Market Reform Proposals

Pete FullerNEPOOL Markets Committee March 12, 2013

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Today’s Discussion

A bit of background

The building blocks: energy, ancillary services, capacity

A cohesive approach to the overall market design

Next steps

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Qualifier

As currently structured and administered, FCM is deeply flawed: Mitigation policies should provide the marginal

existing resource a reasonable opportunity to recover all of its annual fixed costs

A demand curve that recognizes the incremental value of additional capacity is essential, especially in the absence of a supply curve based on long-run costs

Reliability reviews of existing resource offers (delist bids) should be eliminated; all constraints that are to be enforced through planning or operability criteria should be specified in the auction requirements

Background – The Cost of Doing Business

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Sources: Unit costs: ISO-NE RMR Agreements, http://www.iso-ne.com/genrtion_resrcs/reports/rmr/index.html FCA2-7 prices: ISO-NE website, http://www.iso-ne.com/markets/othrmkts_data/fcm/cal_results/index.html Potential FCA8 prices: UBS, “New England: The Next Bust and Boom,” November 6, 2012. “… beginning with the ‘17/18 auction (held in Feb ‘14), FERC has mandated the floor be removed resulting in a substantial degradation in capacity prices (at best $0.99/kW- mnth), however, given the over-supply, the auction prices could be much lower (closer to spot prices of ~$0.20/kw-mnth of late).”

Background – Fuel Diversity Benefits

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What’s powering New England through the peak?

Look at fuel usage during high electricity demand on the peak of a summer day in 2011. Oil-fired resources produced 14% of electric energy during the peak but produced only 1% of electricity

over the entire year.

Source: ISO New England 2013 Regional Energy Outlook, http://www.iso-ne.com/committees/comm_wkgrps/strategic_planning_discussion/materials/2013_reo.pdf

At times of peak load – the periods that most influence Loss of Load Probability and ICR – oil and coal continue to be relied upon

• on-site fuel storage is an inherent characteristic for these resources

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The Building Blocks

Energy

Ancillary Services

Capacity

Real-Time Energy – the Foundation

RT Energy prices need to reflect the full cost (and/or value) of meeting demand and reserves at any given moment

This signal is critical to both supply and demand sides of the market

RT price exposure is a primary driver for efficient hedging behavior DA Energy Market – hedge on a daily basis through

a centralized financial mechanism Standard and customized hedges are also available

in the market through bilateral contracts RT prices discipline behavior of suppliers with DA

schedules

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Ancillary Services

Provide access for ISO to the flexibility and responsiveness needed to balance and manage real-time load dynamics and contingencies

“It is important not to confuse the capacity product with operating reserve products. The capacity product is not an operating reserve product.” (Patton, 2/19/13)

Not all resources need to have high ramp rates, short start times, etc, but it is important that some do

LFRM, augmented by real-time reserves co-optimized with energy (plus regulation) provide the operating flexibility to maintain real-time reliability

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Capacity

Capacity as a planning mechanism Capacity requirements (ICR) are based on risk of

disconnecting firm load – due to resource deficiency – in all hours, with most risk residing in peak load hours

As a result, the delivery of capacity should be measured in all hours, or a subset of hours reflecting the highest risk of resource deficiency

Capacity as an economic mechanism Capacity market: the ‘balancing market’ through which

resources can seek to recover fixed costs not covered by energy or ancillary service margins

Mitigation policy uses the wrong conceptual benchmark for capacity market offers

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Capacity price ≤ Total annual costs – (Energy & Ancillary margins) + Risk

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An Alternative to ISO-NE’s Performance Incentives Proposal Address energy market pricing problems in the

energy market Increase RCPFs to allow for automated re-dispatch

in the event of reserve scarcity Reflect reliability commitments in energy prices Eliminate, or put a price on, all ‘unpriced operator

actions’ Real-time prices that reflect the full cost (and/or

value) of meeting reserve constraints provide the same incentive as ISO’s proposal for suppliers to be available Likely to be more efficient than ISO proposal since

they will reflect actual conditions rather than a proxy rate

An Alternative, continued

The ‘penalty’ for unavailability/non-performance is buying back the DA obligation in real-time

Making scarcity pricing visible to buyers increases efficiency of incentives and hedging Patton (2/19/13) raises concerns with ISO’s

proposal that loads will not bid efficiently DA, DA prices may be suppressed, and there may be inefficient incentives to self-commit gen

Efficient real-time price formation in the energy market avoids these concerns

Additional hedges or options to limit the volatility of energy costs should be commercial products, not regulatory products

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An Alternative, continued

Make the capacity product a capacity product Procure enough to meet resource adequacy criterion Primary obligation is to offer capability to the E&AS

markets every day Measure performance that is within the control of the

resource owner, ie, how available is the resource’s full capability in the daily markets? Focus on high-load hours where most of the

resource deficiency risk resides EFORp: probability that a resource will not be

available due to forced outages or forced deratings when there is a demand on the unit to generate during defined peak hour periods

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An Alternative, continued

Structure the capacity market to reward resources that exceed their target availability and penalize those that under-deliver Target could be the resource’s long-run average

availability, or a class average Extended forced outages would necessarily result in

economic consequences PJM’s Peak-Hour Period Availability mechanism uses

this framework (PJM Manual 18) “[The Peak-Hour Period Availability] provision establishes a means to assess

whether generation resources committed as capacity actually are available at expected levels during peak periods, and credits or charges resources to the extent they exceed or fall short of that expected availability. This will provide generation owners a significant added incentive to ensure that their capacity resources are available when they are most needed, and provide loads greater assurance that their payments for capacity will help maintain peak period reliability.”

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An Alternative, continued

Eliminate Peak Energy Rent deduction Viewed as an option, PER has a strike price at a 22,000 heat

rate Current PER is based on real-time delivery & pricing, even

though ~90% of the market clears DA and does not see RT pricing

De-couple energy price options from the capacity product The capacity product is in response to the requirement to

have resources at least equal to ICR Options and other hedges should be pursued in commercial

transactions, not regulatory constructs Appendix A (mitigation) and FERC anti-manipulation rules

are more than adequate to address concerns with real-time pricing behavior

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An Alternative, continued

Capacity market price formation Investors need a reasonable degree of

price/revenue certainty Prices need to average, over time, the long-run

net cost of the marginal resource Revise mitigation approach

Establish reference prices for existing resources based on long-run average costs Suppliers may discount their offers in response

to actual or perceived competition A sloped demand curve (recommended by FERC,

Patton, etc) would also temper year-to-year price volatility for investors, and enhance reliability

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Next Steps

Consulting with a number of stakeholders Significant interest from all segments of

NEPOOL and the regulatory community

Plan is to develop sufficient design detail to include in the ISO/Analysis Group evaluation

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Thanks for your consideration.