Valuing an FTR obligation and an FTR option from the hourly congestion spread, and why most of the value sits in a few hundred hours.
A financial transmission right pays the holder the price at the sink node minus the price at the source node, for every hour of its term, on its MW quantity. Its value is the sum over all hours of that spread times the MW: an obligation counts negative hours against you, an option ignores them. On an illustrative 50 MW annual right with an expected spread of 4.96 per MWh, the obligation is worth 2,172,000 and the option 2,322,000; bought at an auction price of 4.20, the obligation's expected profit is 332,400, and more than half of its value comes from 6.3 per cent of the hours.
Worked in full in Energy Trading by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
In markets with locational or zonal prices, power bought at one point and delivered to another is exposed to congestion: when the line between them is full, the importing side prices above the exporting side. A financial transmission right is a financial contract that pays that price difference. It carries no physical capacity. In US organised markets these are FTRs, or congestion revenue rights in some; on many European borders long-term rights are issued as FTR options. A generator at a cheap node that has sold its output forward at a liquid hub buys one to hedge the basis; a trader buys one as a view on congestion. Either way the valuation is the same arithmetic as a price duration curve, applied to the spread rather than to the price.
| Hours | Share of year | Spread per MWh | Obligation value per MW | Share of value |
|---|---|---|---|---|
| 4,380 | 50.0% | 0.00 | 0 | 0.0% |
| 2,190 | 25.0% | 4.00 | 8,760 | 20.2% |
| 1,140 | 13.0% | 12.00 | 13,680 | 31.5% |
| 400 | 4.6% | 30.00 | 12,000 | 27.6% |
| 150 | 1.7% | 80.00 | 12,000 | 27.6% |
| 500 | 5.7% | −6.00 | −3,000 | −6.9% |
| 8,760 | 100% | 4.96 | 43,440 | 100% |
The right is 50 MW for the full year, 438,000 MWh, and it clears at an auction price of 4.20 per MWh. Half the hours are uncongested and pay nothing; 500 hours flow the other way, when the source node prices above the sink.
Obligation value per MW = Σ hours × spread = 8,760 + 13,680 + 12,000 + 12,000 − 3,000 = 43,440
Option value per MW = Σ hours × MAX(spread, 0) = 43,440 + 3,000 = 46,440
Position values: obligation 50 × 43,440 = 2,172,000; option 50 × 46,440 = 2,322,000
Average spread: obligation 43,440 / 8,760 = 4.96 per MWh; option 5.30 per MWh
Auction cost of the obligation = 4.20 × 8,760 × 50 = 1,839,600; expected profit = 2,172,000 − 1,839,600 = 332,400, 18.1 per cent of the cost
Excel, with hours in A2:A7 and spreads in B2:B7: =SUMPRODUCT(A2:A7,B2:B7)*MW for the obligation, =SUMPRODUCT(A2:A7,(B2:B7>0)*B2:B7)*MW for the option.
The obligation's expected value is 4.96 per MWh, 0.76 above the clearing price. Yet the bulk of the hours contribute little: the 550 hours at 30 and 80, 6.3 per cent of the year, carry 55.2 per cent of the value, and the 150 most congested hours alone carry 27.6 per cent from 1.7 per cent of the year. Those are the hours of outages, heat waves and wind surges, which are exactly the hours a historical average is least able to forecast. Valuing an FTR is mostly a judgement about a few hundred hours.
The option is worth 150,000 more than the obligation because it drops the 500 reverse-flow hours. A bidder should pay up to 5.30 per MWh for the option at these expected spreads, against 4.96 for the obligation, before any discount for risk.
| Scenario | Spread per MWh | Value | Profit after auction cost |
|---|---|---|---|
| All spreads halved | 2.48 | 1,086,000 | −753,600 |
| All spreads 75% | 3.72 | 1,629,000 | −210,600 |
| Base case | 4.96 | 2,172,000 | 332,400 |
| All spreads 125% | 6.20 | 2,715,000 | 875,400 |
| 150 spike hours do not happen | 3.59 | 1,572,000 | −267,600 |
| Reverse-flow hours 1,000 | 4.62 | 2,022,000 | 182,400 |
| Reverse-flow hours 1,500 | 4.27 | 1,872,000 | 32,400 |
An 18.1 per cent margin over the auction price disappears with a modest fall in congestion: the obligation loses money if spreads come in at 75 per cent of expectation, or if the spike hours simply do not occur, for instance because a planned outage on the line is cancelled. Reverse flows matter only to the obligation; the option's value stays at 2,322,000 whatever happens in those hours.
For a 50 MW baseload generator at the source node that has sold its output forward at the sink hub, the basis is a cost: it is paid the source price and settles the forward at the sink price, so it loses the spread in every congested hour, 2,172,000 expected over the year and 4,000 in each of the worst hours. The obligation pays exactly that spread back. Bought at 1,839,600, it converts an uncertain basis cost into a fixed one. Here the hedger should prefer the obligation over the option: in reverse-flow hours the generator gains on the basis, and the obligation's payment simply offsets that gain, which is why it is cheaper.
An FTR's value is hours times spread times MW, summed: 2,172,000 for this 50 MW obligation, 2,322,000 for the option. Price it bucket by bucket, because the spike hours carry most of the value and most of the risk. The book's price duration curve and margin workbooks are in the free companion files.
An obligation pays the spread in every hour, positive or negative, so the holder pays when power flows the other way. An option pays only positive spreads. On the illustrative 50 MW annual right, 500 reverse-flow hours at minus 6 cost the obligation 150,000, making the option worth 2,322,000 against 2,172,000.
No more than the expected spread per MWh, less a premium for the risk in the congested hours. In the illustrative case the obligation's expected value is 4.96 per MWh and the option's 5.30. At a clearing price of 4.20 the obligation earns 332,400 expected, but loses 210,600 if spreads come in at 75 per cent of expectation.
No. It is a financial contract settled on the price difference between two nodes or zones; power is still bought and sold at each location. Its purpose is to hedge or take a view on congestion: for a 50 MW generator selling at a remote hub, it offsets an expected basis cost of 2,172,000 a year in the illustrative case.
This article is one calculation from Energy Trading. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: infrastructure, data centres and energy → · All 1614 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.