Electricity Markets

Understanding — and reimagining — financial transmission rights

For many reasons, the cost to generate electricity varies from generator to generator.

People served through a regional transmission organization or independent system operator get the lowest cost generation available to meet the demand at a given time. But when demand in one area exceeds the capacity of the transmission system to deliver the least-cost power option, those customers receive electricity from higher-cost generation sources, which creates an additional “congestion cost.”

Financial transmission rights and similar instruments (including congestion revenue rights, transmission congestion contracts, and transmission revenue rights) were created in the RTO/ISO markets so that load-serving entities (utilities and others responsible for providing power to end-use customers) can hedge such congestion costs. Because load-serving entities pay more for congestion than generators receive, FTRs are a mechanism to return this surplus payment.

Depending upon the RTO/ISO, FTRs are allocated directly to load-serving entities (with the remainder sold in an auction), sold only through auctions, or the load-serving entities get rights to the revenue from the auctions. The load-serving entities, generators, and financial institutions may all participate in the auctions.

FTRs have not consistently covered load-serving entities’ congestion costs in all RTOs/ISOs. Recent data from the market monitors shows that:

  • Over the past five years, the revenue offset in the PJM Interconnection has been between 50% and 104% of congestion costs.
  • Midcontinent Independent System Operator FTRs covered 97% of congestion costs in 2019.
  • Ratepayers in the California ISO paid about $900 million in excess congestion costs through 2019, although a series of changes to its congestion revenue rights market have reduced, but not eliminated, these ratepayer losses.
  • Last year, FTRs were fully funded in ISO-New England, and load serving entities in Southwest Power Pool received more from their hedges than they paid in congestion.
  • In the New York ISO, where all transmission congestion contracts are auctioned, owners of TCCs paid more than they received in revenue.

There are many reasons that congestion costs are not always fully recovered through these tools. One reason is that the FTRs do not always match the actual flows of power. A second and more significant concern is that auction prices are often lower than the value of the FTRs, allowing financial entities to purchase these instruments at a price below what they receive in congestion payments, creating a loss to load.

Another concern is how RTOs and ISOs manage credit and counterparty risk in all their markets, including the FTR market. The default of one financial trader in PJM, GreenHat, highlighted significant issues in how RTOs handled counterparty risk and the ineffectiveness of PJM’s credit policy at the time. An independent investigation stated that financial participants highlighted the potential default years before it occurred.

A key question is whether such a complicated construct that allows financial entities to participate is truly the most efficient and effective means to hedge against congestion costs, or whether a new mechanism could be created to directly return the surplus costs to load-serving entities.

What others are saying about FTRs

Here’s what different groups have to say about FTRs and the participation of financial entities in them. 

Most of the profits went to “financial entities that do not sell power or serve load in the ISO.” – CAISO market monitor

“Traders are buying the hedges themselves because they are a profitable speculation. This is the exact opposite of what should prevail in a successful hedging market.” – John Parsons, economist, Massachusetts Institute of Technology, in a report on PJM’s FTR

Financial traders’ participation in the FTR markets “provides liquidity and competition, not just in the FTR market, but also in the broader energy market.” – Energy Trading Institute

“[Such] trading is considered speculative because it is an attempt to profit by engaging in a risky financial transaction that isn’t tied to any physical position in the ISO-NE marketplace. Speculative trading is permitted in FTR auctions because of the liquidity and competition it provides.” – ISO-New England’s internal market monitor