1
Optimal Fuel and Emission Acquisition
Contracts Using a Supply Chain Model
J. De La Cruz-Soto 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
This work was supported by ANUIES-PROMEP, Mexico
avier is with the Industrial Electromechanical Division of Universidad
Tecnolgica de Nayarit (e-mail: javier.delacruz@utnay.edu.mx)
G. Gutierrez-Alcaraz is with the Department of Electrical and Electronic
Engineering, Instituto Tecnolgico de Morelia, Morelia Michoacn, Mexico,
58120 (e-mail: ggutiera@gmail.com).
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
II. INTRODUCTION
T 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 must-
run 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.
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 non-
storable 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-to-
day 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
2
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-to-
day 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
 3

current futures contract impractical. Actual delivery on f T

electric futures contracts is also not really practical; outside of q

n=1 t =1
n,t ( Pgn,t ) qTOT =0 (6)
the power business, while actual deliveries on futures
contracts are not common, it is clearly possible to make or
Fuel transport network: Transported fuel of suppliers is
accept these deliveries.
consumed for generations unit and lines of transport should
Therefore, contingent markets have been introduced to operate within operational limits.
reduce uncertainty, via trading commodities/services at date t
to be delivered sometime in the future. The objective of T R U S T R U
contingent delivery contracts is to make the markets complete:
one contract for every good in every state of the market. The
CT
t =1 r =1 u =1 s =1
t , r ,u, s = CC
t =1 r =1 u =1
u,r ,t ;
(7)

introduction of complete markets, therefore, permits the CTr ,u ,s CTrMax

,u , s
j J (8)
accounting of uncertainty with a large economy of means.
Managing risk in energys physical and financial markets
Storage characteristic: balance equations and operatives limit
is complicated by the urgent need to mitigate GHG emissions.
and storage are presented in (9) y (10) respectively.
In the US, the federal Clean Air Act Amendment of 1990
established nationwide limits on SO2 emissions and allocated R S (9)
emissions credits to generators, permitting the free exchange Almu ,r ,t Almu ,r ,t 1 + CTt ,r ,u ,s + AIu ,r CCu ,r ,t
of allowance credits while meeting environmental restrictions. r =1 s =1

The emission allowances trading gives flexibility to (10)

, r ,t Almu , r ,t Almu , r ,t
AlmuMin Max
t = 1KT
generating units in the treatment of pollution constraints.

The power production cost function is given by:

IV. MATHEMATICAL MODEL
P ( ai + bi Pg i ,t + d i Pg i ,t ) if Pg i ,t > 0
F 2

Ci ,t ( Pgi ,t ) =
The optimization problem is to minimize the total costs of t
(11)
generating electricity and transshipping fuels, subject to 0 if Pg i ,t = 0
operational constraints and fuel contractual agreements, over a
specified period. It can be formulated as:
where it is assumed that generation unit does not present
T R U T R U S production cost, when no output power is delivered.
MinCost = ht Cu ,,r ,t ( Pgu ,r ,t ) + cr ,s ,u CTt ,r ,s ,u
t =1 r =1 u=1 t =1 r =1 u=1 s =1 (1)
T R U Emission constraint: Amount of CO2 emission is operate
+ Almu ,r ,t ar ,s ,u under established limit which could be modified obtained CO2
t =1 r =1 u =1
bonus.
subject to the following constraints. Eu ,r ,t EuMax
, r ,t + Ebu , r ,t
(12)

DC power flow equations: At every period the power flow The emissions are given by the following expression:
would be estimated
Eu ,t = + Pgu ,t + Pgu2,t (13)
t = G pt F dt ; t = 1,..., T (2)
ref = 0 (3) 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
Transmission line power flow limits: Power flow at each Climate Exchange (ECX), Insurance Futures Exchange
transmission line must be within operative limits, then: (IFEX), Montreal Climate Exchange (MCeX) and the Chicago
Climate Exchange (CCX). From the latter we will briefly
1
xnm
(
n,t m,t Fnm)
max n, m N and t = 1,..., T (4) describe how transactions are conducted [15].
The Chicago Climate Exchange (CCX) has mechanisms
for contracts to carry out the transactions and deals with CO2
Unit capacity constrain: Any unit at any time should operate emissions. Each contract has a size of 100 metric tons of CO2
within operational limits, then transaction methods in the CCX are:

PguMin Pgu PguMax (5) 1. CCX offers an internet-based, electronic trading

system for submission of bids and offers for
anonymous, cleared agreements executed on price
Water consumption: Total amount of water that the hydraulic
and time priority.
unit must consume.
2. Electronic bilateral agreements between members.
 4

3. Pre-negotiated block trades and cash transactions whereas the second does. The IEEE 30-bus modified system
may be negotiated at any time, but must be reported in Figure 2 is used.
to CCX in accordance with its rules [16]. The fuel transportation network characteristics are given in
It is worth to mention that there are other variations to Table I.
trade bonds in the CCX, however in this paper we consider
bilateral agreements between members. TABLE I
FUEL TRANSPORTATION NETWORK DATA
12000 Element Transport Cost unit transported Transport capacity
($) (fuel / all-periods)
$ / hr

1 Road 0.5 8,000

10000
2 Railroad 0.6 8,000
3 River 0.3 20,000
8000 4 River 0.4 30,000
5 Pipeline 0.5 25,000
6000 6 Pipeline 0.3 28,000
7 Pipeline 0.5 55,000
4000 8 Pipeline 0.6 52,000
9 Railroad 0.05 10,000
2000

1
0 Carreteras
5 100 150 200 250 300 350 400 450 S2
(a) MW S1
Ferrocarril 2
700
CO2 ton / hr

Gaseoductos
600
4
Ros
500
3
400 S3
5

300

200
6 8
100
9
S5
0
50 100 150 200 250 300 350 400 450
MW S4 7

(b)
Figure 1 Maximum generation due to CO2 emissions

The need to purchase CO2 bonds for a generating unit is Figure 2 IEEE 30-bus system
based on capacity, fuel type and the approach used by
environmental regulators to allow a certain amount of Nodal demand pattern for the study period, 26 weeks, is
emissions without receiving a penalty. shown in Figure 3.
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 40
output, upper curve, which it is reduced to 248 MW by
considering emission constraint, Figure 2(b) shows the 30
Demand
restriction in terms of CO2 emissions, then this unit to a (MW)
20
maximum power for an hour, would require 484.6 Bond of
CO2 which can be obtained through 5 contracts of 100 metric 10
tons. In making this acquisition of the unit will be issuing 25
bonds more than 3 times the amount of emissions allowed. 0 20
0 15
5
10 10
15 Periods of study
20 5
Bus of system 25 (weeks)
30 0
V. NUMERICAL EXAMPLE
Figure 3 Demand pattern
This section presents two numerical cases in which we
have created a portfolio of contracts for a generating unit. The
Figure 4 shows the expected prices of fuel. The fuel prices
first case does not consider the purchase of emission bonds,
were taken from [17] and the price of water is 0.0028 $/m3 as
in [18].
 5

70
TABLE IV
CONSUMED FUEL BY GENERATION UNIT
$ / oil bbl 60
Unit Consume fuel
1 (Coal) 261171.58 (tons)
50
2 (Water) 40602018. (m3)
$/coal tons

3 (Oil) 35351.32 (barrel)

40
4 (Coal) 100313.08 (tons)
30
5 (NG) 325709.05 (103 ft3)
6 (NG) 448143.35 (103 ft3)
20

Nodal marginal costs are shown in Figure 6.

$ / 103 ft3 of
10

NG
0
0 5 10 15 20 25
65

Figure 4 Fuel price

60

Table II reports thermal equivalence [19].

Marginal cost
55

($/MW-h)
TABLE II 50
THERMAL EQUIVALENCE
Fuel Thermal equivalence 45
3
Natural Gas 27.49208 m /MBtu
40
Oil 0.172413 barrel/MBtu
Coal 0.049581 ton/MBtu 0
35
0 5 10
10 15 20
20 25 30 Weeks
A. Case 1 Nodes
Since the purchase of emission bonds is not considered, Figure 6 Marginal costs: Case 1
each generation unit has a maximum amount of emissions
equivalent to 0.295 tons of CO2 per MW in each hour. The average marginal cost of the system is $50.11/ MWh.
Now, we proceed to establish a portfolio of fuel contracts for
TABLE III generation unit 1. We consider that the unit has unavailability
EMISSION CONSTRAINT
rates based on the different elements or factors shown in Table
Unit Allowance emission
(CO2 tons) V.
1 128856.00
2 103084.80 TABLE V
3 64428.00 UNAVAILABILITY RATES
4 70870.80 Element Unavailability
5 38656.80 Generation unit 0.05
6 51542.40 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
A representation of fuel portfolio contracts is depicted in
generation unit is shown in Table IV.
Figure 7.
90 Deviations in the size of blocks

Forward contract Future and options Unavailable

80 contract capacity

70 G-1
Unavailab ility grids and congestion

60
Outpu t power

Unavailability G-1
(MW)

50
Available capacity Emission constrain t
G-2
40

30 G-4

20
G-5 G-6
10 Fuel maximum cons umed in 26 weeks
G-3
0
Figure 7 Blocks of fuel consumed
0 5 10 15 20 25
Weeks
Figure 7 shows the total amount of fuel that the unit may
Figure 5 Output power of generation unit: Case 1
consume considering the impact of outages and emission
 6

constraints. We note that the effect of the emission constraint than in the previous case, due to the effect of the acquisition
is significant (almost 25% of the capacity of the unit is of emission bonds for unit 1. Bus 8 presents the highest
unavailable) if emission bonds are not purchased. It is marginal cost because there are penalties in the high limit of
important to point out that these blocks are not static, but are the line that is connected in this node.
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 140

PORTFOLIO OF FUEL CONTRACTS

120
Contract Quantity

Marginal cost
(coals tons)

($/MW-h)
100
Forward 245483.51
Future 15688.05 80

Options 15688.05
60

The exercise price of the option is $0.5/ton, since high coal 40

0
prices are expected (see Figure 3). 20
0 10
5
10 Weeks
15 20
20
B. Case 2 Nodes 25
30

In this case we consider hedging the purchase of emission Figure 9 Marginal costs: Case 2
bonds for unit 1 to $2/CO2 ton, where they acquire 11326.8
CO2 tons, equivalent to the same amount of bonds. This Total operating cost is $24,255,185.03, which is lower
amount was chosen because no emission constraints are than case 1 due to the effect of emission bonds. The following
considered in this unit. Each units power output is shown in decomposition into blocks establishes the fuel contracts
Figure 8. portfolio.
Deviations in the size of blocks
100
Forward contract Future and options
contract
90

80 G-1

Unavailability grids and congestion

70
Outpu t power

Block not scheduling

Unavailability G-1
(MW)

60
G-2 Available capacity Available capacity
50
(CO2 bonds)
40

30 G-4
20
G-5
G-6
10
Fuel maximum consumed in 26 weeks
G-3
0
0 5 10 15 20 25 Figure 10 Blocks of fuel consumed
Weeks

Figure 8 Output power of generation unit: case 2 In this case, the bond purchase CO2 emission removes a
restriction imposed in case 1, using most capacity of unit 1, in
From Figure 8 we can observe that unit 1 produces more the same way would be slightly higher amounts of fuel
energy with respect to case 1 due to the acquisition of purchased through futures and options contracts. Moreover in
emission bonds. On the other hand, unit 6 reduces its output this case has a small available block that is not scheduling; the
power because it is more expensive than coal-fired and portfolio of contracts for unit 1 is shown in Table VIII.
hydraulic units. Oils unit is at minimum capacity. Fuel
consumption per generation unit is shown in Table VII. TABLE VIII
PORTFOLIO OF FUEL CONTRACTS
TABLE VII Contract Quantity
CONSUMED FUEL BY GENERATION UNIT: CASE 2 (coals tons)
Unit Consume fuel Forward 268433.40
1 Coal 282561.48 (tons) Future 16972.90
2 Water 40602018 (m3) Options 16972.90
3 Oil 35351.32 (barrel)
4 Coal 97486.32 (tons) The exercise price of the option is again $0.5 /ton, due to
5 NG 307400.20 (103 ft3)
the expected higher costs of coal.
6 NG 335731.73 (103 ft3)
The same analysis can be performed for the other units to
obtain the portfolio of contracts.
Nodal marginal cost for this case is illustrated in Figure 9.
The average marginal cost is $37.84/MWh, which is lower
 7

VI. CONCLUSION [14] Kaye, R.J.; Outhred, H.R.; Bannister, C.H., Forward contracts for the
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VII. ACKNOWLEDGMENT BIOGRAPHIES

Javier de la Cruz Soto gratefully acknowledges scholarship Javier de la Cruz-Soto received his B.S. Electrical Engineering from
Instituto Tecnolgico de Sonora in 2007 and M. S. in Electrical Engineering
provision by CONACyT/Mexico. in 2009 from Instituto Tecnolgico de Morelia, Mxico. Currently is a full
time lecturer in the Industrial Electromechanical Division of Universidad
Tecnolgica de Nayarit.
Guillermo Gutirrez-Alcaraz (IEEE: M 99) has been with the Department of
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