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Spot-Market Clearing

Solving the electricity credit malaise.

Fortnightly Magazine - May 2005

presented below. All numbers have been proportionally scaled from the actual to preserve anonymity. For the analyzed market, with (scaled) annual consumption of approximately 220 TWh, both average and 99th percentile potential losses were examined:

  • Average losses: The amount that the spot market should, on the balance of probabilities, expect to lose through default during the year. Participants should budget for their socialized share of this loss.
  • 99th percentile (P99) potential losses: Represents the level of losses which, to 99 percent likelihood, the actual losses will be less than. Stated differently, the statistical likelihood of losses exceeding the P99 loss is 1 percent. It is standard risk-management practice to hold sufficient risk capital to cover the P99 loss. This capital, cannot be deployed for other purposes.

Results for the example market are summarized in Table 1. These represent losses in excess of collateral held. Provisioning for this risk has a cost to participants, also shown. Spot-market clearing eliminates these risks, and their associated costs.

Spot-market clearing also leads to significant market-wide reductions in cash requirements, summarized in Table 2. These are driven by:

  • Reduction in required collateral postings: Although spot-market clearing requires all participants to post collateral, the acceleration of settlement time frame results in lower potential exposures, and hence lower collateral postings than many participants are currently required to make.
  • Change in float: The acceleration of settlement time frame results in a reduced period of float for net purchasers. As, at the time of analysis, the cost of money for net producers was on average higher than that for net purchasers, an overall cash benefit resulted.

As one would anticipate, the cash benefits of spot-market clearing do not flow uniformly to all participants. That would be an unrealistic panacea. However, the negative cash impact to some must be weighed against the credit risk benefit they receive, as well as the overall credit risk and cash benefits to the market as a whole. -TWB, FXS

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