1

Optimal Fuel and Emission Acquisition Contracts Using a Supply Chain Model
J. De La Cruz-Soto Student Member, IEEE, G. Gutirrez-Alcaraz Member, IEEE
Abstract-- For an electric power system to meet the demand for electricity depends not only on subsystems of generation, transmission and distribution, but also on the ability to supply primary energy sources such as natural gas, oil and coal. The effects of a contingency in some of the subsystems, including supply networks, can propagate and affect system operations in terms of availability and price. In a vertically integrated industry the operation of electric power systems has omitted energy supply aspects and the use of financial instruments as part of trade policy. In this paper a supply chain model is used to analyze the acquisition of fuel contracts for generating units. Numerical examples are provided. Index TermsFuel contracts, supply chain.

I. NOM ENCLATURE The following nomenclature will be used throughout the present work: u Number of generating units f Generators with fuel restrictions N Nodes of power system T Number of periods of study R Type of fuel (coal, oil and NG) Cu ,,r ,t Cost per MBtu of unity u in period t of fuel type r

Pgu ,r ,t Generated power by the unit u in period t of fuel type r Network admittance matrix G Incidence matrix to generators
F Incidence matrix to loads p Active power vectors of generators

d Active power vectors of loads

ref Reference bus voltage phase angle

xnm Reactance of line nm

max Fnm Transmission capacity limit of line nm

CTt ,r ,u , s Transported fuel of the period t of fuel type r to generator u of supplier s

qTOT Total amount of fuel specified by T-O-P contract

CCu , r ,t Consumed fuel of unit u in period t of fuel type r Eu ,r ,t Input-output characteristic in CO2 emission by the unit u at period t of fuel r

Ebu ,r ,t CO2 bonus obtained by the unit u at period t of fuel type r

Almu ,r ,t Storage fuel of unit u at period t of fuel type r

AI u , r Initial storage of unit u at period t of fuel type r

This work was supported by ANUIES-PROMEP, Mexico Authors are with the Department of Electrical and Electronic Engineering, Instituto Tecnolgico de Morelia, Morelia Michoacn, Mexico, 58120 (e-mail: eljavi_7@hotmail.com, ggutier@itmorelia.edu.mx ).

HE economic operations of an electric power system require that expenditures for fuel be minimized as much as possible. Traditionally, primary energy sources were secured via long-term contracts. However, oil price volatility in the last two years and price oscillations in other fossil fuels used by generating units require finely-tuned financial policies to obtain fuel in order to avoid negative impacts, including high fuel prices. Under centralized decision-making, it is important to consider both the characteristics of the power system, and its ability to obtain and supply the different forms of raw energy required by the various generating units. Several studies in the literature report the use of financial arrangements for trading electricity [1-5]. Other literature has examined the use of fuel acquisition and optimal scheduling in generation companies decision-making [3]. A particle swarm optimization (PSO) approach to support electricity producers for multi-period optimal contract allocation is reported in [1]. The proposed model makes use of contracts with physical (spot and forward) and financial (options) settlement to sell energy by the generation company into deregulated markets. A two-period equilibrium model, where strategic generators compete with their rivals by supply function in a spot market and by Cournot conjectures in a financial options market, is presented in [2]. In [3] discusses the implementation of an alternative scheme involving auctions of long-term call options and forward contracts as part of the instruments adopted in countries with emerging economies to ensure resource adequacy, e.g., Brazil, Chile, Peru, El Salvador, Panama and Turkey. An approach to incorporate call and put options, forward contracts, and reliability mustrun contracts in multi-area unit commitment and economic dispatch solutions is proposed in [4]. Take-or-pay contracts are considered in an optimization model [6-8]. Analyzing the impacts of the unavailability of a generating unit on decisions to sell energy by forward contracts is shown in [9]. [10] presents the viability of using derivative financial instruments for each of the agents that integrate the Chilean electricity market as part of the countrys trade policy. In this paper a supply chain model is used to analyze the acquisition of fuel contracts for generating units. Fuel contracts are always traded at a certain degree of uncertainty. With this model, we obtain an approximate value of the amount of fuel to purchase, based on a set price over a period of time. By integrating as many restrictions as possible, our model will most closely resemble the real world, obtaining the fuel consumption for each generation unit.

II. INTRODUCTION

III. ENERGY MARKETS: FUEL, ELECTRICITY AND EMISSIONS Organized energy markets provide economic benefits to generating companies via well-designed commercial policies, where it is possible to hedge the price of different primary sources of supply (coal, oil and natural gas) and the wholesale price of electricity. Such financial arrangements are part of the economic welfare of a power system, because they allow compensation for most undesirable operating conditions. Under liberalization two types of markets have evolved: Financial markets: A financial market is a market for the exchange of capital and credit. Currency markets, future capital and financial markets are considered. Physical markets: Physical markets are markets where traded products are brought and sold for immediate delivery. Since AC power cannot be stored, the process of price risk management is far more complex than for other nonstorable commodities like live hog, which can usually be stored long enough to make delivery. The reason is that if a commodity cannot be stored, there is no connection between the spot price today and the equilibrium forward price for delivery tomorrow. This lack of connection between spot and forward prices makes hedging very difficult for the commodity, electricity, because there is no necessary relationship between the price at which the futures contract is closed out and the subsequent spot price. The implication is that futures contracts for electricity do not provide the price discovery function that they do for storable commodities. For storable commodities, arbitrage forces create a close relationship between spot and competitive forward or futures prices. These same forces also limit the variability of day-today spot prices. The simple economics of spot and forward prices is well-understood. For example, a commodity may be stored for some amount of time t > 0 . In the case of nonstorable commodities like live cattle, it is at least a few days or weeks. Only in the case of AC power does t = 0 . When a commodity may be stored for time t, arbitrage forces will make the forward price for local delivery for t periods ahead (Ft) approximately equal to the future value of the spot price (St). That is, where the effective interest rate per period is r, and friction in the form of commissions, storage costs, etc., is ignored (or included in r), arbitrage forces will guarantee that Ft=S[1+r]t. If the forward price is more or less than this, an arbitrageur can make a riskless profit [11]. These two types of arbitrage together ensure that Ft=S[1+r]t. The equation is sometimes represented as simply the definition of an equilibrium forward price if the interest rate and spot price are given. In reality, it expresses a joint determination of both spot and futures, especially as the time until forward delivery becomes short. The reason that a true two-way linkage exists is simple. If, for example, a significant shortage is predicted for tomorrow, the resulting rise in tomorrows forward price will cause arbitrageurs to immediately start buying spot today and selling forward for delivery tomorrow; clearly, the spot purchases drive up the spot price, but the forward sale into

tomorrows market helps reduce tomorrows forward price. In addition, the deliveries from this arbitrage take product out of todays relative surplus and deliver them into tomorrows shortage, helping to mitigate the predicted shortage for tomorrow and reduce tomorrows spot price. Therefore, for a commodity that is storable for at least a day or two, the possibility for arbitrage also creates a close relationship between day-to-day spot prices as well as between spot and forward prices. But for electricity, which is not a storable commodity, there is no relationship at all between the equilibrium spot price today and todays equilibrium forward price for tomorrow. There is also no arbitrage limit on day-today spot price volatility as there is for storable goods [12, 13]. In the case of storable agricultural crops, the conditions for using futures contracts to manage price risk are especially favorable. The significant price swings for these commodities are usually caused by variations in predicted supply during the production period. Demand for these products is generally very stable, although when affected by changes in consumers income (consumers tend to substitute less expensive products), or changes in consumer preferences, the changes are usually quite gradual. On the other hand significant price swings are usually caused by weather during the production period, which affects anticipated supply. Since the demand tends to be inelastic, the price response can be rapid, but after the crop is harvested and the size of the crop is known, the huge price swings that can be caused by a drought or flood cannot occur when the crop is being shipped to market. Simply stated, the market value of a crop planted in May can vary substantially before it is harvested in November, but once the crop is harvested, both supply and demand are known, and no major price swings occur between harvest and delivery. If our hypothetical crop is hedged in the December contract, the basis should be reasonably stable and predictable from harvest through the delivery period [11, 13]. For any commodity the objective of risk management is to stabilize profits. Thus, a power retailer must announce its guaranteed price to its customers far in advance in an environment where cost may vary by many orders of magnitude, especially in high demand scenarios [14]. Power retailers have several risk management tools at their disposal. One common tool is a long-term firm power agreement with a local generating company [13]. This forward contract eliminates price uncertainty, but negotiating the price will be affected by the relative strength of the parties. A more competitive price could be achieved when the power retailer can simply take long futures positions and use the gains on these futures positions to offset any increases in the spot price that occur. However, this raises the problem of basis risk during the delivery period. In the case of hedging electricity, basis risk is potentially much more significant than in many other hedging environments, so much so that it makes the current futures contract impractical. Actual delivery on electric futures contracts is also not really practical; outside of the power business, while actual deliveries on futures contracts are not common, it is clearly possible to make or

accept these deliveries. Therefore, contingent markets have been introduced to reduce uncertainty, via trading commodities/services at date t to be delivered sometime in the future. The objective of contingent delivery contracts is to make the markets complete: one contract for every good in every state of the market. The introduction of complete markets, therefore, permits the accounting of uncertainty with a large economy of means. Managing risk in energys physical and financial markets is complicated by the urgent need to mitigate GHG emissions. In the US, the federal Clean Air Act Amendment of 1990 established nationwide limits on SO2 emissions and allocated emissions credits to generators, permitting the free exchange of allowance credits while meeting environmental restrictions. The emission allowances trading gives flexibility to generating units in the treatment of pollution constraints.

Fuel transport network: Transported fuel of suppliers is consumed for generations unit and lines of transport should operate within operational limits.

CT
t =1 r =1 u =1 s =1

t , r ,u, s

CC
t =1 r =1 u =1

u,r ,t ;

(7) (8)

CTr ,u ,s CTrMax j J ,u , s

Storage characteristic: balance equations and operatives limit and storage are presented in (9) y (10) respectively.
Almu ,r ,t Almu ,r ,t 1 + CTt ,r ,u ,s + AIu ,r CCu ,r ,t
r =1 s =1 R S

(9) (10)

Alm

Min u , r ,t

Max Almu ,r ,t Almu ,r ,t

t = 1KT

IV. MATHEMATICAL MODEL The optimization problem is to minimize the total costs of generating electricity and transshipping fuels, subject to operational constraints and fuel contractual agreements, over a specified period. It can be formulated as:
MinCost = ht Cu ,,r ,t ( Pgu ,r ,t ) + cr ,s ,u CTt ,r ,s ,u
t =1 r =1 u=1
T R T R U T R U S

The power production cost function is given by:

P ( ai + bi Pg i ,t + d i Pg i ,t Ci ,t ( Pgi ,t ) = 0
F t 2

if Pg i ,t > 0 if Pg i ,t = 0

(11)

where it is assumed that generation unit does not present production cost, when no output power is delivered.

t =1 r =1 u =1

s =1

(1)

+ Almu ,r ,t ar ,s ,u
t =1 r =1 u =1

subject to the following constraints.

Emission constraint: Amount of CO2 emission is operate under established limit which could be modified obtained CO2 bonus. (12) Eu ,r ,t EuMaxt + Ebu ,r ,t ,r , The emissions are given by the following expression:
2 Eu ,t = + Pgu ,t + Pgu ,t

DC power flow equations: At every period the power flow would be estimated
t = G pt F dt ;

t = 1,..., T

(2)

(13)

ref = 0

(3)

Transmission line power flow limits: Power flow at each transmission line must be within operative limits, then:
1 max n,t m,t Fnm xnm

n, m N and t = 1,..., T

(4)

Unit capacity constrain: Any unit at any time should operate within operational limits, then
Min Max Pgu Pgu Pgu

The marketing of the bonds of CO2 will be done through an emissions trading market. Currently there are several markets for emissions all over the world such as: European Climate Exchange (ECX), Insurance Futures Exchange (IFEX), Montreal Climate Exchange (MCeX) and the Chicago Climate Exchange (CCX). From the latter we will briefly describe how transactions are conducted [15]. The Chicago Climate Exchange (CCX) has mechanisms for contracts to carry out the transactions and deals with CO2 emissions. Each contract has a size of 100 metric tons of CO2 transaction methods in the CCX are: 1. CCX offers an internet-based, electronic trading system for submission of bids and offers for anonymous, cleared agreements executed on price and time priority. Electronic bilateral agreements between members. Pre-negotiated block trades and cash transactions may be negotiated at any time, but must be reported to CCX in accordance with its rules [16].

(5)

Water consumption: Total amount of water that the hydraulic unit must consume.

q
n=1 t =1

n,t ( Pgn,t ) qTOT

=0

(6)

2. 3.

It is worth to mention that there are other variations to trade bonds in the CCX, however in this paper we consider bilateral agreements between members.
12000 $ / hr 10000 8000 6000 4000 2000

Element 1 2 3 4 5 6 7 8 9

TABLE I FUEL TRANSPORTATION NETWORK DATA Transport Cost unit transported Transport capacity ($) (fuel / all-periods) Road 0.5 8,000 Railroad 0.6 8,000 River 0.3 20,000 River 0.4 30,000 Pipeline 0.5 25,000 Pipeline 0.3 28,000 Pipeline 0.5 55,000 Pipeline 0.6 52,000 Railroad 0.05 10,000

1 Carreteras

S2 S1
2

100

150

200

250

300

350

400

450
MW

(a)
700 CO2 ton / hr 600 500

Ferrocarril

Gaseoductos 4 Ros

S3

400 300 200 100 0 50 100 150 200 250 300 350 400 450
MW
S4
6

8 9

S5
7

(b) Figure 1 Maximum generation due to CO2 emissions

The need to purchase CO2 bonds for a generating unit is based on capacity, fuel type and the approach used by environmental regulators to allow a certain amount of emissions without receiving a penalty. When a thermal unit is subject to restrictions on CO2 emissions will generally reduced capacity to generate the maximum allowed by the amount of emissions, though the restriction will depend on the type of fuel used per unit. Figure 1 (a) depicts a 450 MW thermal generations unit output, upper curve, which it is reduced to 248 MW by considering emission constraint, Figure 2(b) shows the restriction in terms of CO2 emissions, then this unit to a maximum power for an hour, would require 484.6 Bond of CO2 which can be obtained through 5 contracts of 100 metric tons. In making this acquisition of the unit will be issuing bonds more than 3 times the amount of emissions allowed. V. NUMERICAL EXAMPLE This section presents two numerical cases in which we have created a portfolio of contracts for a generating unit. The first case does not consider the purchase of emission bonds, whereas the second does. The IEEE 30-bus modified system in Figure 2 is used. The fuel transportation network characteristics are given in Table I.

Figure 2 IEEE 30-bus system

Nodal demand pattern for the study period, 26 weeks, is shown in Figure 3.

40 30 Demand (MW) 20 10 25 0 0 20 5 15 15 Bus of system 10 10 20 25 5 30 0 Periods of study (weeks)

Figure 3 Demand pattern

Figure 4 shows the expected prices of fuel. The fuel prices were taken from [17] and the price of water is 0.0028 $/m3 as in [18].

5
70 $ / oil bbl 60

50 $/coal tons

40 30

TABLE IV CONSUMED FUEL BY GENERATION UNIT Unit Consume fuel 1 (Coal) 261171.58 (tons) 2 (Water) 40602018. (m3) 3 (Oil) 35351.32 (barrel) 4 (Coal) 100313.08 (tons) 5 (NG) 325709.05 (103 ft3) 6 (NG) 448143.35 (103 ft3)

20

Nodal marginal costs are shown in Figure 6.

$ / 103 ft3 of NG

10 0

10

15

20

25

65 60

Figure 4 Fuel price

Marginal cost ($/MW-h)

Table II reports thermal equivalence [19].

TABLE II THERMAL EQUIVALENCE Thermal equivalence 27.49208 m /MBtu 0.172413 barrel/MBtu 0.049581 ton/MBtu
3

55 50 45 40 35 0 0 5 10 15 10 20 25 30 20

Fuel

Natural Gas Oil Coal

A. Case 1 Since the purchase of emission bonds is not considered, each generation unit has a maximum amount of emissions equivalent to 0.295 tons of CO2 per MW in each hour.
TABLE III EMISSION CONSTRAINT Unit Allowance emission (CO2 tons) 1 128856.00 2 103084.80 3 64428.00 4 70870.80 5 38656.80 6 51542.40

Nodes

Weeks

Figure 6 Marginal costs: Case 1

The average marginal cost of the system is $50.11/ MWh. Now, we proceed to establish a portfolio of fuel contracts for generation unit 1. We consider that the unit has unavailability rates based on the different elements or factors shown in Table V.
TABLE V UNAVAILABILITY RATES Element Unavailability Generation unit 0.05 Transmission grid 0.000978 Fuel transport grid 0.00009 Transport grid congestion 0.009

Total operating cost is $24,463,298.08. The power outputs for each unit are depicted in Figure 5. Fuel consumption per generation unit is shown in Table IV.
90

A representation of fuel portfolio contracts is depicted in Figure 7.

Deviations in the size of blocks Forward contract Future and options contract Unavailable capacity

80 70 60 50 40 30 20 10 0

G-1
Unavailab ility grids and congestion

Outpu t power (MW)

Unavailability G-1

G-2

Available capacity

Emission constrain t

G-4 G-6
Fuel maximum cons umed in 26 weeks

G-5

G-3
0 5 10 15 20 25

Figure 7 Blocks of fuel consumed

Weeks

Figure 5 Output power of generation unit: Case 1

Figure 7 shows the total amount of fuel that the unit may consume considering the impact of outages and emission constraints. We note that the effect of the emission constraint

is significant (almost 25% of the capacity of the unit is unavailable) if emission bonds are not purchased. It is important to point out that these blocks are not static, but are changeable depending on whether or not there are failures in some of the elements. The portfolio of contracts for unit 1 is shown in Table VI.
TABLE VI PORTFOLIO OF FUEL CONTRACTS Contract Quantity (coals tons) Forward 245483.51 Future 15688.05 Options 15688.05

of emission bonds for unit 1. Bus 8 presents the highest marginal cost because there are penalties in the high limit of the line that is connected in this node.

140 120

Marginal cost ($/MW-h)

100 80 60 40 0 20 0 10 10 15 20 20 30

The exercise price of the option is $0.5/ton, since high coal prices are expected (see Figure 3). B. Case 2 In this case we consider hedging the purchase of emission bonds for unit 1 to $2/CO2 ton, where they acquire 11326.8 CO2 tons, equivalent to the same amount of bonds. This amount was chosen because no emission constraints are considered in this unit. Each units power output is shown in Figure 8.
100 90 80 Outpu t power (MW) 70 60 50 40 30 20 10 0 0 5 G-5 G-4 G-6 G-3 10 15 Weeks 20 25 G-2 G-1

Weeks

Nodes

25

Figure 9 Marginal costs: Case 2

Total operating cost is $24,255,185.03, which is lower than case 1 due to the effect of emission bonds. The following decomposition into blocks establishes the fuel contracts portfolio.
Deviations in the size of blocks Forward contract Future and options contract

Unavailability grids and congestion

Block not scheduling

Unavailability G-1

Available capacity

Available capacity (CO2 bonds)

Fuel maximum consumed in 26 weeks

Figure 10 Blocks of fuel consumed

Figure 8 Output power of generation unit: case 2

From Figure 8 we can observe that unit 1 produces more energy with respect to case 1 due to the acquisition of emission bonds. On the other hand, unit 6 reduces its output power because it is more expensive than coal-fired and hydraulic units. Oils unit is at minimum capacity. Fuel consumption per generation unit is shown in Table VII.
TABLE VII CONSUMED FUEL BY GENERATION UNIT: CASE 2 Unit Consume fuel 1 Coal 282561.48 (tons) 2 Water 40602018 (m3) 3 Oil 35351.32 (barrel) 4 Coal 97486.32 (tons) 5 NG 307400.20 (103 ft3) 6 NG 335731.73 (103 ft3)

In this case, the bond purchase CO2 emission removes a restriction imposed in case 1, using most capacity of unit 1, in the same way would be slightly higher amounts of fuel purchased through futures and options contracts. Moreover in this case has a small available block that is not scheduling; the portfolio of contracts for unit 1 is shown in Table VIII.
TABLE VIII PORTFOLIO OF FUEL CONTRACTS Contract Quantity (coals tons) Forward 268433.40 Future 16972.90 Options 16972.90

Nodal marginal cost for this case is illustrated in Figure 9. The average marginal cost is $37.84/MWh, which is lower than in the previous case, due to the effect of the acquisition

The exercise price of the option is again $0.5 /ton, due to the expected higher costs of coal. The same analysis can be performed for the other units to obtain the portfolio of contracts.

VI. CONCLUSION The price of energy highly correlates with fuel price volatility. The selection of an appropriate portfolio of contracts will allow generation units to avoid deficiencies or excesses of primary raw energy (coal, oil and natural gas), thus minimizing the production costs of electricity. Some analytical methods borrowed from the financial literature (Portfolio Theory and Real Options) can be successfully applied, but it is also important to consider the physical ability to supply fuel to the generation units in a power system. In this paper a supply chain model was used to analyze the purchase of a fuel contracts portfolio, where the unavailability of a generation unit, electric transmission, transport fuel grids and congestion are the measures of uncertainty.

[14] Kaye, R.J.; Outhred, H.R.; Bannister, C.H., Forward contracts for the operation of an electricity industry under spot pricing, IEEE Trans. On Power Systems, Vol. 5, Feb. 1990. pp. 46 52 [15] ECX available: www.ecx.eu/. IFEX available: www.theifex.com/. MCeX available: www.mcex.ca. [16] Chicago Climate Exchange, Contract Specifications, chicagoclimatex.com, Available: http://www.chicagoclimatex.com/content.jsf?id=483 [Accessed: March 2009]. [17] Energy Information Administration, Available: http://www.eia.doe.gov. [18] Mxico, CONAGUA, Resolucin del comit de informacin, Subdireccin general jurdica, Gerencia de descentralizacin y de transparencia y acceso a la informacin pblica unidad de enlace, Oficio No. BOO.00.02, Expediente No. 08-4345, Registro No. S/N, Mxico D.F, 28-Oct.-2008 [19] Energy Information Administration, Energy Calculator - Common Units and Conversions, Available: http://www.eia.doe.gov/kids/energyfacts/science/energy_calculator.html.

VII. ACKNOWLEDGMENT Javier de la Cruz Soto gratefully acknowledges scholarship provision by CONACyT/Mexico. VIII. REFERENCES
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BIOGRAPHIES
Javier de la Cruz-Soto received his BSEE from Instituto Tecnolgico de Sonora in 2007. Currently, he is pursing MSEE at Programa de Graduados e Investigacin en Ingeniera Elctrica, Instituto Tecnolgico de Morelia, Mxico. Guillermo Gutirrez-Alcaraz (IEEE: M 99) received his B.S. and M.S. in Electrical Engineering from Instituto Tecnolgico de Morelia. Morelia Mxico, in 1995 and 1996 respectively.

[2]

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