How undervalued cross border capacities really are?
With auctions for yearly cross border capacities less than two weeks away it might help shed some light on the pricing mechanism behind cross border capacities.
Transmission rights are spread options
Talking about pricing only makes sense when one considers cross border capacities as a financial instrument. But what kind of financial instrument are we talking about? Most cross border capacities give the owner the right but not the obligation to transfer electricity between borders for a limited period of time. Since the owner of the capacity will only ‘exercise’ the capacity (transport electricity or collect rent) when the difference between the two cross border markets is positive the financial consequence of owning the capacity can only be positive (disregarding those cases where the right is nominated and not closed before this since this transforms the TR into a forwad). Same holds for financial transmission rights without the need to transport electricity and just getting the payoff between the two markets in case of positive price difference. Having said that, an instrument, which can only bring profit (or zero) at maturity, should have positive value at the time of the sale (auction). Since the payoff in any time depends on the difference between the spread on two cross border markets the capacity acts in effect as a call option on the spread between prices of the two markets.
What is new and why does it make sense to invest in cross border capacities?