Capacity Demand Curve in ISO-NE: 2 nd Set of Responses to Stakeholder Questions

1. Capacity Demand Curve in ISO-NE: 2nd Set of Responses to Stakeholder Questions ISO New England Samuel A. Newell Kathleen Spees Mike DeLucia Ben Housman February 11, 2014

2. Table of Contents

3. What is the Initial Draft Demand Curve Proposal for the April 1, 2014 FERC Filing? • System Curve • 3-point curve defined as at right • One revision to Initial Candidate Curve is to remove the minimum constraint on the kink point price (see slide 7) Locational Curves • Will remain vertical as now for FCA 9 • Downward-sloping curves will be developed after the April 1, 2014 filing deadline Reconfiguration Auctions • Will reflect the same system and locational demand curves as in the three-year forward capacity auction (FCA) Draft Candidate Demand Curve Notes: LOLE lines shown in gray between 1-in-5 and 1-in-10 increase by increments of 1 (i.e. 1-in-6, 1-in-7, etc.), while lines in gray between 1-in-15 and 1-in-100 increase by increments of 10 (starting at 1-in-20).

4. What are the Considerations when Setting the Price Cap? • The primary considerations when setting a price cap are tradeoffs among: • Price volatility (which increases with the price cap) • Risk of low reliability events (decreases with an increasing price cap) • Average procured quantity and cost (i.e., reducing the price cap requires right-shifting the demand curve and therefore increasing average procured quantity) • Price cap should be high enoughto: • Support long-run average prices equal to Net CONE • Exceed the true Net CONE, including a substantial margin for administrative error • Reflect the very high value of capacity during shortage years when capacity is scarce • Prevent an excessive number of years at the price cap • However, limiting the price capto a reasonable level will: • Mitigate extreme price volatility • Prevent payments that far exceed the value of capacity during shortage years • Acknowledge the possibility that additional supply may become available (at a high price) in reconfiguration auctions • Limit the incentives for exercising market power (although these incentives remain substantial) • Overall, these considerations suggest a price cap of in the range of 1.5 – 2.25 x Net CONE is most reasonable

5. What if the Price Cap is at 1.5 x Net CONE? Price Cap at 1.5x Net CONE • We have received one stakeholder request to review a lower price cap at 1.5x Net CONE (among other questions related to the cap) • 1.5x Net CONE is in the reasonable range for a price cap (see prior slide), but would require offsetting adjustments to maintain reliability • A right-stretched curve, tuned to 0.1 LOLE would add: • 3.6% to the reserve margin at the Kink • 8.7% to the reserve margin at the Foot • Other options for right-shifting the curve to maintain 0.1 LOLE also exist

6. What if the Price Cap is at 1.5 x Gross CONE? Price Cap at 1.5x Gross CONE • Another alternative is to set the price cap as a multiple of Gross CONE, we test 1.5x Gross CONE consistent with the NYISO approach • Performance of the curve is almost identical to the candidate curve (due to its similarity to the 2x Net CONE parameter under our base assumptions) Impact of High E&A/S • Curve shape would differ more substantially as E&A/S becomes high, although the two options would still deliver relatively similar price and reliability results

7. What if the Kink Point has no Minimum? Removing the Kink Point Minimum • As discussed in the last meeting, the initial candidate curve included a minimum on the price and kink points tied to Gross CONE • Imposing a minimum on the cap is necessary to prevent low reliability outcomes, although it introduces some over-procurement at high E&A/S levels • Removing the minimum price on the kink point partially mitigates this potential over-procurement problem without introducing new performance concerns. We have therefore updated the candidate curve to remove this minimum

8. How is Self-Supply Treated in Other Markets?

9. How Do the Reconfiguration Auctions Affect Demand Curve Performance? • Between FCA and delivery, several changes can occur (not currently captured in our Monte Carlo modeling): • Demand changes: • Load Forecast Error: As described in the following slides, ISO-NE’s estimate of needed quantity can change, with positive and negative changes being equally likely • Supply changes: • Incremental Supply: some additional supply could materialize if high reconfiguration auction prices are anticipated, but there are no historical examples in ISO-NE or elsewhere to demonstrate the market’s capability to generate supply in this condition • Decremental Supply: some procured supply may disappear due to problems with existing units or delays with new resources • Disappearing Options: the total quantity of offered supply is likely to contract with shorter forward periods as the option to procure some types of supply disappears (e.g. new gen), resulting in a steeper supply curve • Potential Consequences: • With disappearing supply options and few historical examples to demonstrate the market’s capability to generate incremental supply in RAs when short, there is a risk that increases in the load forecast would not be offset by incremental supply in RAs • This would result in lower reliability, as illustrated in the following slides

10. How Substantially Does Supply Contract on a Short-Term Basis? Contracting Supply • Evidence from PJM demonstrates intuitive result that short term auctions: • Have a steeper supply curve, and • Attract fewer total supply offers • Some higher-cost resources drop out: • Major investments in new/retrofit gen • Decisions must be made 2-3 years out • Short-Term Resources • Other shorter-term resources can wait until months prior to delivery to commit: • DR suppliers state preference for short-term commitments citing excess risk 3 years out (but no empirical evidence that the risk causes them to bid at a premium) • Importers have uncertain opportunity costs and uncertain need for self-supply • Even in a short market, some incremental supply may be available short-term (e.g. high-cost DR) PJM Supply Curves 3, 2, and 1 Years Forward Source: Brattle 2011 Review of PJM’s RPM

11. How Large is the 3-Year Forward (Non-Weather) Load Forecast Error? • ISO-NE does not currently consider non-weather load forecast error (LFE) in FCM: • Creates additional uncertainty not currently considered when calculating NICR • Not considered in our Monte Carlo simulations • Historical three-year forward load forecast error: • Average of zero, with standard deviation +/- 3.3% • Under-forecast through much of 1990’s and early 2000’s; over-forecast in recent recession • Assume a normal distribution centered on zero for our purposes Three-Year Forward Non-Weather LFE Historical Non-Weather LFE (One, Three, and Five Years Forward)

12. Can You Summarize the Performance of all Curves Tested to Date?