The rules of the Syldavian electricity market stipulate that all participants must trade energy exclusively through the Power Pool. However, the Syldavia Alu- minum Company (SALCo) and the Northern Syldavia Power Company (NSPCo) have signed a contract for difference for the delivery of 200 MW on a continuous basis at a strike price of 16 $/MWh. a. Trace the flow of power and money between these companies when the pool price takes the following values: 16 $/MWh, 18 $/MWh and 13 $/MWh. b. What happens if during one hour the Northern Syldavia Power Company is able to deliver only 50 MWh and the pool price is 18 $/MWh? c. What happens if during one hour the Syldavia Aluminum Company consumes only 100 MWh and the pool price is 13 $/MWh?
The Correct Answer and Explanation is:
Answer
a. Flow of Power and Money (Assuming 200 MWh traded per hour)
Case 1: Pool Price = $16/MWh (equal to strike price)
- SALCo buys 200 MWh from the pool at $16/MWh = $3,200
- NSPCo sells 200 MWh to the pool at $16/MWh = $3,200
- Contract for Difference (CfD) payment = $0
- No money exchanged between SALCo and NSPCo, since pool price = strike price.
Case 2: Pool Price = $18/MWh (above strike price)
- SALCo pays pool: 200 MWh × $18 = $3,600
- NSPCo earns from pool: 200 MWh × $18 = $3,600
- CfD: NSPCo pays SALCo the difference:
200 MWh × ($18 – $16) = $400- Net for SALCo: $3,600 (paid to pool) – $400 (received from NSPCo) = $3,200
- Net for NSPCo: $3,600 (from pool) – $400 (paid to SALCo) = $3,200
Case 3: Pool Price = $13/MWh (below strike price)
- SALCo pays pool: 200 MWh × $13 = $2,600
- NSPCo earns from pool: 200 MWh × $13 = $2,600
- CfD: SALCo pays NSPCo the difference:
200 MWh × ($16 – $13) = $600- Net for SALCo: $2,600 (pool) + $600 (CfD) = $3,200
- Net for NSPCo: $2,600 (pool) + $600 (CfD) = $3,200
b. NSPCo delivers only 50 MWh at $18/MWh
- NSPCo earns from pool: 50 MWh × $18 = $900
- SALCo buys 200 MWh from pool: 200 MWh × $18 = $3,600
- CfD obligation remains on 200 MWh:
NSPCo must pay: 200 MWh × ($18 – $16) = $400 - NSPCo’s total revenue: $900 (pool) – $400 (CfD) = $500
- SALCo’s net cost: $3,600 (pool) – $400 (CfD) = $3,200
- NSPCo may face penalties for failing to deliver full energy unless contract includes flexibility.
c. SALCo consumes only 100 MWh at $13/MWh
- SALCo pays pool: 100 MWh × $13 = $1,300
- NSPCo sells 200 MWh to pool: 200 MWh × $13 = $2,600
- CfD still applies to 200 MWh:
SALCo pays NSPCo: 200 MWh × ($16 – $13) = $600 - SALCo total cost: $1,300 (pool) + $600 (CfD) = $1,900
- NSPCo total revenue: $2,600 (pool) + $600 (CfD) = $3,200
- SALCo may lose value unless CfD is volume-adjusted or includes penalties.
Explanation
In Syldavia’s electricity market, energy must be traded through the Power Pool, but financial arrangements like Contracts for Difference (CfDs) allow parties to hedge against price volatility. In this case, the Syldavia Aluminum Company (SALCo) and Northern Syldavia Power Company (NSPCo) agreed to a CfD for 200 MW at a strike price of $16/MWh, locking in a predictable financial exchange irrespective of fluctuating pool prices.
The CfD ensures that both parties financially settle at the strike price, even though physical delivery occurs via the pool. When the pool price equals the strike price ($16/MWh), no additional payments are made. When the price rises above the strike ($18), SALCo pays more to the pool but is reimbursed the difference by NSPCo. When it falls below the strike ($13), SALCo pays less to the pool but compensates NSPCo to maintain their $16/MWh net.
In exceptional cases, such as NSPCo underdelivering (b) or SALCo under-consuming (c), the CfD still typically applies on the agreed volume unless explicitly structured otherwise. For example, if NSPCo only delivers 50 MWh, it still owes CfD payments on 200 MWh, which may cause a loss if not offset by generation revenue. Conversely, if SALCo consumes only 100 MWh, it still owes CfD payments on 200 MWh, potentially overpaying for unused energy.
These examples illustrate how CfDs decouple physical delivery from financial settlement, offering price certainty but also exposing parties to volume risk if actual consumption or generation deviates from contracted quantities. Managing such contracts requires careful planning and possibly additional agreements to handle deviations fairly.
