FTR Background

FTRs are financial hedges that help protect energy purchasers or generators from price uncertainty caused by transmission losses and constraints.

They confer the right to receive the difference between the prices at the nodes between which the hedge is written for a defined amount of megawatts and a defined period of time.

FTRs can be matched with an energy hedge to provide a high degree of price certainty.
FTRs are a standard component of the market design in most overseas electricity markets that, like New Zealand, are based on locational marginal (or nodal) pricing.

Nodal prices introduce locational price risk

In electricity markets using locational marginal pricing (LMP, or nodal pricing), price differences between two points, or nodes, in a network are caused by network losses and constraints (locational risk). Consequently, energy contracts cannot be established at a fixed price without either the seller or the purchaser assuming locational price risk, where there is any risk of constraints arising between the generation and offtake locations.

FTRs can help reduce locational price risk

The only cash stream correlated with nodal price differences is the rentals and the only known product that effectively exploits this correlation is a financial transmission right (FTR).

The holder of an FTR receives the rentals associated with the FTR for a fixed capacity, duration and direction. If matched with an energy contract the FTR owner is fully hedged.

LMP markets around the world have implemented some form of tradable FTR as an important risk management tool in an integrated market design.

FTRs can protect investment

FTRs also protect “first movers” from future demand growth on transmission assets and provide a means for transmission investors and regulators to compare the cost of transmission constraints with the cost of new investment.

Locational price risk is partially managed through vertical integration

In the absence of tradable instruments the New Zealand electricity industry has moved to regional vertical integration between retail and generation. Whilst this arrangement provides good hedging characteristics for some it may not for others and has limitations for independent electricity retailers.