Highlights of the Midwest ISOHighlights of the Midwest ISO2003 State of the Market Report2003 State of the Market Report

Prepared by:Prepared by:

Independent Market MonitorIndependent Market MonitorMidwest ISOMidwest ISO

April 2004April 2004

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IntroductionIntroduction

• The Midwest ISO currently provides transmission service and is the The Midwest ISO currently provides transmission service and is the reliability coordinator for the region, but does not yet operate centralized reliability coordinator for the region, but does not yet operate centralized spot markets for energy or ancillary services.spot markets for energy or ancillary services.

• Hence, the report evaluates the transmission service and operations, and the Hence, the report evaluates the transmission service and operations, and the bilateral market outcomes in 2003. bilateral market outcomes in 2003.

• The report contains an assessment of the current market conditions and The report contains an assessment of the current market conditions and characteristics in anticipation of the markets to be implemented by Dec-04.characteristics in anticipation of the markets to be implemented by Dec-04.

• The areas in the report include:The areas in the report include:

Characteristics of the Midwest Supply and Demand;Characteristics of the Midwest Supply and Demand;

Wholesale Market Prices; Wholesale Market Prices;

Transmission Service; Transmission Service;

Transmission Operations;Transmission Operations;

Market Power Issues; andMarket Power Issues; and

Market Development.Market Development.

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Wholesale Electricity PricesWholesale Electricity Prices

• The following figure shows price trends in the bilateral electricity markets The following figure shows price trends in the bilateral electricity markets during 2003, as well as trends in fuel prices during the year.during 2003, as well as trends in fuel prices during the year.

The prices shown are prices associated with day-ahead forward contracts The prices shown are prices associated with day-ahead forward contracts for delivery at the Cinergy Hub.for delivery at the Cinergy Hub.

• Prices were substantially higher in peak hours than off-peak hours, and Prices were substantially higher in peak hours than off-peak hours, and higher during the higher load conditions in the summer as expected. higher during the higher load conditions in the summer as expected.

• Natural gas prices peaked early in the year, which caused the highest Natural gas prices peaked early in the year, which caused the highest monthly average prices to occur in February in 2003.monthly average prices to occur in February in 2003.

Natural gas costs have a much greater effect on peak prices because gas-Natural gas costs have a much greater effect on peak prices because gas-fired resources are frequently on the margin during peak hours and fired resources are frequently on the margin during peak hours and typically not economic during off-peak hours. typically not economic during off-peak hours.

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Monthly Average Electricity and Fuel Prices Monthly Average Electricity and Fuel Prices Cinergy Day-Ahead Electricity Prices -- 2003Cinergy Day-Ahead Electricity Prices -- 2003

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Natural Gas Index

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Change in Resources, Load, and Resource MarginChange in Resources, Load, and Resource Margin

• The following figure show the quantities by fuel type in each sub-region The following figure show the quantities by fuel type in each sub-region within MISO, as well as the resource margin for the sub-regions.within MISO, as well as the resource margin for the sub-regions.

• From 2002 to 2003, peak load grew by 3800 and total resources increased by From 2002 to 2003, peak load grew by 3800 and total resources increased by 3200 MW, resulting in a slight decrease in the overall resource margin.3200 MW, resulting in a slight decrease in the overall resource margin.

The overall resource margin in the MISO is 22.9 percent.The overall resource margin in the MISO is 22.9 percent.

The WUMS sub-region has the lowest resource margin at 16.4 percent and The WUMS sub-region has the lowest resource margin at 16.4 percent and relies most heavily on imports into the sub-region.relies most heavily on imports into the sub-region.

• The figures also shows that:The figures also shows that:

Roughly half of the MISO resources are located in ECAR.Roughly half of the MISO resources are located in ECAR.

MISO and each of its sub regions relies heavily on coal-fired generation.MISO and each of its sub regions relies heavily on coal-fired generation.

Close to 60% of the generation in the Midwest ISO is coal-fired.Close to 60% of the generation in the Midwest ISO is coal-fired.

Nuclear, Oil, and Hydro resources account for almost 25% of the resources.Nuclear, Oil, and Hydro resources account for almost 25% of the resources.

Natural gas-fired generating resources are 16% of the supply in the Midwest, Natural gas-fired generating resources are 16% of the supply in the Midwest, although they account for the majority of the new capacity.although they account for the majority of the new capacity.

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MISO Capacity by Fuel Type in the MISO Capacity by Fuel Type in the Midwest ISO Sub-RegionsMidwest ISO Sub-Regions

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ECAR N MAPP S MAIN Iowa/MPS WUMS

Other

Oil

Natural Gas

Nuclear

Hydro

Coal

25.4%25.4%

16.5%16.5%

29.7%29.7%

23.4%23.4% 16.4%16.4%

Resource Resource MarginMargin

Market Concentration in MISO Sub-regionsMarket Concentration in MISO Sub-regions

• The table below shows the Herfindahl-Hirschman Index (HHI) for each sub-The table below shows the Herfindahl-Hirschman Index (HHI) for each sub-region within MISO, a measure of market concentration calculated by region within MISO, a measure of market concentration calculated by summing the squares of each supplier’s market share.summing the squares of each supplier’s market share. HHIs do not provide a definitive measure of market power, which must HHIs do not provide a definitive measure of market power, which must

consider demand and network constraint factors.consider demand and network constraint factors.

• The HHIs in the Midwest are higher than in other regions because the The HHIs in the Midwest are higher than in other regions because the vertically integrated utilities have divested less capacity than in other regions.vertically integrated utilities have divested less capacity than in other regions.

• In addition to having the lowest capacity margin, WUMS is the most highly In addition to having the lowest capacity margin, WUMS is the most highly concentrated of the MISO regions.concentrated of the MISO regions.

MISO Subregion HHIECAR 563North MAPP 938South MAIN 1,736Iowa/MPS 1,343WUMS 2,656MISO 261

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Load in MISO during 2003Load in MISO during 2003

• The next figure shows the load duration curve for the Midwest ISO in 2003.The next figure shows the load duration curve for the Midwest ISO in 2003.

This curve shows the number of hours (on the x-axis) in which the load This curve shows the number of hours (on the x-axis) in which the load exceeds a given load level (on the y-axis). exceeds a given load level (on the y-axis).

• The load duration curve exhibits the typical high peak demand in electricity The load duration curve exhibits the typical high peak demand in electricity markets.markets.

The peak load is 25 percent higher than the load level at highest 5 The peak load is 25 percent higher than the load level at highest 5 percent load level.percent load level.

This illustrates the need in any electricity market for peaking resources – This illustrates the need in any electricity market for peaking resources – more than one-fourth of the generation can be expected to run in less more than one-fourth of the generation can be expected to run in less than 5 percent of the hours.than 5 percent of the hours.

This indicates how critical it is for the wholesale markets to price This indicates how critical it is for the wholesale markets to price electricity efficiently in these hours. electricity efficiently in these hours.

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Midwest ISO Load Duration CurveMidwest ISO Load Duration Curve

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0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000 7500 8000 8500

Number of Hours

Loa

d(G

W)

95% Load Level

Peak load 25% higher than 95% load level

* Due to incomplete data for 2003, loads not included for Ameren, FE, NIPS, and MDU.* Due to incomplete data for 2003, loads not included for Ameren, FE, NIPS, and MDU.

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Blackout of 2003Blackout of 2003

• A blackout occurred in the eastern interconnect on August 14, 2003 with the A blackout occurred in the eastern interconnect on August 14, 2003 with the vast majority of the load and generation restored over the next three days.vast majority of the load and generation restored over the next three days.

• According to the U.S.-Canada Task Force, it was caused by: a) insufficient According to the U.S.-Canada Task Force, it was caused by: a) insufficient recognition of voltage problems on the FirstEnergy system, b) inadequate recognition of voltage problems on the FirstEnergy system, b) inadequate monitoring of the FE network, and c) failure to manage tree growth. monitoring of the FE network, and c) failure to manage tree growth.

• The following figure shows the prices posted by Megawatt Daily and the The following figure shows the prices posted by Megawatt Daily and the Intercontinental Exchange (“ICE”) at the Cinergy Hub during the summer.Intercontinental Exchange (“ICE”) at the Cinergy Hub during the summer.

Prices increased by close to $7 per MWh following the blackout on Prices increased by close to $7 per MWh following the blackout on August 15.August 15.

Larger increases of approximately $20 per MWh were reported for the Larger increases of approximately $20 per MWh were reported for the weekend days of August 16 and 17 during the restoration process.weekend days of August 16 and 17 during the restoration process.

These increases are consistent with the uncertainty that prevailed These increases are consistent with the uncertainty that prevailed regarding unit availability and load levels during this period.regarding unit availability and load levels during this period.

• We monitored the restoration process, including generation outages prior to We monitored the restoration process, including generation outages prior to and following the blackout. We did not detect any withholding of resources and following the blackout. We did not detect any withholding of resources or other forms of price manipulation during this period.or other forms of price manipulation during this period.

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Prices During the Blackout in 2003Prices During the Blackout in 2003Daily Peak Price at the Cinergy HubDaily Peak Price at the Cinergy Hub

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Weekend peak prices, not reported by ICE

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Disposition of Transmission Reservation RequestsDisposition of Transmission Reservation Requests

• We evaluated disposition of transmission requests from February 2002 to We evaluated disposition of transmission requests from February 2002 to December 2003, which is summarized in the following figure.December 2003, which is summarized in the following figure.

• The volume of approved requests increased through 2002 and 2003. The volume of approved requests increased through 2002 and 2003.

• Approval levels on a monthly basis ranged from 80 to 97 percent, but were Approval levels on a monthly basis ranged from 80 to 97 percent, but were significantly higher for short-term than longer-term service.significantly higher for short-term than longer-term service.

• The high rate and increasing numbers of approvals in 2003 indicate that The high rate and increasing numbers of approvals in 2003 indicate that transmission has generally been available for participants, which contributes transmission has generally been available for participants, which contributes to efficient wholesale trading.to efficient wholesale trading.

• The figure shows that most confirmed are new requests, not existing service The figure shows that most confirmed are new requests, not existing service that has been “redirected” to alternate receipt or delivery points.that has been “redirected” to alternate receipt or delivery points.

Nonetheless, the revenue allocation rules provide affiliates of TOs an Nonetheless, the revenue allocation rules provide affiliates of TOs an advantage over their unaffiliated competitors by redirecting service back advantage over their unaffiliated competitors by redirecting service back to their affiliates control area to retain the transmission revenue.to their affiliates control area to retain the transmission revenue.

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Disposition of Reservation Requests 2002-2003 Disposition of Reservation Requests 2002-2003

89%

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97%92%

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RefusedApproved and Confirmed Non-RedirectApproved and Confirmed RedirectInvalid/Other

Percentage Approved

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Evaluation of Unconfirmed Transmission RequestsEvaluation of Unconfirmed Transmission Requests

• The following chart shows the total volume of unconfirmed daily firm The following chart shows the total volume of unconfirmed daily firm requests during 2003.requests during 2003.

• We evaluate whether these requests may indicate “potential hoarding” of We evaluate whether these requests may indicate “potential hoarding” of transmission using three criteria (ATC is unavailable during the trading transmission using three criteria (ATC is unavailable during the trading window, requests are refused, ATC is available after the trading window).window, requests are refused, ATC is available after the trading window).

These results show that there has not been a substantial quantity of These results show that there has not been a substantial quantity of unconfirmed requests that meet these criteria.unconfirmed requests that meet these criteria.

• The tariff rules allow participants a free call option on firm transmission The tariff rules allow participants a free call option on firm transmission capacity for the period between the approval and the confirmation deadline. capacity for the period between the approval and the confirmation deadline.

• This conduct can block participants’ access to firm service (whether This conduct can block participants’ access to firm service (whether intentional or unintentional) intentional or unintentional)

Hence, we recommend the MISO consider tariff revisions to eliminate Hence, we recommend the MISO consider tariff revisions to eliminate this free call on the MISO’s firm transmission.this free call on the MISO’s firm transmission.

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Approved and Confirmed Requests and Approved and Confirmed Requests and Potential HoardingPotential Hoarding

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TLR Events and Curtailments in 2003TLR Events and Curtailments in 2003

• The next figure shows the number of TLRs by level that occurred in 2002 to The next figure shows the number of TLRs by level that occurred in 2002 to 2003 and the quantity of transactions curtailed. The TLR levels include:2003 and the quantity of transactions curtailed. The TLR levels include:

Level 3 – non-firm curtailments.Level 3 – non-firm curtailments.

Level 4 – commitment or redispatch of specific resources.Level 4 – commitment or redispatch of specific resources.

Level 5 – curtailment of firm transactions.Level 5 – curtailment of firm transactions.

• The TLRs called on Midwest ISO flowgates (level 3 and above) account for The TLRs called on Midwest ISO flowgates (level 3 and above) account for 62 percent of all TLRs called in the eastern interconnect62 percent of all TLRs called in the eastern interconnect

This is not surprising since much of the eastern interconnect relies on This is not surprising since much of the eastern interconnect relies on centralized redispatch to manage congestion rather than TLRs.centralized redispatch to manage congestion rather than TLRs.

• The figure shows that the curtailment quantities have increased significantly The figure shows that the curtailment quantities have increased significantly from 2002 as the number of TLR events has increased.from 2002 as the number of TLR events has increased.

Most of the increase (particularly of level 5 TLRs) is related to imports into Most of the increase (particularly of level 5 TLRs) is related to imports into the Upper Peninsula of Michigan, caused by a large unit outage in Michigan.the Upper Peninsula of Michigan, caused by a large unit outage in Michigan.

A substantial increase also occurred in Iowa, due in part to poor hydro A substantial increase also occurred in Iowa, due in part to poor hydro conditions in Manitoba cause significant shifts in regional power flows.conditions in Manitoba cause significant shifts in regional power flows.

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TLR Events and Transactions Curtailed TLR Events and Transactions Curtailed 2002 to 20032002 to 2003

TLR Events and Transactions Curtailed2002-2003

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TLR Events and Curtailments in 2003TLR Events and Curtailments in 2003

• The next analysis evaluates the TLR calls by the Midwest ISO in 2003 by The next analysis evaluates the TLR calls by the Midwest ISO in 2003 by examining the flowgate flows in hours when TLRs were called.examining the flowgate flows in hours when TLRs were called.

• The following figure shows the distribution of the over and under-curtailments The following figure shows the distribution of the over and under-curtailments during 2003.during 2003.

Over-curtailment = curtailments that cause the flow to be less than 95% of the Over-curtailment = curtailments that cause the flow to be less than 95% of the limit (this is the target for the TLR curtailments).limit (this is the target for the TLR curtailments).

Under-curtailment = additional relief necessary to reduce flows to the limit.Under-curtailment = additional relief necessary to reduce flows to the limit.

• This figure shows that:This figure shows that:

Almost 40 percent of the curtailments are accurate, with over or under-Almost 40 percent of the curtailments are accurate, with over or under-curtailments of less than 1 percent of the flowgate limit;curtailments of less than 1 percent of the flowgate limit;

The bulk of the curtailments (86%) are in the range of 5 percent over-The bulk of the curtailments (86%) are in the range of 5 percent over-curtailment to 5 percent under-curtailment.curtailment to 5 percent under-curtailment.

The mean value is a 1.3 percent over-curtailment.The mean value is a 1.3 percent over-curtailment.

• These results are positive considering the uncertainties inherent in the TLR These results are positive considering the uncertainties inherent in the TLR process.process.

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Distribution of Over and Under-Curtailments Distribution of Over and Under-Curtailments During TLR Events in 2003During TLR Events in 2003

2%

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Over-Curtailment Accurate Under-Curtailment

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The TLR Process and Market EfficiencyThe TLR Process and Market Efficiency

Although the MISO has managed the process well, TLRs are not an efficient Although the MISO has managed the process well, TLRs are not an efficient means to manage congestion. The Report contains three important findings:means to manage congestion. The Report contains three important findings:

1.1. The TLR curtailment quantities were more than three times larger on The TLR curtailment quantities were more than three times larger on average than the potential redispatch amounts.average than the potential redispatch amounts.

– Centralized redispatch, such as proposed under MISO’s energy markets, Centralized redispatch, such as proposed under MISO’s energy markets, will select the most effective generators to redispatch.will select the most effective generators to redispatch.

2.2. The current bilateral energy markets do not accurately reflect congestion The current bilateral energy markets do not accurately reflect congestion occurring on the system in general.occurring on the system in general.

– Improved accuracy and transparency of the price signals under the MISO Improved accuracy and transparency of the price signals under the MISO energy markets will provide significant benefits.energy markets will provide significant benefits.

3.3. The proposed energy markets will also increase the utilization of the The proposed energy markets will also increase the utilization of the transmission network and promote reliability.transmission network and promote reliability.

– The real-time redispatch (every 5 minutes) will allow interfaces to be The real-time redispatch (every 5 minutes) will allow interfaces to be operated closer to the rated limits (e.g., lower TRMs and other offsets).operated closer to the rated limits (e.g., lower TRMs and other offsets).

– The relief available from redispatch is much more predictable and timely The relief available from redispatch is much more predictable and timely than through current processes -- should contribute to improved reliability.than through current processes -- should contribute to improved reliability.

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AFC Issues and AnalysisAFC Issues and Analysis

• MISO calculates available flowgate capability (“AFC”) for firm and non-MISO calculates available flowgate capability (“AFC”) for firm and non-firm transmission service of various durations (hourly to yearly).firm transmission service of various durations (hourly to yearly).

• To assess the accuracy of the AFC values, the following figure shows the To assess the accuracy of the AFC values, the following figure shows the percent of the flowgate capability available based on the real-time flows in percent of the flowgate capability available based on the real-time flows in hours when a flowgate has a zero AFC.hours when a flowgate has a zero AFC.

The most frequent result is 0 percent. This occurs when the flow is The most frequent result is 0 percent. This occurs when the flow is equal to the limit or a TLR has been called on the flowgate.equal to the limit or a TLR has been called on the flowgate.

In almost one fourth of cases, the portion of the flowgate that is unused In almost one fourth of cases, the portion of the flowgate that is unused is less than 10 percent.is less than 10 percent.

However, more than 30 percent of the flowgate capability is physically However, more than 30 percent of the flowgate capability is physically unused in almost one half of the cases.unused in almost one half of the cases.

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Available Flowgate Capability During HoursAvailable Flowgate Capability During Hourswith Zero Hourly Non-Firm AFC -- 2003with Zero Hourly Non-Firm AFC -- 2003

30% to 60%60% to 90%

90% to 100%

< -10%

-10% to 10%

10% to 30%

Least Consistent with Real-Time Flows

34% of Total

29% of Total

23% of Total

10% of Total

3%

Most Consistent with Real-Time Flows

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AFC Issues and AnalysisAFC Issues and Analysis

• We note that: We note that: Some of the AFC values are calculated by other entities; and Some of the AFC values are calculated by other entities; and

The effect of understated AFCs is mitigated by the fact that the MISO will The effect of understated AFCs is mitigated by the fact that the MISO will often approve hourly non-firm service in these hours.often approve hourly non-firm service in these hours.

• Nonetheless, it is important to continue to improve the AFC values and make Nonetheless, it is important to continue to improve the AFC values and make them as accurate an indicator of available capability as possible.them as accurate an indicator of available capability as possible.

• MISO made some improvements in the calculation of the hourly non-firm MISO made some improvements in the calculation of the hourly non-firm AFC values in 2003:AFC values in 2003: In May, MISO restored hourly AFC quantities associated with daily and In May, MISO restored hourly AFC quantities associated with daily and

longer-term reservations that were not scheduled by the scheduling deadline.longer-term reservations that were not scheduled by the scheduling deadline.

In December, MISO began using the State Estimator information to improve In December, MISO began using the State Estimator information to improve their short-term AFC models.their short-term AFC models.

Based on our review, these improvements have not resolved these issues. Based on our review, these improvements have not resolved these issues.

• Hence, we recommend the MISO fully utilized the state estimator results and Hence, we recommend the MISO fully utilized the state estimator results and continue to investigate other improvements to improve the accuracy of the continue to investigate other improvements to improve the accuracy of the AFC values.AFC values.

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Market Power AnalysisMarket Power Analysis

• The report summarizes the pivotal supplier analysis supporting the recently The report summarizes the pivotal supplier analysis supporting the recently filed market power mitigation measures.filed market power mitigation measures.

Market power concerns in electricity markets are typically the result of Market power concerns in electricity markets are typically the result of locational market.locational market.

Locational market power arises when transmission constraints are binding, Locational market power arises when transmission constraints are binding, preventing adequate competition and giving rise to potential market power.preventing adequate competition and giving rise to potential market power.

This market power is frequently related to a supplier that becomes “pivotal”. This market power is frequently related to a supplier that becomes “pivotal”. A supplier is pivotal when a transmission constraint cannot be managed A supplier is pivotal when a transmission constraint cannot be managed without its resources.without its resources.

• The analysis in this section shows that a number of MISO’s flowgates have The analysis in this section shows that a number of MISO’s flowgates have at least one pivotal supplier.at least one pivotal supplier.

Of the flowgates exhibit a one or more pivotal suppliers, generally only Of the flowgates exhibit a one or more pivotal suppliers, generally only flowgates affecting flows into or within WUMS are frequently congested.flowgates affecting flows into or within WUMS are frequently congested.

• The market power issues raised by these results will be addressed by the The market power issues raised by these results will be addressed by the Midwest ISO’s mitigation measures. Midwest ISO’s mitigation measures.

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Summary of Market DevelopmentsSummary of Market Developments

• GridAmerica began operations October 2003.GridAmerica began operations October 2003.

• Development of Day 2 market rules continued during 2003. Development of Day 2 market rules continued during 2003.

The tariff was filed on March 31, 2004.The tariff was filed on March 31, 2004.

Day 2 markets are now scheduled to begin December 2004.Day 2 markets are now scheduled to begin December 2004.

The Day 2 markets will be initially composed of day-ahead and real-time The Day 2 markets will be initially composed of day-ahead and real-time energy markets, including a real-time pricing provision to set energy prices energy markets, including a real-time pricing provision to set energy prices efficiently when the market is in a shortage.efficiently when the market is in a shortage.

• Continued development of the markets after this initial implementation will Continued development of the markets after this initial implementation will be important, including:be important, including:

Operating reserve and regulation markets; andOperating reserve and regulation markets; and

Long-term resource adequacy provisions.Long-term resource adequacy provisions.

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Summary of Market DevelopmentsSummary of Market Developments

• A Joint Operating Agreement with PJM was filed in December 2003.A Joint Operating Agreement with PJM was filed in December 2003.

This agreement provides the basis for the market-to-market coordination to This agreement provides the basis for the market-to-market coordination to resolve serious issues associated with the electrical interactions between the resolve serious issues associated with the electrical interactions between the two markets. two markets.

Work is underway to develop the software to implement the market-to-Work is underway to develop the software to implement the market-to-market coordination provisions, which are essential to implement as part of market coordination provisions, which are essential to implement as part of the MISO’s Day 2 markets.the MISO’s Day 2 markets.

The agreement is also expected to improve emergency protocols, system The agreement is also expected to improve emergency protocols, system planning, and market monitoring between PJM and MISO.planning, and market monitoring between PJM and MISO.

• As the SPP develops its RTO markets, similar coordination provisions will As the SPP develops its RTO markets, similar coordination provisions will be needed with SPP.be needed with SPP.