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Blockchain_Contract_for_Difference_Market_place_for_Hedging_Renewable_Electricity_Transactions.pdf (1.76 MB)

Structuring Contract-for-Difference Instruments for Hedging Electricity Price Risks on a Blockchain-based Marketplace

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posted on 05.03.2021, 13:40 by Olakunle Alao, Paul Cuffe
The volatile nature of day-ahead electricity markets means that participants often resort to some form of derivative hedging instrument. One such derivative instrument is a Contract-for-Difference (CfD), specifically available to renewable generators in some jurisdictions to enable them to hedge against their price risk. CfD is a bilateral arrangement between a generator selling into, and an offtaker buying out of, a centrally cleared pool market for electricity. In this arrangement, the generator subsidizes the offtaker when the spot price is high; whereas, the offtaker subsidizes the generator when the spot price is low. This establishes a synthetic bilateral electricity transaction, operating in parallel to the pool market. Embracing CfD to hedge against price risk presents new risks such as counterparty credit, margining, third-party, and legal risks. They also incur high costs and possess underlying process risks. Decentralized Finance - an overarching term representing financial services built on top of a public blockchain - seems to present particularly compelling opportunities in electricity derivatives for these reasons. Therefore, we propose a novel Decentralized Finance instrument: a blockchain-based marketplace governed by a smart contract to act as a mediator between stakeholders mutually enrolled in bilateral CfD arrangements. The employed smart contract structure autonomously and irrefutably enforces the terms of the CfD, underpinned by a novel collateralization and settlement mechanism. This novel approach mitigates the hedging-related and underlying process risks of traditional CfD instruments.

Funding

SEAI Research, Development & Demonstration Funding Program 2018, grant number 18/RDD/373

History

Email Address of Submitting Author

olakunle.alao@ucdconnect.ie

ORCID of Submitting Author

https://orcid.org/0000-0003-0752-7334

Submitting Author's Institution

University College Dublin

Submitting Author's Country

Ireland