Design of electrical trading markets ~ Quant Lego

Spot vs forward power markets

The forward power market is where the bulk of speculative tradings occur, while the spot power market is where daily auctions occur.
The forward market is open to anyone with sufficient money to meet trading requirements, while the spot market is open only to power providers with the ability to generate power and place it to the transmission grid.
In forward market both physical contracts (requiring delivery of power) and financial contracts (settle in cash) are traded, while spot market involves only physical contracts.
In spot market it is possible to buy spot power in arbitrary small sizes for immediate use anywhere in the country, while in the forward market it is only possible to trade large (month) blocks at a limited number (~20) of locations around the country.
Trading power in large units at a limited number of locations has two consequences:

Pro: it is easier to standardize contracts and find trading partners
Con: trading prices at extended geographic areas around a major hub may not represent the exact price of power anywhere in the region ==> Power is often traded in two pieces: (1) standardized forward trades made at major hub to get the desired regional exposure approximately correct; (2) smaller fine-tuning trades to lock in an exact price at the specific location.

Market design under LMP methodology

Congestion charge: In periods of heavy demand, power lines can become overloaded ==> The primary way of rerouting power around congestion is to activate power plants close to the area of high demand even though their costs may not be low enough to enter winning bids of auction (out-of-merit-bid) ==> Under the FERC's Standard Market Design (SMD), the cost line congestion are paid by the affected parties (in a single location), rather than being shared by every user of the entire grid.
Line loss charge: Under the FERC's SMD, power produced only get paid for deliverable power, not on the gross power placed into a power grid.
Locational Marginal Price (LMP) = clearing price (same everywhere in a power grid) + congestion charge (location specific) + Line loss charge (location specific) ==> Different prices are assigned to different locations in a power grid ==> location has become a major factor determining the profitability of a power plant, in addition to fuel cost and efficiency ==> There is economic incentive for power producers to relieve both line loss in transmission and line congestion ==> Power grid reliability increased significantly (compared with unregulated markets).
There are three types of locations for calculating prices under SMD:

Node prices: corresponds directly to the power price at an 'electrical bus', where power enters or leaves the transmission grid. Power generators are paid the nodal price of the electrical bus where they deliver power into the transmission grid.
Zone price: is the average of all nodal prices within a limited geographical area. This is the price that customers pay for the power they receive.
Hub price: is an average of selected nodal prices across several zones, and it serves as the benchmark price for a power grid ==> Hub prices are used extensively in forward market tradings. In most ISO/RTO regions, the clearing price for power and the hub price are synonymous.

Here is a nice introduction about FTR.
FTR is a financial instrument closely linked to Locational Marginal Price (LMP). It helps customers manage the price risk of having purchased or sold power at a major hub and then being forced to pay a different price when they deliver or receive power at a specific node.
FTRs are tradable contracts made between two parties, which take opposite sides of an obligation to pay or receive the difference in price between two nodes. One party need to pay the other when there is a congestion.
Sometimes FTRs can be structured as options, acting as insurance against adverse price change due to congestion.

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