Market Reform Proposals

1. Market Reform Proposals Pete Fuller NEPOOL Markets Committee August 7, 2013

2. Today’s Discussion • NRG’s market reform proposals • Improved energy market pricing • FCM as a capacity market • Hedging as a commercial activity • Pricing the FCM margin based on long-run costs • Detail on EFORp proposal • Analysis Group’s Impact Analysis

3. 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

4. An Alternative to ISO-NE’s PI Proposal • 1) Address energy market pricing problems in the energy market • 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 and for loads to consume efficiently • 2) Make the capacity product a capacity product • Procure enough to meet resource adequacy criterion • 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 adequacy deficiency risk resides

5. An Alternative, continued • 3) Eliminate Peak Energy Rent deduction • De-couple energy price options from the capacity product • Hedging should be done commercially, not as part of the regulatory requirement • 4) Enable all resources to compete on the basis of long-run costs

6. An EFORp Availability Metric • Implement a metric in the capacity market to reward resources that exceed their target availability and penalize those that under-deliver • Continue to transact on the basis of ICAP, but use each resource’s EFORp performance to reward or penalize it in the current year • Employ the concept of a ‘self-contained’ mechanism – all money flows among suppliers so load is not exposed to any additional costs above the FCM Clearing Price • Maintain the current ‘stop-loss’ equal to annual revenues • 1.5x multiplier on marginal over/under-performance relative to EFORp basis

7. EFORp Metric, continued • 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 • Propose to measure EFORp in peak hours, such as the hours ending 1400-1800 on non-holiday weekdays June-September and hours ending 1800-1900 on non-holiday weekdays October-May (already in the ISO-NE tariff) • Other period definitions are possible, including a weighted mechanism that puts most emphasis on these hours but includes other hours as well

8. EFORp Metric, continued • Upon clearing the FCA, calculate, for each resource and for the system, Baseline Available MWresource = Cleared ICAP x (1 - EFORp, 5-yr avg) Baseline Available MWsystem = ∑Baseline Available MWresource Baseline Shareresource, %= Baseline Avail MWresource / Baseline Avail MWsystem • In each period (annually), calculate, for each resource and for the system, Period Available MWresource = Cleared ICAP x (1 - EFORp, period) Period Available MWsystem = ∑Period Available MWresource Period Shareresource, %= Period Available MWresource / Period Available MWsystem • To the extent a resource has taken on or shed capacity obligations via bilaterals or reconfiguration auctions, the Baseline ‘Cleared ICAP’ would be adjusted accordingly.

9. EFORp Metric, continued • For each resource, the difference between its Period Share and its Baseline Share represents the extent to which it was more or less available than was assumed in setting the original auction requirements, and the extent to which it was supporting a greater or lesser share of the system’s ICR needs • Translate the percentage difference in the Period and Baseline Shares to MW by multiplying by the Baseline Available MWsystem. The payment, plus or minus, is this MW difference times the FCM clearing price times the marginal multiplier (i.e., 1.5x).

10. EFORp Metric, continued

11. EFORp Metric, continued

12. Analysis Group’s Impact Assessment • Reference: FCM PI Impact Assessment, Additional Data and NRG Alternative Analysis, Analysis Group, August 2013 • General: • Looks at a single year – this snapshot gives no indication of long-run investment behavior or sustainability of the market design • Likely underestimates risks perceived by suppliers and investors and the resultant impact on market exit and entry • NRG Alternative: • Analysis does not look at impacts on demand participation in the market of the RCPF change, via hedging or price-driven consumption decisions • Evaluates “change in net payments by load” but not changes in behavior

13. AG’s Impact Assessment (continued) • NRG Alternative (continued) • Analysis does not address the proposal for all resources to compete on the basis of long-run costs (slide 13 supply curve) • Does not evaluate the ‘risk premium’ associated with uncertainty about resource availability • The conclusion of a $0 clearing price is at odds with empirical evidence in Texas and long-run sustainability • Brattle and others have suggested that even with scarcity pricing higher than $5,000/MWh, a capacity market is needed to sustain resource adequacy1 1 E.g., “Assessment of Resource Adequacy Proposals,” September 11, 2012, Public Utility Commission of Texas Project No. 40000

14. Summary • NRG’s Alternative: • Provides incentives for efficient behavior to both suppliers and load-servers/consumers • Short-run production and consumption incentives as well as long-run hedging incentives • Enables the market to reveal the long-run costs of the marginal resource in all years, and as a result, achieve a long-run average price outcome reflecting the net long-run cost of resources • Supports investment through this improved price expectation • The Impact Assessment does not address any of these aspects and benefits of the NRG Alternative

15. Thanks for your consideration.