Based on an empirical analysis of publicly available data from years 2000 and 2001, it appears that New York TCCs provided market participants with a potentially effective hedge against volatile congestion rents. However, the prices paid for TCCs systematically diverged from the resulting congestion rents for distant locations and at high prices. The price paid for the hedge not being in line with the congestion rents, i.e. unreasonably high risk premiums are being paid, suggests an inefficient market. The low liquidity of TCC markets and the deviation of TCC feasibility requirements from actual energy flows are possible explanations.
Year of Publication
The attached report is a preprint version of an article accepted for publication by the journal Managerial Finance under the title "Efficiency of the New York independent system operator market for transmission congestion contracts." The published version is available from the publisher here.