Ancillary Services Market Reserves Market Design Rationale Draft For Discussion

1. Ancillary Services Market Reserves Market Design Rationale Draft For Discussion NEPOOL Markets Committee 21 January 2005 Marc D. Montalvo

2. Objectives • The ISO would like to use this meeting time to meet the following objectives: • Discuss and potentially converge on the key design choice with regard to the implementation of the Reserves market (Not the details, but the concept) • Discuss the rationale for the proposed ISO package and the Ancillary Services Market Options (Presentation titled Ancillary Services Market Options)

3. The decision tree • The ISO believes that the decision tree starts with the following key decision: • The choice of a “Forward and Real-time reserves market vs a Day-ahead and Real-time reserves market” • The ISO has attached a white paper that discusses the rationale for this key design choice • The ISO is working towards other white papers (the course of which is partly dependent on the key design choice above) and the market impact analysis

4. Outline • Overview of Design Proposal • LFRM with Real-time Reserve Pricing vs. Day-ahead and Real-time Reserves Markets

5. Locational Forward Reserve Market Overview • Establish System-wide and Locational Reserve Requirements. • Allow Portfolio-Based Offers • Allow Bilateral Trading of Obligations • Allow participation of Asset Related Demands

6. Real-Time Reserve Pricing Overview • Real-Time Co-optimization of energy and reserves. • Location-Based Reserve Requirements Calculated in Real-Time. • Reserve Constraint Penalty Factors applied to produce shortage prices.

7. Market Settlement Overview • Locational Forward Reserves and Real-Time Reserves are Separate Markets; they do not settle against each other. • LFRM payments and penalties assessed in real-time. • LFRM Resources are not eligible to receive Real-Time Reserve Clearing Prices. • Resources designated to provide reserves in Real-Time are eligible to receive the Real-Time Reserve Clearing price and are not subject to non-performance penalties.

8. Key Design Choice • Locational Forward Reserves Market with Real-Time Reserve Pricing or Day-Ahead and Real-Time Reserves Markets.

9. ‘LFRM and RT’ or ‘DA and RT’ Reserves Markets • Market Goal: Efficient investment in and operation of resources capable of producing energy in response to contingencies • Day-ahead and Real-time Markets are unlikely to provide sufficient incentive for efficient capital investment • Variable costs associated with being available to provide reserves in real-time are negligible. • Availability bids Day-ahead should equal expected value of shortages in Real-time. Given probability of shortages in Real-time, this value is near zero. • Day-ahead and Real-time Reserve Prices tend towards zero.

10. ‘LFRM and RT’ or ‘DA and RT’ Reserves Markets • Proposed Real-time Pricing Mechanism provides efficient allocation of resources in Real-time • Proposed LFRM allows capacity capable of providing 10 and 30 minute contingency response to be priced • LFRM should select resources with the lowest opportunity costs, lowest commitment costs, and highest availability

11. ‘LFRM and RT’ or ‘DA and RT’ Reserves Markets • Market Risk • Forward reserves market is new • Frequent market redesigns lead to uncertainty and hesitancy among potential market investors • Technical Risk • The ISO’s systems vendor has not implemented a co-optimized day-ahead reserve market design • Concerns regarding the significant development costs and the impact on schedule • Lack of sufficient industry experience in the implementation of an expensive market design

12. Questions