A Forward Energy Market to Improve Resiliency

Electricity markets use energy prices to balance supply and demand in real-time. Frequent shocks to supply and demand imply high volatility of spot prices. Prices that average about $50 per megawatt-hour may vary from -200 to 5,000 dollars, depending on market circumstances. Market participants trade forward energy to manage risk from the high spot-price volatility. Demanders typically buy ahead a quantity roughly equal to their real-time consumption, and suppliers sell forward an amount about equal to their real-time production. This note describes how the system operator can facilitate forward trading with a forward energy market. The products are financial derivatives of the day-ahead energy product. (The day-ahead market already manages risk between day-ahead and real-time products.) Monthly forward energy is traded up to 12 × 4 = 48 months ahead by day type (weekday, weekend) and hour. Hourly forward energy is traded up to 24 × 30 = 720 hours ahead. The products also differ by load zone to hedge congesti on risk and include renewable energy certificates (RECs) to manage renewable standards. These monthly and hourly products enable both sides of the market to establish forward positions to manage risk better. Trade occurs without friction with hourly clearing using the Budish-Cramton-Lee-Kyle-Malec flow trading methodology. Flow trading allows participants to adjust portfolio positions efficiently as information changes. The approach identifies unique prices and quantities for the products that maximize as-bid social welfare. The system operator performs the settlement and optimizes collateral requirements. There is transparency about price, quantity, and forward positions. Load-serving entities have a mandatory schedule of purchase obligations, increasing linearly from 0 percent 48 months ahead to 100 percent one month ahead; dominant suppliers have a symmetric obligation to sell; in other respects, the market is voluntary. The forward energy market replaces any capacity market or capacity requirements. The forward energy market has several advantages: it gives participants flexibility in adjusting positions to manage risk better, ties collateral requirements to default exposure, mitigates market power, and provides robust price signals to guide behavior. A full-scale simulation of a US market provides proof-of-concept of the forward energy market.