According to the Commission Regulation (EU) 2016/1719 of 26 September 2016 establishing a guideline on forward capacity allocation (FCA Regulation), Financial Transmission Rights Option (FTR option) is a sub-type of the broader category of Long Term Transmission Rights and means a right entitling its holder to receive a financial remuneration based on the day ahead allocation results between two bidding zones during a specified period of time in a specific direction.
The analogous definition of the Financial Transmission Right Option is used by Harmonised allocation rules for long‐term transmission rights as stipulated in the Annex to Decision of the Agency for the Cooperation of Energy Operators (ACER) No 03/2017 of 2 October 2017.
As the ACER and CEER explain in their Draft Policy Paper of 1 June 2022 (on the Further Development of the EU Electricity Forward Market for Consultation, p. 23, 24):
- FTR options are Financial Transmission Rights (FTRs) auctioned at yearly or monthly auctions which give the right to the FTR holder to receive from the Transmission System Operators (TSOs) the market spread (i.e. day-ahead price difference) on the concerned oriented bidding zone border, if positive, for each MW of FTRs it holds;
- In case the market spread on the concerned oriented bidding zone border is negative, there is no financial exchange between TSOs and FTR holder;
- Physical Transmission Rights (PTRs) with UIOSI and FTR options are financially fully equivalent – they offer the same level of hedging to the holder (except in very specific cases such as scarcity situation);
- Consequently, most PTR holders decide not to nominate PTRs physically and rather receive the market spread remuneration which makes the use of these PTRs equivalent to FTR options.
Financial Transmission Rights Options are regulated in Articles 33 and 35 of the FCA Regulation - see box.
Financial transmission rights — options
1. Holders of FTRs — options shall be entitled to obtain remuneration in accordance with Article 35.
2. The implementation of FTRs — options shall be subject to the application of day-ahead price coupling in accordance with Articles 38 to 50 of Regulation (EU) 2015/1222.
Principles for long-term transmission rights remuneration
1. The relevant TSOs performing the allocation of transmission rights on a bidding zone border through the single allocation platform shall remunerate the long-term transmission rights holders in case the price difference is positive in the direction of the long-term transmission rights.
2. The holders of FTRs — obligations shall remunerate the relevant TSOs through the single allocation platform allocating transmission rights on a bidding zone border in case the price difference is negative in the direction of the FTRs — obligations.
3. The remuneration of long-term transmission rights in paragraphs 1 and 2 shall comply with the following principles:
(a) where the cross-zonal capacity is allocated through implicit allocation or another method resulting from a fallback situation in the day-ahead time frame, the remuneration of long-term transmission rights shall be equal to the market spread;
(b) where the cross-zonal capacity is allocated through explicit auction in the day-ahead time frame, the remuneration of long-term transmission rights shall be equal to the clearing price of the daily auction.
4. In case allocation constraints on interconnections between bidding zones have been included in the day-ahead capacity allocation process in accordance with Article 23(3) of Regulation (EU) 2015/1222, they may be taken into account for the calculation of the remuneration of long-term transmission rights pursuant to paragraph 3.
The ACER in its policy paper of 6 February 2023 on the further development of the EU electricity forward market underlines that PTR options with Use-It-Or-Sell-It (UIOSI) and FTR options are financially fully equivalent – they offer the same level of hedging to the holder (except in very specific cases such as scarcity situations (curtailment in day-ahead market) where FTR holder would be exposed to imbalance prices which may be higher than DA prices, whereas PTR holder would still be exposed to day-ahead prices).
Among regulatory concerns regarding FTR options in the context of the objectives of efficient electricity forward market functioning are the following:
1. Hedging with FTR options is more costly as the values of FTR options represent only positive market spread, which may be significantly higher than average market spread. Higher prices also mean higher costs of collaterals.
2. The value of FTR options is more difficult to estimate. Market participants need to forecast prices for each market time unit during delivery period and then take the average of the positive values. This may be quite a challenge for FTR options with long maturity times and delivery periods.
3. FTR options are not well suited to integrate forward markets. Integration of forward markets with cross-zonal capacities would require an arbitrage between two markets, i.e. buying/selling futures in one bidding zone, buying FTRs and selling/buying futures in another bidding zone. As futures are predominant hedging contracts in zonal forward markets, FTR options are not compatible with such arbitrage as they do not enable risk-free arbitrage or such arbitrage comes at a higher cost than necessary.
4. FTR options may significantly reduce the volume of allocated FTRs. First, because FTR options do not allow for netting of cross-zonal capacity and no capacity can be allocated in the opposite direction due to allocation of FTR options. Second, in FTR options the cross-zonal capacity is usually allocated fully in both directions, which means there are no capacity leftovers. This means that the objective of having daily auctions or continuous trading with capacity leftovers would be significantly reduced. Such trade would be possible only if market participants (re)sell some FTR options and thereby release some previously allocated capacity.
5. In light with the difficulty of FTR options valuation, FTR options are likely significantly contributing to undervaluation. Hence, keeping FTR options may not be able to address this problem. While undervaluation on the one hand causes loss of congestion income for TSOs and end consumers, it on the other hand means significant risk-free profits for market participants.
The ENTSO-E Policy Paper of December 2022 among potential options for further development of EU's electricity forward markets considers also the one where FTR Options remain the standard hedging product and will replace PTRs at all European borders. In addition to the current design, the following market design improvements would be applied in this scenario:
- FTR Options shall be issued on a rolling basis. Auctions for their allocation should take place sufficiently ahead of each year, quarter and month for base load and peak load profiles.
For the sake of adequacy between the FTR auction with the market needs (i.e. the electricity forward market), the volume offered to the auctions needs to be adiusted with the electricity forward market liquidity. Thus, each product (yearly, monthly, quarterly) shall be offered in several auctions as it takes time to absorb high volumes issued in one auction due to the low liquidity in the future market.
- Establishment of a secondary market for FTR Options.
- Introduction of minimum prices. For each auction, a minimum price shall be defined which guarantees a minimum FT value. The unsold capacity could be offered to the next auction. TSOs are assured not to sell the capacity at an undervalued price.
- Assessment of shortening the auction answer delay. Currently, the results of long-term auctions are published after 25 min. This time could be shortened as the long publication times could mean higher risks for market participants. Consequently, the willingness to pay for long-term products could improve. Furthermore, possibilities to arrange long-term auctions closer to the start of the delivery period are likely to be beneficial for market participants. Both options remain to be assessed by TSOs and JAO, also considering the implications of long-term flow-based allocation.
- The auction calendar will be defined in such a manner as to have the auctions scheduled at different times or even days for every border, in order to allow market participants to take part in all auctions. This would lead to more liquidity on different bidding zone borders.
The implementation of the proposed improvements would be subject to the investigations related to Long-Term Flow-Based Allocation.
According to the ENTSO-E, with the implementation of the proposed adjustments, FTR Options would provide a fair hedging opportunity for market participants as it limits their financial risks to the FTR Option price only - instead, the financial risks remain at the TSOs on the expense of the end-consumer. Furthermore, the proposed adjustments could potentially improve, to a certain degree, the issues related to access to liquidity and to the secondary markets.
However, FTR Options would not completely remove the exposure of market participants to the volatility of their home bidding zone price as the volume of cross-border hedges is limited to the underlying capacity (no netting possible).