Designing Hedging Instruments for Locational Price Risks – Lessons from North American Financial Transmission Rights

Abstract

Locational marginal pricing (LMP) provides efficient locational dispatch and investment signals but requires a complementary congestion hedging instrument to function effectively. This paper investigates how exposure to locational price differences is managed in North American nodal electricity markets through the implementation of financial transmission rights (FTRs). Drawing on insights from 15 industry experts directly involved across all major North American electricity markets, we consolidate first-hand perspectives that reveal the practical complexities of FTR design and implementation. While most interviewees view FTRs positively, their experiences uncover multiple nuanced challenges to successfully design locational hedging instruments, which are often overlooked in the academic literature. As FTR design depends on market characteristics, we apply the findings to the European electricity market and discuss implications for a possible implementation of LMP in Europe.