June 4-5, 2013 | Westborough, ma

1. June 4-5, 2013 | Westborough, ma Matthew White Senior Economistmarket development A Strategic Planning Initiative FCM Performance Incentives Andrew Gillespie Principal analyst Market development Ron Coutu MANAGER, Bus. Tech. & Solutions

2. Presentation Topics • Overview • Balancing Ratio & Application to Zones – follow-up • Maximum Loss Limit (or Stop-Loss) – more details • Treatment of Resources with Multiple Commitment Period Elections

3. Overview

4. FCM Performance Incentives - Overview • Capacity resources with uncertain performance present a risk to system reliability if too many resources cannot ‘perform’ when needed most – during a capacity deficiency • In this context, ‘perform’ means delivery of either energy or reserves during a capacity deficiency • The current FCM construct provides insufficient incentives for resources to make investments to improve performance • FCM Performance Incentives provides market signals and investment incentives for resources to improve performance i.e., deliver energy or reserves during a capacity deficiency

5. Future Topics (approximate dates) • Elaboration on the details of this proposal will be the topic of future presentations to the Markets Committee, including but not limited to: • Balancing ratio & application to zones ~ May/June • Maximum Loss Limit (or stop loss) ~ May/June • Resources with multiple commitment period elections ~ June • Financial Assurance impacts (w/B&F committee) ~ June • Establishing the Performance Payment Rate ~ July/August • Bilateral trading ~ July/August • Reliability rejection of de-list bids ~ July/August

6. Balancing ratio For the system and zones

7. Balancing Ratio - Follow-up Issues • Exports during scarcity conditions • Balancing ratio > 1 • Reserve Zone applicability

8. Balancing Ratio - Exports • Exports during scarcity conditions are load, like any other load in the system since there are generators providing the MWhs to export • But this “load” is not “firm” load and is not paying for capacity, shouldn’t they pay? • This load can be “curtailed” and it will be in a timely fashion according to the scheduling rules, so it is not “firm”

9. Balancing Ratio – Greater than 1 • Balancing ratio > 1 • If the numerator is greater than total CSO the Balancing Ratio could be greater than 1 • HIGHLY unlikely scenario (ICR load forecast would have to have been very wrong) • Implications: • CSO is a share of the obligation • Preserves the incentives to provide MW during EXTREME system needs • Resources who have CSO = Maximum Output may be assessed as under-performing by a small amount • Risk can be factored into FCA offer

10. Balancing Ratio – Reserve Zones • Reserve Zones • Applicability of FCM PI is limited to Reserves Zones that are also coterminous with Capacity Zones (currently NEMA and CT only) • Therefore, Southwest CT is NOT a Capacity Zone, and any scarcity in SWCT would NOT be a scarcity condition under FCM PI • If more Capacity Zones are added then associated Reserve Zones would be included • IF SWCT was a Capacity Zone it would be a Reserve Zone for scarcity conditions

11. STOP-LOSS PROVISIONS Conceptual Design and Main Elements

12. Review • Provide a liability limit on a capacity supplier’s financial loss exposure for non-performance during the commitment period • Maintain performance incentives. A good stop-loss design should minimally distort: • Incentives to perform during scarcity conditions • Incentives to trade-out or replace a non-performing CSO resource

13. Mechanics: Three Major Components • At the Resource-Level: How the stop-loss works • At the Pool-Level: How the money flows The two new examples demonstrate the interdependence of these first two components, and issues under evaluation • The Stop-Loss amount

14. Monthly or Annual Stop-Loss ? • Issue under consideration: Whether stop-loss limit caps the monthly or the annual loss exposure? • Trade offs: • Bilateral trading of CSOs is simpler with monthly stop-loss design • Short-pay risk may be higher with monthly stop-loss design The following examples illustrate the mechanics of each alternative and these trade-offs

15. Examples: The Basics For simplicity, in the following example the numbers have been scaled down to demonstrate the concept • Resource has a 1MW Capacity Supply Obligation • A stop-loss amount of $10 is used for demonstration purposes only (Examples 1-3 link here: A04A ISO Presentation 05-14-13 Revision 2)

16. Example 4 – Stop-Loss For demonstration purposes only, a $10 Stop-Loss amount is used • Similar to Example 2, the pre-stop-loss cumulative net will continue to be calculated, and evaluated against the stopped amount ($10) • The amount ‘borrowed’ ($5) from the reserve fund is ‘repaid’ in subsequent periods; by the end of the commitment period, the net financial position is above the stop-loss amount

17. Implications of Example 4 • For each CSO MW, a tally of the cumulative net financial position must be maintained • In Example 4, the same resource held the CSO for the entire commitment period; however, if this CSO were traded to another resource the cumulative net financial position would go with the CSO • The resource assuming the CSO would assume the cumulative net financial position of the CSO • This would mean that CSO trading must now consider the condition of the CSO at the time of the trade – the ‘value’ of the CSO is impacted by the cumulative net financial position of the CSO • This adds a non-homogeneity to CSO transfers

18. Example 5 – Resetting the Net Financial Position For demonstration purposes only, a $10 Stop-Loss amount is used • The amount ‘borrowed’ from the reserve fund is NEVER ‘repaid’ in subsequent periods because the net financial position is reset (i.e., there is NO cumulative net financial position to apply to the whole commitment period) • Resetting the net financial position each sub-period within the commitment period would apply to the CSO (whether or not the CSO is transferred)

19. Implications of Example 5 • If the cumulative net financial position is not maintained, if it is reset when traded monthly and/or for sub-periods within the commitment period, any ‘borrowed’ amounts are lost • This maintains a homogeneity to CSO transfers, but • This increases the chance that any stopped resource will deplete the reserve fund, requiring the payments to other capacity suppliers in that sub-period to be adjusted downward

20. Trade-offs • Tracking cumulative net financial position (Example 4) • This approach maintains the “incentives to perform during scarcity conditions” by ensuring, to the extent possible, that the marginal incentive to perform remains constant – i.e., performance credits are not reduced to cover any shortfall in performance charges • However, this requires every CSO MW to be tracked and complicates the transfer of CSOs between resources • Resetting net financial position (Example 5) • This approach maintains the “incentives to trade-out or replace a non-performing CSO resource” by maintaining the homogeneity of CSOs • However, if the stop-loss value is the same the likelihood that performance credits will have to be reduced to cover any shortfall in performance charges due to a stopped-out CSO increases

21. 3. The Stop-Loss Value Three competing considerations to be balanced: • Incentive problems if stop-loss is set too low • Economic argument against setting the stop-loss too high • Stop-Loss value should be consistent with loss exposure for other capacity reduction events Stop-Loss value remains under evaluation, depends on annual versus monthly stop-loss cap

22. Perspective • $15/kW-mo. = $15,000/MW-mo = $180,000/MW-yr • Example: • A 1MW resource with zero performance (energy & reserves = 0) • Performance Payment Rate = $5,000/MWh • Average Balancing Ratio = 0.75 How many hours of scarcity in a year would there have to be for a resource’s net performance charges to reach $180,000 in a year? • 48 hours → $5,000/MWh x (0 – 0.75(1MW)) x H = $180,000 How many hours of scarcity in a month would there have to be for a resource’s net performance charges to reach $15,000 in a month? • 4 hours → $5,000/MWh x (0 – 0.75(1MW)) x H = $15,000 Observation: It seems more likely that a resource would ‘stop-out’ using a monthly limit (if constant across all sub-periods) than an equivalent annual limit

23. Treatment of resources with multiple commitment period elections

24. Background and Context • A ‘New’ resource can elect up to four additional commitment periods (III.13.1.1.2.2.4) • A resource may select up to four additional consecutive commitment periods to receive the ‘original’ clearing price, indexed for inflation • The resource is paid this price, regardless of the instant FCA price • No de-list bids are allowed during any additional period(s) elected • ‘New’ resources clearing in FCA 6 & 7 are subject to the one-time out-of-market treatment in FCA 8 (III.A.21.3) • Resources that ‘pass’ this test will be included as Existing resources in FCA 9 • Resource that do not ‘pass’ must clear as ‘New’ in a subsequent auction to be awarded a Capacity Supply Obligation

25. Affected Resources (link: 2013 Celt Report, (released May 1, 2013) - affected resources from Table 4.2

26. Affected Resources Summary

27. Resources with Multiple Commitment Period Elections – The Problem • Affected resources with a multiple period election (going into FCA 9) ‘fixed’ a price for multiple years without considering the FCM pay-for-performance mechanism • The ‘fixed’ price may not be commensurate with the new FCM pay-for-performance mechanism • The following is NOT intended to apply to any new resources electing multiple commitment periods going forward (those clearing as new in FCA 9 and beyond)

28. Under Consideration For affected resources only, offer two alternatives: • A resource may maintain the original ‘fixed’ price • The stop-loss for the resource would be set to zero • A resource may opt out of the election • The ‘fixed’ price and remaining duration are forfeited • For an FCA in which the resource previously elected a ‘fixed’ price, a resource may opt out and even submit a de-list bid • However, the choice to opt out is irrevocable • Treatment under FCM pay-for-performance would apply regardless of choice

29. Option 1. Discussion • A resource may maintain the original ‘fixed’ price • The resource’s stop-loss for the affected commitment period would be set to zero • This is the same maximum-loss exposure facing these resources today • All auctions to date have cleared at the floor price; for affected resources (those clearing in FCA 5, 6 and 7) the average clearing price for most affected resources is $3.41/kW-mo.

30. Option 2. Discussion • A resource may opt out of the election • A de-list bid may be submitted • The ‘fixed’ price and remaining duration are forfeited • This option allows the resource to take a potentially higher clearing price, or no obligation at all depending on whether or not a submitted de-list bid clears • In this way the resource is facing the same ‘risk’ and same ‘reward’ opportunities as all other existing resources – participating just like any other existing resource

31. Logistics & timing

32. Logistics & Timing • ISO Direction: ISO White Paper (October 2012) onFCM Performance Incentives Also at: http://www.iso-ne.com/spi > Materials • Timeframes: • Mar-Sep 2013: Markets Committee • Fall 2013: MC & PC votes • Q4 2013: FERC Filing • Implement: For FCA 9 (FCA held 2015, CCP of 2018/19) • A major initiative: Impact analysis with MC Q2-Q3 2013

33. Andrew Gillespie agillespie@iso-ne.com • Ron Coutu rcoutu@iso-ne.com Matthew White mwhite@iso-ne.com