Summary of New York’s Proposed Mitigation for Locational Market Power

1. Summary of New York’s Proposed Mitigation for Locational Market Power Presented to: NEPOOL Markets Committee David B. Patton, Ph.D. Potomac Economics April 17, 2002

2. In its SMD White Paper, the Commission has proposed a resource-specific offer cap for mitigating locational market power in an LMP market. The same basic measure is used in other markets, although the triggers are different: New York and New England both employ an offer cap that is triggered when two tests are met – 1) conduct test indicating that the bid has been raised considerably and 2) an impact test to preclude mitigation when the conduct has little effect on the market. PJM employs its offer cap at variable cost + 10% when transmission constraints are binding (other than the major interfaces) – no conduct or impact tests. The offer cap does not interfere with the operation of the market and is not intended to be punitive – the supplier receives the LMP at it location. Mitigation in an LMP Market

3. The combination of the conduct and impact tests seeks to minimize unwarranted intervention by the RTO by requiring substantial evidence of an abuse of market power prior to mitigation. Conduct test for economic withholding: the participant has changed one or more elements of its bid by more than a prescribed threshold amount over its reference level. The current threshold for energy is the lower of a 300% increase or $100 per MWh for energy bids. The reference level is intended to serve as a competitive proxy for the generators’ marginal cost. It is generally established based on the units accepted bids over the past 90 days, and changes over the unit’s output range. Impact test: the market price or bid production cost guarantee payments to the generator change by more than a prescribed threshold amount (e.g., $100 per MWh for energy). Overview of Mitigation Structure

4. New York had previously been mitigated with measures that were implemented when the generating assets were divested (prior to the opening of the NYISO markets). In addition, some of the constraints internal to NYC were managed with out-of-merit dispatch and did not contribute to higher LMPs. The ISO will soon be modeling these constraints – which will create 8 load pockets within the city. These constraints raise significant locational market power issues: When the constraints are binding, units within the load pockets frequently must run to resolve the constraint. Concentration of generation ownership within the pockets is generally high. Suppliers within the pockets may be able to increase the frequency of the load pocket congestion by withholding supply. New York City Mitigation

5. Relatively large conduct and impact thresholds are valuable in ensuring that mitigation is imposed only when warranted, minimizing potential interference with competitive bids. These thresholds are reasonable for market power issue that occur periodically. However, frequently occurring transmission constraints can allow substantial market power to be exercised within these threshold levels. Therefore, the NYISO has proposed mitigation for transmission constrained areas that is consistent with the conduct-impact structure, but with lower thresholds – i.e., load pocket thresholds (“LPT”). The proposed mitigation would be applied when constraints are binding – the general mitigation measures would apply to generation within NYC when constraints are not binding. In this system, the impact test serves the purpose of the structural screen – attempts to withhold will not have an impact when multiple suppliers have resources available to resolve the constraint. New York City Mitigation

6. The exposure of the market to locational market power generally increases as the frequency of the transmission congestion increases. Hence, this exposure can be addressed with load-pocket thresholds that decline as the frequency of the constraints increases. The declining LPT addresses the potential for sustained exercises of locational market power exercised under the threshold amount. The frequency of congestion would be measured by the number of hours of congestion over a rolling 12 month period. LPT would naturally change with changes in congestion due to new generation or transmission. The LPT would be adjusted for changes in fuel prices. The LPT function is shown on the following chart. Thresholds for Locational Market Power Mitigation

7. Load Pocket Range NYC Range (572 in 2001) The threshold function is defined by the following: Threshold * Constrained Hours = Max % Value OR Threshold = Max % * Avg. Price * 8760 8760 Hours * Average Price of Threshold Constrained Hours

8. The alternative scenarios shown on the prior figure represent the amount by which prices in a constrained area would rise on average if the supplier(s) perfectly exercise market power (raising prices by the threshold). Expected price increases will necessarily be lower than this level for the following reasons: The transmission congestion will not always create significant market power. The extent of locational market power will depends on load levels, the number of suppliers, and other factors. The congestion may not always be foreseen by the supplier. The NYISO has proposed the 2 percent level. This relatively low level is justified, in part, because the load pockets are “nested” within NYC – enabling the total potential price increase in some areas to be higher than this level. New York City Mitigation: Real Time