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I have been reading around energy markets recently and recent schemes such as Voluntary Carbon Markets, similar to the 'cap and trade' style of the Kyoto Agreement in 1997.

I have been reading in particularly about energy derivatives. But I have a question about the delivery of these commodities. I understand how, for example, oil gets delivered. Simply, barrels get shipped to your location with arrival at maturity. However, with electricity market derivatives, how does that get delivered? Say if a trader were to take a futures contract for a certain wattage of electricity, how does it get delivered? I doubt it would be as simple as a fuel cell showing up at your front door? Or does some other kind of deal with an energy supplier/ national grid get worked out?

I have done some research but I can't see anything about the method of delivery. This site here says that electricity derivatives are deliverable, but how?

Edit: I'd like to specify a particular market, anything regarding Europe or North America would be really insightful. Especially if anyone has any answers regarding delivery during the recent winter storm in Texas.

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  • $\begingroup$ I'm not sure but it might make sense to specify which market / region you're covering. If I remember correctly, in the Netherlands physical delivery of a fixed amount of kW takes place over an agreed period. $\endgroup$
    – Bob Jansen ♦
    Apr 13, 2021 at 18:59
  • $\begingroup$ Thanks for your comment, I'll edit my question accordingly to include a specific market. In the example you mentioned, what's the mechanism of delivery? Is it by drawing additional current from a national grid? Or a temporary external supply? $\endgroup$
    – Hamish Gibson
    Apr 13, 2021 at 19:02
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    $\begingroup$ Do mind, my knowledge stems from an internship at an energy provider I did in 2009, so quite fuzzy. End-users would buy the derivative from us and take delivery by drawing from the grid. I guess they finally settled during invoicing. For energy providers or traders, they would either close out our cash settle. So maybe it's better described as a mix of both. Delivery tends to take place (the energy company has to deliver!) but you could view the whole as cash settled where end-users draw from the grid as normal consumers would and add their trading PnL to their bill. $\endgroup$
    – Bob Jansen ♦
    Apr 13, 2021 at 19:10
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    $\begingroup$ Each contract is good for 10 barrels of electrons. Or positrons (shipper's choice). Just don't mix them. $\endgroup$
    – Brian B
    Apr 13, 2021 at 19:37
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    $\begingroup$ Brian B, surely if you mix them then your portfolio would be delta neutron? $\endgroup$
    – Hamish Gibson
    May 13, 2021 at 18:03

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Electricity markets are term markets, ie to specify delivery, one needs to define the reference period (year, quarter, month, week) and the capacity (MW in wholesale markets). To give an example, the month of April has 30 days, ie 720 hours, a 5MW forward contract thus delivers a total energy quantity of 5*720 MWh = 3600 MWh. In other words, delivery is not instantaneous (ie delivery of all 3600 MWh) like offloading some quantity of tangible physical goods, but it occurs over time. Electricity markets therefore trade the abovementioned forward / futures contracts. These contracts are thus the deliverable of option deals.

Assume you trade a call option on 50MW of electricity for delivery in 2024 with a strike at 100. Assume that the call option ends up in the money when it expires (assuming standard expiry) in Dec'23. In this event, the holder of the option will call the seller (in OTC options markets this is still done by phone, however this gradually shifts to exchanges) to exercise the option. As a result of the exercise, the seller will then issue a forward contract, whereby it sells 50MW of electricity for delivery in 2024 at a price of 100 EUR/MWh.

Note that contrary to what many non-practitioners believe, power market options are generally not financially settled (unless agreed to be, however these cases are rare). This is the case because traders in power options mostly intend to physically hedge a position, ie they want a delivery contract rather than monetary compensation for the difference between strike and market price.

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ZRH is right https://quant.stackexchange.com/a/76435/69690 but I wonder if the answer for the OP isn't simpler: wires, usually up on big pylons or towers. The ones you see along the interstate.

In North America and Europe, the bulk electrical system is well defined, with transmission tariffs akin to rail or pipeline tariffs describing transmission capacity and nodes at substations/switching yards. Physical contracts will specify the node (or maybe area) where title is transferred. The seller is responsible for delivering to that point. From there, either a market operator (ISO/RTO) or the buyer is responsible for scheduling to some place where the energy is used or resold. This is done using NERC Tags (eTags now that they're digital).

Electricity basically cannot be stored--at least not at grid scale for significant amounts of time*--so it's all highly orchestrated by a grid operator called a Balancing Authority (BA) that ensures supply and demand are always balanced. When supply is less than demand, a BA will order some distribution (demand) disconnected from the grid (load shed), though there lots of contingency responses that are implemented before that.

Texas is unusual in that the energy is completely separated from not just transmission (high voltage) but also distribution (lower but still pretty high voltage). The theory is you get more price competition for consumers, but it makes it harder to figure out who's responsible when things go sideways.

In cap-and-trade systems, the underlying is essentially a certificate held digitally by a central registrar. Certificates are created by some governing body, typically a state or province, and then destroyed again when the surrenders them back to the governing body to satisfy a compliance obligation. Cap-and-trade is a triumph of finance (trading) over public policy, since a simple carbon tax would have been less complicated to administer.

*Yes, that is changing, and the rate of growth is increasing. But, for now, it's moving the marginal MW from low price hours to high price hours. Figure a few percent of the largest demand of the day. California probably has the best charts on this today: https://www.caiso.com/TodaysOutlook/Pages/supply.html#section-batteries-trend

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The exchange defines contract terms (including settlement). Usually on the exchange website they state exactly how the contract is settled. Try looking there.

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  • $\begingroup$ Here is an example of @thatDataGuy response on the Intercontinental Exchange (ICE) for ERCOT North Peak product specs you can read through including how they are settled $\endgroup$
    – maluwalmk
    May 26 at 23:42

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