1. Contracts and risk on
electricity markets

2. Context
 Power markets are rapidly evolving due to liberalization.
 Incumbent monopolies are declining as we can see with the state of EDF.
 Competition in power market is slowly but surely growing.
 An example : The antitrust case of EDF by the European Commission.

3. Objective of this essay
 Understanding the fundamentals behind transactions on the power market.
 What are the fundamentals behind a system where multiple means of
transactions coexists?
 Analyzing risk and its management for agents.
 How agents are apprehending this specific rational on power market?
 Reviewing implications of electricity transactions for electro-intensive
industry.
 An economic and financial approach of the subject.

4. Power markets and multiprice system

5. The French power market
• A wholesale market with
• Spot transactions
• Intraday; day-ahead; week-end
• Futures
• Monthly; quarterly; (weekly?)
• Standardized long term contracts
• Yearly
• An over-the-counter market
• With mostly long term contracts
• Observations:
• A hierarchy
• An evolution

6. Two cases study: California’s crisis
and the NETA
 California: An example of a failed restructuring program and of a spot based
market.
 Illustrate the need of a second bilateral market and hedging tool for consumers.
 The reference: Joskow in California's electricity crisis (2001)
 The NETA: A program with an aim to replace a spot market by a market
“based on bilateral trading between generators, suppliers, traders and
customers” (National Audit Office, 2003)
 The new market still have short term tools but they are either agreements or
transactions used for balancing the system

7. First step: Risk allocation – Polinsky’s
Model
• Many questions:
• How those different type of transaction affect it?
• Will the spot market will increase the risk of suppliers or of buyers?
• Do the characteristics of the buyers have a significant impact?
• An answer from theory decision: the best mean is the one that minimizes the
risk.
• In this case, mean of transaction are seen as insurance tool.
• Polinsky. (1986). Fixed Price versus Spot Price Contracts: A Study in Risk
Allocation.

8. Second step: equilibrium in a multiprice
system - Hubbard and Weiner’s Model
• Need for a deeper analysis of the market with an optimal price and quantity
for contract and spot transactions.
• This analysis will allow us to find the optimal situation for agents where two
means of exchange exists: one with a fixed price and one with a flexible price.
• Hubbard, & Weiner. (1992). Long-Term Contracting and Multiple-Price
Systems.

9. Other rationales
 Wolak. (1996). Why Do Firms Simultaneously Purchase in Spot and Contract
Markets? Evidence from the United States Steam Coal Market.
 Quantity risk
 More an agent avoids quantity shortage more the demand for contracts will be high.
 Market structure
 An increasing number of sellers will lower transaction costs and lead to an higher
demand for spot transactions.
 Williamson. (1979). Transaction-Cost Economics: The Governance of Contractual Relations
 Contractual relations
 Based on game theory, spot transactions can be regarded as a reward or an incitation to
not breach a contract.
 Teece. (1976). The multinational corporation and the resource cost of international technology
transfer

10. To sum up: what theory and reality
show?
 Actual markets highlights the complexity of the existence of multiple means
of transaction.
 Such systems exist due to the specific nature of electricity.
 The evolution of a multiprice system depends on many factors, the main one
is risk, but also on:
 The origin of uncertainty, supply and demand characteristics, risk aversion …
 Arbitrages between spot transactions and long term agreements can be seen
as a way of reducing this risk.

11. Risk management on power markets
Futures as arbitrators tools.

12. The demand for futures
Firm 2
𝑛𝑜𝑡 𝑒𝑛𝑡𝑒𝑟𝑖𝑛𝑔 𝑒𝑛𝑡𝑒𝑟𝑖𝑛𝑔
Firm 1
𝑛𝑜𝑡 𝑒𝑛𝑡𝑒𝑟𝑖𝑛𝑔 0.111; 0.111 {0.0625; 0.75}
𝑒𝑛𝑡𝑒𝑟𝑖𝑛𝑔 0.75; 0.0625 0.08,0.08
• A strategic tools that can appears even
without uncertainty
• A game theory approach to explain the
existence of such contracts.
• A duopoly and a prisoner dilemma
• With Cournot and Stackelberg games
• Allaz, & Vila. (1989). Cournot Competition,
Forward Markets and Efficiency.

13. Other implications of futures on power
markets
 Futures increase liquidity by raising the demand for spot transaction.
 Termini. (2007). Spot, Bilateral and Futures Trading in Electricity Markets.
Implications for Stability.
 An important role on power markets where price are highly volatile.
 Futures mitigate market power by reducing price to marginal cost
 Termini. (2007) and Allaz, & Vila. (1989)
 Also very present on power markets due to historical but also economic reasons.

14. Application for the electro-intensive
industry
Definition and review of the Exeltium consortium

15. Legal definition
 At the beginning:
 The ratio between the electricity consumed and the added value of the firm is above 2.5
Kwh/€.
 55% of the total annual consumption has to be during baseload (between 8 pm and 8
am);
 A ratio between the energy consumption below a certain power threshold and the higher
power or equal to 8 000 hours;
 The eligibility of the CSPE;
 New conditions:
 A firm is electro intensive when it is in a sectors which takes part in the European
exchange of C02 quotas with an intensity of at least 4%;
 A site is considered electro intensive when its annual consumption is at least 5OGWh;
 A site is considered hyper electro intensive when its ratio between the electricity
consumed and the added value of the firm is above 6 Kwh/€ and when the firm is in a
sectors which takes part in the European exchange of C02 quotas with an intensity of at
least 25%;

16. Electro-intensive industry and electricity
 Those industries are particularly vulnerable to any change in electricity price.
 Electricity count for more than 6 % of their revenue.
 A proof: French authorities decided to protect those industries by lowering price
constraints.
 Based on a study, an increase of 1% of the electricity cost leads to a decrease of
0.14% of the production in the paper industry.
 Bordigoni. (2013). Détermination du rôle de l’energie dans la compétitivité de
l’industrie manufacturière : Etudes économétriques et modélisation des
interdépendances.
 Those observations illustrate the need for a solid and significant risk management
policy.