Critique of Adjusted Offer Curve

1. Critique of Adjusted Offer Curve Shams Siddiqi, Ph.D. Crescent Power, Inc. (512) 263-0653 shams@crescentpower.net April 17, 2009

2. Problems with AOC • Violates Fundamental Principle of Market Design • Adversely Impacts Reliability • Has Efficiency Issues • Sends Distorted Price Signals • Hits Consumers Twice

3. Violates Fundamental Principle • Fundamentals of the Nodal Market are carefully designed so that Participants have the incentive to follow ERCOT dispatch instructions • Reliability of the system is ensured through Participants being financially motivated to comply with ERCOT’s actions to maintain reliability • LMPs must reflect the price that motivates the generator to follow ERCOT dispatch instructions • Breaking this fundamental principle of the Nodal Market design would result in the market not working properly – in particular Reliability & Efficiency would be adversely impacted • AOC violates this fundamental principle

4. Basics of Market Design • Generator offer curves represent that unit’s willingness to sell (when moving up the curve) or buy (when moving down the curve) from the market • When ERCOT dispatches the unit to a particular point on the curve, the LMP at that unit’s node is exactly equal to its offer at that point on the curve – thus the unit has no incentive to generate more or less than the dispatch level • When the unit is fully dispatched, the LMP is greater than its maximum offer and vice versa – all incentive compatible • If price is positive and unit generates above ERCOT’s dispatch level, that amount of energy is provided free to the system as a Penalty

5. LMP & Offer Curve Example Nodal LMP Price ($/MWh) Willingness to sell or Offer Curve Quantity (MWh) Base Point

6. Adverse Reliability Impacts • AOC artificially adjusts wind resources’ offer curves such that they do not reflect the resource’s willingness to buy or sell at the offer price • With AOC, ERCOT dispatch instructions and LMPs at the wind resource nodes create a strong incentive for the wind resource not to follow ERCOT instructions • E.g., LMP at the node could be positive and yet the wind resource is being fully curtailed • The “Penalty” for the wind resource would be paying $0 for its curtailed output – given PTC and REC income, this “Penalty” still provides a strong incentive wind resources to not follow instructions • Financial incentives to ensure Reliability lost w/AOC

7. LMP & Offer Curve Under AOC Adjusted Offer Curve Nodal LMP Willingness to sell or true Offer Curve Price ($/MWh) Quantity (MWh) Base Point

8. Efficiency Issues • AOC will always result in more wind curtailment than under an undistorted Nodal Market (Societal welfare maximizing level) • AOC may fully curtail Non-priority wind with little impact on a constraint rather than curtail a few MWs of Priority wind with large impact on the constraint • Due to the meshed nature of the grid, AOC may curtail wind even before dispatching down more expensive thermal resources

9. Distorted Price Signals • AOC will increase prices at times that wind produces the most while maintaining the high prices when the wind does not produce – this distorted price signal may encourage bad investments decisions (say base load resources) and discourage innovative storage solutions • Bad investment decisions would lead to even more wind curtailments and yet, as long as all wind isn’t curtailed, prices would still be artificially distorted by AOC • AOC would prevent more efficient wind or other resources to replace older wind (equivalent to protecting gas steam unit by not allowing newer combined cycle unit to offer below GS unit cost)

10. Consumers Pay Twice • AOC will result in higher prices ERCOT-wide and much reduced congestion rent (as intended); thus (pick any two): • Consumers pay for the CREZ lines • Consumers pay higher market prices due to AOC • Consumers get less congestion revenues due to AOC, particularly those not buying wind from West Texas

11. Conclusion: AOC is Problematic • Violates Fundamental Principles of Market Design • Adversely Impacts Reliability • Adversely Impacts Efficiency • Distorts Price Signals • Hits Consumers Twice • Has many implementation issues