March 12, 2014

1. March 12, 2014 Robert Ethier Vice President, Market Development Capacity Demand Curve ISO’s Recommended Curve and Net CONE

2. Contents • Background and Overview • Recap of Demand Curve Objectives • Key Issues Highlighted by Stakeholder Process • Summary of Proposal • Recommended Demand Curve • Detailed Features • Performance • Performance Sensitivities • Net CONE • Adjustment to Initial Price Lock-In

3. Background and Overview • On January 24, FERC issued an order requiring that the ISO file a sloped demand curve by April 1: • The ISO must “submit its proposed [sloped] demand curve by April 1, 2014, to allow sufficient time for implementation prior to FCA 9.” • Discussions began with the NEPOOL MC on February 6 • Scope includes a system-wide sloped demand curve, Net CONE, deletion of pool-wide Inadequate Supply/Insufficient Competition rules, and changing the administrative payment rate for zonal IS/IC/Carry Forward rules to Net CONE • Changes incorporated in posted Tariff language • ISO is also including a change to the length of the initial price lock-in, from 5 to 7 years

4. Recap of Demand Curve Objectives • Reliability • Maintain 1-in-10 LOLE target on a long-term average basis • Rarely drop below a “minimum acceptable” reserve margin corresponding to a 1-in-5 LOLE level where ISO-NE might intervene in the market • Efficient Prices • Long-run average price at Net CONE, consistent with a market capable of attracting sufficient merchant entry to attain reliability objectives at least cost • Short-run prices consistent with current fundamentals, going above Net CONE during shortage and below Net CONE during surplus • Rationalize prices according to the incremental value of capacity • Mitigate Price Volatility • Reduce price volatility impact from lumpiness and small movements and uncertainties in supply, demand, and transmission (no bimodal price distribution) • Few outcomes at the administrative cap, with cap no greater than 2x Net CONE • Other • Reduce susceptibility to market power • Minimize contentiousness and uncertainty from administrative parameters

5. Key Issues Highlighted in Stakeholder Process • Brattle has noted that there are a range of curves that appear to be reasonable based on objectives and analysis • ISO agrees with Brattle demand curve objectives • When selecting its proposed curve and Net CONE, the ISO placed significant weight on three issues: • Cap value, and consequences if an FCA was not competitive • Limit risk with non-competitive FCA • Intercept of demand curve and Net ICR • Provide reasonable assurance of meeting 1-day-in-10 target • Consequences of errors in Net CONE • Reliability degrades quickly when short, while cost of buying more is relatively modest

6. Summary of Proposal • Net CONE uses Combined Cycle technology • $11.08/kW-mo (rounded to $11.1 in presentation) • Cap at 1.65 x Net CONE • Reliability index of 1-in-7 • $18.27/kW-mo • Kink at 0.7 x Net CONE • Reliability index of 1-in-16 • $7.70/kW-mo • Net ICR ≈1.27 x Net CONE • Reliability index of 1-in-10 • $14.07/kW-mo • ISO is also including a change to the length of the initial price lock-in, from 5 to 7 years

7. Recommended Demand Curve • Key Changes from Brattle’s Initial Candidate • Updated Net CONE value from $8.32/kW-m to $11.1/kW-mo • Lowered cap from 2×Net CONE to 1.65×Net CONE • Helps mitigate supplier market power • Reduces exposure to very high prices • Closer to PJM and NYISO curves at 1.5×Net CONE and 1.6×Net CONE, respectively • Rest of curve slightly right-shifted to maintain resource adequacy Price at Cap: $18.27 Price at NICR: $14.07

8. The Curve’s Features Support the Design Objectives Demand Curve Parameter Values • Shape: convex • Avoids low-reliability outcomes • Recognizes declining marginal value • Cap: 1.65 × Net CONE starting at 1-in-7 • High enough to attract new entry • Low enough to help mitigate potential market power & exposure to very high prices • Minimum at 1x Gross CONE to prevent curve collapse and under-procurement if projected E&AS is high and Net CONE is consequently underestimated • Kink: 0.7 × Net CONE at 1-in-16 • Tuned to meet reliability objectives in combination with cap point • Produces curve with price at NICR equal to about 1.25×Net CONE • Toe: $0 price at 1-in-100 • Maintains convex shape Note: Price cap is subject to a minimum price of 1x Gross CONE. Demand Curve Slope Note: MWquantities based on FCA7; due to supply elasticity, price impacts from a 100 MW shift in supply-demand would be less than the slope suggests.

9. Performance Simulation Results

10. Performance Sensitivities Simulation Results

11. Net CONE • Technology • The ISO agrees with Brattle that it is appropriate to use Combined Cycle technology as the basis for Net CONE • Appropriately balances considerations, including lowest cost generation being actively developed in region • Net CONE • The ISO supports the final Brattle value of $11.08/kW-mo as the appropriate value for net CONE • Reflects reasonable assumptions • Reflects stakeholder feedback

12. Adjustment to Length of Initial Price Lock-In • The ISO proposes to change the maximum length of the initial price lock-in available to new resources • Change is a complement to reduction in the cap price • The ISO is concerned about lack of confidence in the market, and the consequences for competitive entry • New England’s capacity market has history of very low prices and administrative intervention, which deters investors • Undoing that perception will require multiple auctions with competitive new entry • Modestly extending the available lock-in period reduces that risk • Need for lock-in will be reevaluated after series of successful auctions • Proposal to increase from 5 to 7 years

13. How Longer Lock-In Helps Compensate for Lowered Cap Price • New entrants/developers are concerned about market stability and, with the current lock-in, may require a very high price to enter; a low cap threatens to prevent entry • If this is true, a longer lock-in could compensate for a lower cap. For example: • If Net CONE estimates are accurate but entrants haircut post-lock-in prices by about 50%, they would enter with a 5-year lock-in if price ≥ 2×Net CONE. Thus they would enter with our initially proposed cap of 2x, but not 1.65x. • With a 7-year lock-in and the same post-lock-in haircut, the CC would be willing to enter at 1.61×Net CONE (same NPV). • This is consistent with the final proposed cap of 1.65xNet CONE; would be lower if adjusted for a longer lock-in’s effect on risk and cost of capital. • This example supports proposal to offer a 7-year lock-in along with the lower price cap.