Capacity Markets Investment in Generation Capacity Payments

1. Capacity Markets Investment in Generation Capacity Payments October 31, 2005 J. W. Charlton

2. Objective Advocate an organized capacity market in the form of a formal capacity market versus an energy only market

3. NYISO Overview • NYISO formed December 1, 1999. • Utility generation divestiture rate makes it one of the most divested markets in nation. • NYISO market volume about $7.5 billion in 2004 and over $30 billion since inception. Highest market volume in East. • Unique challenge: New York City is the world’s biggest and most complex load pocket. World finance and communications capital.

4. New York ISO"Hub of the Northeast" Hydro Quebec 35,137 MW* ISO - New England 26,922 MW* IESO 26,160 MW* New York ISO 32,075 MW* PJM 135,000 MW* PJM 135,000 MW* * = Peak Load in Megawatts

5. NEW YORK ENERGY BY FUEL TYPE 2004 GWh

6. NY Markets • Day-Ahead Energy Market • Real-Time Energy Market • Ancillary Service Markets • Installed Capacity (ICAP/UCAP) Market

7. Buying Power in New York Bilateral (forward) Contracts 50% NYISO Day-Ahead Market 45 – 50% Real Time <5% Bilateral Contracts outside the NYISO 50% NYISO Day-Ahead Market 45 - 50% NYISO Real-Time Market <5% 100%

8. Day-Ahead Energy Market • Security Constrained Unit Commitment software simultaneously co-optimizes energy and ancillaries for the least cost solution • Hourly Locational Marginal Prices (LMP) • Binding forward contracts to Suppliers/Loads • Bilateral transactions accommodated concurrently with supply and load bids • Deviations settled against Real-Time Market • Installed capacity suppliers are required to bid in the Day-Ahead Energy market

9. Real-Time Energy Market • Real-Time Commitment (RTC) • Multi-period security constrained unit commitment & dispatch • Co-optimizes to simultaneously solve load, reserves & regulation • Runs every 15 minutes, optimized over 10 1/4hour periods – total 2 ½ hours • RTC15 posts at time 15 and optimized from T30 through T180 • Issues binding commitments for units to start at T30 and T45 • Real-Time Dispatch (RTD) • Multi-period security constrained dispatch • Co-optimizes to simultaneously solve load, reserves & regulation • Runs approximately every 5 minutes • Optimizes over a 60 minute period • RTD15 posts at T15 and optimizes from T15 through T75

10. Ancillary Service MarketsHighlights • Market-Based Services • Regulation • 10-Minute Spinning Reserve • Total 10-Minute Reserve • 30-Minute Reserve • Cost-Based Services • Scheduling, Control and Dispatch • Voltage Support • Black Start

11. NYISO Installed Capacity Market • ICAP Requirements: • are set in advance for the upcoming Capability Year by the New York State Reliability Council (NYSRC). • Load Serving Entities (LSEs) meet their NYISO-allocated ICAP requirements by: • Self-Supply or Bilateral Transactions with Suppliers. • Purchasing in the Capability Period Auctions (6-month strip). • Purchasing in the Monthly Auctions (for balance of Capability Period). • Paying for the balance of their obligation procured on their behalf in the Spot Market Auction (1-month) using a Demand Curve. • All supply is certified/checked out monthly.

12. NY Market Revenue Stream • The New York Energy market: • allows suppliers to recover their variable costs and to compete for profits. • The New York Ancillary Services market: • allows suppliers to recover lost opportunity costs when providing ancillary services. • The New York Installed Capacity (ICAP) market: • is intended to promote Resource Adequacy and; • allow suppliers to recover a portion of their fixed (capital) costs. • The total revenue from these markets is the total revenue stream for suppliers.

13. Need for ICAP Markets

14. Revenue Sources • Potential sources of revenues for generating resources are: • Revenue from the energy market during non-shortage hours, net of fuel and operating costs • Revenue generated in periods of shortage when prices can “spike” to levels 20 times higher than the average annual energy price. • Revenue received in the capacity market. • Ancillary services revenues • The economic value of these sources of revenue governs investment and retirement decisions in wholesale electricity markets

15. Substitutes • Capacity revenues and energy revenues are essentially substitutes. • Under any combination of energy and capacity markets, it is ultimately the market participants that determine the prices in both markets. • Markets with higher capacity revenues generally sustain higher capacity margins and, hence, exhibit less frequent price spikes associated with shortages. • Conversely, markets that generate lower capacity revenues will result in lower capacity margins and more frequent price spikes associated with shortages. • In the limit, energy-only markets that have no capacity revenues rely almost exclusively on severe price spikes to establish long-term economic signals.

16. History and Political Reality • The Northeastern U.S. Markets are a product of: • the history of power system operation • planning practices • historic grid topology • limitations on offer prices to limit market power abuse • eliminating “seams” issues as barriers to trade, and • the need to provide rational long-term price signals that would encourage investment in new generation and transmission where needed • The political reality is that energy prices will not be allowed to “spike” to the levels necessary to encourage new generator investments. • Even if market design did not limit offer prices, regulatory uncertainty would discourage investment in new generating resources

17. Insuring Reliability • Several proposals have been entertained to move to an “energy- only” market design. • Simply cannot be made to work with offer caps of $1000 or less • Regulators and many Stakeholders will not support higher offer caps • Suppliers will forever face regulatory uncertainty • Traditional utility owners have divested, or are divesting, their generation portfolios or spinning them off to unregulated generating companies. • There has been significant debate over how to maintain an adequate reserve margin. • Minimum installed capacity requirements were imposed on the regulated utilities in the Northeast long before divestiture. • To guarantee the same level of reliability under a market scenario, all load serving entities are simply required to contract for sufficient capacity to meet their installed capacity obligations.

18. Installed Capacity Markets in the Northeastern U.S. • ICAP Requirements are set for the upcoming capability year. • Load serving entities can meet their ICAP requirements by: • Self-Supply • Bilateral Transactions with Suppliers • Forward Auctions • Deficiency/Spot Market Auctions • After-the-fact penalty procurement

19. Locational ICAP • Due to transmission constraints into certain localities, areas or zones, some LSE’s must procure at least some of their ICAP requirements from resources electrically located within that locality. • New York (NY) has had locational requirements since inception. There are two such transmission constrained zones: • New York City and • Long Island • PJM and ISO-NE have proposals pending before FERC to introduce locational ICAP to their control areas.

20. Summary/Conclusion • The design of the Northeastern installed capacity markets was born of the pre-existing planning and operating practices of the power pools in the northeast. • The market structures and design features recognize the need for: • system reliability (insured through installed capacity requirements) • overall market designs coordinating energy, capacity and ancillary services • reining in potential market power • encouraging robust competition • mitigating potential barriers to trade • certainty, market stability, and • recognizing the political realities of energy price caps and regulatory oversight. • The designs presently employed with installed capacity markets uniquely balances all of the market needs while appropriately recognizing the value of capacity to meet reliability criteria.