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Congestion revenue rights

Congestion Revenue Rights: Definition, Example, and FAQs

Congestion revenue rights (CRRs) are a class of financial instrument used within organized wholesale electricity markets to hedge against transmission congestion costs. They entitle holders to receive payments or obligate them to pay charges based on the price differences that arise between two specified points on the transmission system when congestion occurs. These rights are a critical component of risk management strategies for market participants, particularly those involved in energy generation, transmission, and consumption within deregulated power markets. CRRs are designed to mitigate the financial impact of variable electricity prices caused by transmission constraints.

History and Origin

The concept of congestion revenue rights, often referred to broadly as financial transmission rights (FTRs), emerged as a solution to manage the economic consequences of transmission congestion in restructured electricity markets. Historically, electricity transmission operated under simpler models, often with physical transmission rights. However, with the unbundling of electricity utilities and the move toward competitive wholesale markets, particularly with the adoption of locational marginal pricing (LMP), new mechanisms were needed to address congestion charges.45, 46, 47

The Federal Energy Regulatory Commission (FERC) played a pivotal role in promoting the development of organized wholesale electricity markets and mechanisms like CRRs. FERC Order 2000, issued in 1999, encouraged the formation of Regional Transmission Organizations (RTOs) to improve grid reliability and efficiency, and these organizations were tasked with developing robust congestion management strategies.41, 42, 43, 44 The transition to LMP, where electricity prices vary by location based on congestion, made financial hedges against these price differences essential. CRRs and FTRs provide this critical hedging function, ensuring that market participants can lock in transmission costs and reduce uncertainty.38, 39, 40

Key Takeaways

  • Congestion revenue rights (CRRs) are financial instruments that allow electricity market participants to hedge against the costs incurred due to transmission congestion.
  • CRRs are typically allocated through annual processes to load-serving entitys or acquired by other market participants through competitive auctions.
  • The value of a CRR is determined by the difference in locational marginal prices (LMP) between a specified source and sink point on the transmission grid, multiplied by the megawatt quantity of the right.
  • CRRs help stabilize costs for market participants and promote more efficient use of the existing transmission infrastructure by providing financial signals about congested paths.
  • While designed to offset congestion charges, CRR markets can experience revenue shortfalls, where collected congestion revenues are insufficient to fully fund payouts to CRR holders, necessitating careful market design and oversight.

Formula and Calculation

The payout or charge for a Congestion Revenue Right is based on the locational marginal price (LMP) difference between its specified source and sink nodes during periods of congestion. The basic calculation for the value of a CRR for a given hour can be expressed as:

CRR Payout (or Charge)=(LMPSink−LMPSource)×CRR Quantity (MW)\text{CRR Payout (or Charge)} = (\text{LMP}_{\text{Sink}} - \text{LMP}_{\text{Source}}) \times \text{CRR Quantity (MW)}

Where:

  • (\text{LMP}_{\text{Sink}}) is the locational marginal pricing at the delivery point (sink node).
  • (\text{LMP}_{\text{Source}}) is the locational marginal pricing at the injection point (source node).
  • (\text{CRR Quantity (MW)}) is the megawatt amount of the congestion revenue right.

If (\text{LMP}{\text{Sink}}) is higher than (\text{LMP}{\text{Source}}) and the CRR is an obligation, the holder receives a payment. If (\text{LMP}{\text{Sink}}) is lower than (\text{LMP}{\text{Source}}) for an obligation CRR, the holder makes a payment. This payment offsets the congestion charge that a physical transaction would incur or reflects the value of being able to deliver power through a congested path.36, 37

Interpreting the Congestion Revenue Rights

Interpreting congestion revenue rights involves understanding their financial nature as a hedge against volatility in transmission costs. A CRR's value fluctuates based on the actual price differences between its specified source and sink locations in the day-ahead market. A positive CRR value indicates that the price at the sink node was higher than the price at the source node, meaning the holder receives a payment that offsets the higher cost of delivering power into that congested area. Conversely, a negative value implies the source price was higher, and the holder might owe a payment, reflecting a situation where transmission capacity was available in the counter-flow direction.35

For a market participant with a physical energy transaction, acquiring CRRs along the same path as their energy flow helps to stabilize their overall transmission costs. If they pay higher congestion charges in the energy market, their CRRs will provide a corresponding payout, effectively netting out the congestion cost. If congestion is low or non-existent, the CRR payout will be minimal or zero, but so will their congestion charges. This interpretation highlights CRRs as a vital tool for achieving cost certainty in volatile energy markets.

Hypothetical Example

Consider a hypothetical scenario involving ABC Energy, a power generation company, and XYZ Utility, a load-serving entity. ABC Energy has a long-term contract to sell 100 megawatts (MW) of electricity daily from a power plant (Source A) to XYZ Utility's distribution network (Sink B).

On a particular day, due to unexpected transmission line maintenance or high demand, the transmission path from Source A to Sink B becomes congested. The Independent System Operator (ISO) managing the grid dispatches more expensive power closer to Sink B to meet demand, leading to a difference in the locational marginal pricing.

Assume:

  • LMP at Source A = $30/MWh
  • LMP at Sink B = $60/MWh (due to congestion)
  • ABC Energy holds a Congestion Revenue Right for 100 MW from Source A to Sink B.

The congestion charge for ABC Energy's physical delivery of 100 MW would be:
($60/MWh−$30/MWh)×100 MW=$30/MWh×100 MW=$3,000/hour( \text{\$60/MWh} - \text{\$30/MWh} ) \times \text{100 MW} = \text{\$30/MWh} \times \text{100 MW} = \text{\$3,000/hour}

Because ABC Energy holds a CRR for the same path and quantity, they receive a payout from the CRR equal to this amount:
CRR Payout=(LMPSink B−LMPSource A)×CRR Quantity\text{CRR Payout} = ( \text{LMP}_{\text{Sink B}} - \text{LMP}_{\text{Source A}} ) \times \text{CRR Quantity}
CRR Payout=($60/MWh−$30/MWh)×100 MW=$3,000/hour\text{CRR Payout} = ( \text{\$60/MWh} - \text{\$30/MWh} ) \times \text{100 MW} = \text{\$3,000/hour}

In this example, the $3,000/hour payout from the congestion revenue right effectively offsets the $3,000/hour congestion charge ABC Energy incurs on its physical electricity delivery. This demonstrates how CRRs allow market participants to hedge against unpredictable transmission congestion costs.

Practical Applications

Congestion revenue rights are primarily used as a vital financial instrument for hedging against the variability of transmission congestion charges within organized electricity markets. Their practical applications include:

  • Cost Certainty for Load-Serving Entitys: Utilities and other entities that supply electricity to end-users often acquire CRRs to protect their customers from volatile congestion charges. By owning CRRs, they can effectively lock in their transmission costs for a given amount of power flowing between specific points, providing greater predictability in their operations and billing.33, 34
  • Risk Management for Generators and Traders: Power generators and electricity traders utilize CRRs to manage their exposure to basis risk—the risk that the price of electricity at their generation point will differ significantly from their delivery point due to congestion. CRRs allow them to secure a financial offset for these differences.
    *30, 31, 32 Promoting Market Efficiency: CRRs facilitate competitive energy trading by reducing the uncertainties associated with transmission congestion. They allow market participants to make more informed bidding and dispatch decisions without having to constantly factor in unknown congestion costs.
    *29 Transmission Investment Signals: While primarily financial, the consistent value or deficits associated with certain CRR paths can indirectly signal the need for new transmission infrastructure to alleviate persistent congestion.
  • Arbitrage Opportunities: Sophisticated financial traders may participate in CRR auctions, attempting to profit from anticipated differences between the expected future value of a CRR path and its current auction price. This activity, while speculative, adds liquidity to the CRR market.

28Market operators like the California Independent System Operator (CAISO) and PJM Interconnection offer CRRs (or their equivalent, Financial Transmission Rights) through auctions and allocation processes to support these market functions. H26, 27owever, issues surrounding the allocation and funding of congestion revenues, particularly in complex market designs like CAISO's Extended Day-Ahead Market, remain a focus for market regulators and participants.

25## Limitations and Criticisms

Despite their crucial role in managing congestion costs, congestion revenue rights (CRRs) face several limitations and criticisms, primarily concerning revenue adequacy and market design complexity.

One significant issue is "revenue inadequacy" or "shortfalls," where the total revenue collected from congestion charges in the day-ahead market is insufficient to fully compensate CRR holders for their entitlements. This gap often leads to the socialization of these shortfalls, meaning the costs are ultimately borne by transmission system ratepayers or other market participants, even if they did not directly benefit from the CRRs. F21, 22, 23, 24or example, the California Independent System Operator (CAISO) has faced recurring shortfalls, averaging millions of dollars annually, which required revisions to their CRR auction rules to address the issue. C19, 20ritics argue that fundamental design flaws in the auction and allocation processes can lead to these deficits, as the models used to price CRRs might not accurately reflect real-time transmission constraints.

17, 18Another criticism is the potential for market participants to exploit modeling differences between the CRR auction and the real-time electricity market. Sophisticated traders can profit from these discrepancies, further contributing to revenue shortfalls borne by the larger market. F16urthermore, while CRRs provide a financial hedge, they do not directly alleviate the physical congestion on the transmission system. The underlying problem of insufficient transmission capacity or unexpected outages can persist, leading to ongoing high locational marginal pricing differences and the need for significant out-of-merit dispatch.

14, 15## Congestion Revenue Rights vs. Financial Transmission Rights

While often used interchangeably, "Congestion Revenue Rights" (CRRs) and "Financial Transmission Rights" (FTRs) refer to very similar financial instruments designed to hedge against transmission congestion costs in organized wholesale electricity markets. The distinction often lies in the specific terminology adopted by different Regional Transmission Organizations (RTOs) or Independent System Operators (ISOs).

For instance, the California Independent System Operator (CAISO) uses the term Congestion Revenue Rights (CRRs), 12, 13while PJM Interconnection and ISO New England typically refer to them as Financial Transmission Rights (FTRs). 10, 11Both serve the primary purpose of providing a hedging mechanism for market participants against the financial impact of variable locational marginal pricing caused by transmission constraints.

Functionally, both CRRs and FTRs are non-physical, meaning they do not grant the holder the right to physically transmit electricity, nor do they impose an obligation to do so. Instead, they represent a financial entitlement (or obligation) to the difference in congestion charges between two specified points. T7, 8, 9he core confusion arises because their underlying purpose and operational mechanics are fundamentally the same, with regional market operators simply choosing different nomenclature. Therefore, for most practical discussions in electricity markets, the terms can be considered synonymous in their intent to manage transmission congestion financial risk.

FAQs

What is the primary purpose of congestion revenue rights?

The primary purpose of congestion revenue rights (CRRs) is to serve as a financial instrument that allows market participants to hedge against the unpredictable costs associated with transmission congestion in wholesale electricity markets. This helps stabilize costs and provides greater certainty for those buying and selling power.

How are congestion revenue rights acquired?

CRRs are typically acquired through two main methods: allocation and auction. Load-serving entitys often receive an allocation of CRRs based on their historical usage or contribution to the transmission system. Other market participants, including financial traders, can bid for CRRs in competitive auctions conducted by the Independent System Operator (ISO) or Regional Transmission Organization (RTO).

4, 5, 6### Do CRRs guarantee a profit?
No, CRRs do not guarantee a profit. They are a hedging tool designed to offset congestion charges. If the congestion on the specified path behaves as expected, the CRR will largely offset the congestion costs incurred by the holder's physical transactions. However, if congestion patterns differ from expectations, or if there are market design issues, the CRR may not perfectly hedge the risk and could even result in a net payment from the holder.

3### How do CRRs differ from physical transmission rights?
CRRs are purely financial instruments. They provide a financial offset to congestion charges but do not grant any physical right or obligation to transmit electricity over the transmission system. In contrast, physical transmission rights (which largely preceded CRRs in many markets) granted the holder the actual capacity to move power, often on a "use-it-or-lose-it" basis. CRRs offer greater flexibility and allow for broader participation in managing congestion risk.1, 2