Contract Design for Facilitating Risk Management in Local Electricity Markets

Abstract

Local electricity markets (LEMs) based on distribution-level locational marginal pricing (DLMPs) are attracting increasing attention from market participants and regulators. However, the resulting spatio-temporal uncertainty in DLMPs exposes distribution-level actors to volatile surpluses, creating a need for efficient hedging strategies. In this paper, we develop a three-stage LEM design and its associated hedge contracts for DLMP-based market participants. We design, analyze, and numerically test two families of cash-settled contracts: flexibility service provider (FSP) contracts (FCs), which hedge the temporal volatility of DLMPs faced by FSP portfolios, and network contracts (NCs), which hedge the spatial DLMP risk borne by the distribution network operator (DNO). The contracts are constructed so that FC payouts replicate FSP surpluses (FSs) and NC payouts replicate the merchandising surplus (MS) of the distribution network, including the effects of congestion and ohmic losses. We prove that the joint portfolio of FCs and NCs is revenue adequate, in the sense that total contract payouts equal total social welfare from the DLMP-based dispatch in every modeled scenario, and we illustrate the construction using a modified IEEE 33-bus system. This contract framework aligns financial payouts with fundamental market surpluses and can support broader participation of distributed energy resources in DLMP-based LEMs.