11/16/2012 | Milford ma

1. 11/16/2012 | Milford ma Matthew White Senior Economist A Strategic Planning Initiative FCM Performance Incentives Ron Coutu Andrew Gillespie MANAGER, Bus. Tech. & Solutions Principal analyst

2. Today’s Agenda • Problems We’re Trying to Solve • Solution Approaches Considered • Proposed Direction: FCM Performance Incentives • Rationale, Key Elements, Benefits and Costs • Next Steps: Stakeholder Input & Issues Ahead

3. Logistics & Timing • ISO Direction: ISO White Paper (October 2012) onFCM Performance Incentives Also at: http://www.iso-ne.com/spi > Materials • Timeframes: • Dec-Jan-Feb: Informal stakeholder input • MC: Spring through Fall 2013 • Implement: For 2014 FCA (FCA 9, CCP of 2018/19) • A major initiative: Impact analysis with MC Q2-Q3 2013

4. Broader Context • Five Challenges in Strategic Planning Initiative • Risk 1: Resource performance and flexibility • Risk 2: Increasing reliance on gas-fired capacity • Risk 3: Retirement of generators • Risk 4: Integration of greater intermittent/variable resources • Risk 5: Alignment of markets and (transmission) planning • May 2012. White Paper, Using FCM to Meet Strategic Challenges • Offered scope & timeframes • Oct. 2012. ISO direction: FCM Performance Incentives • Primarily designed to address SPI Risks 1-3.

5. PERFORMANCE Concerns and incentives The Problems We’re Trying to Solve

6. Several problems, different timeframes • Reliability risks of growing gas dependence NE Gas Studies • No catastrophes, yet. Why? • ISO manages risks, when anticipated, using oil-steam and coal units • Two pressing concerns • These are 50+ year old units, and may not perform as needed • These units are ‘at risk’ for retirement (2018+/- timeframe). • What then? Without new incentives: • Little confidence that remaining and new capacity will perform better than they do today. Puts system reliability at increasing risk. • Incentives must be addressed now for 2018/19 investment

7. Incentives for investment and availability • No single, least-cost technology solution • For gas: dual-fuel, non-interruptible transport, backup LNG supply… • Best options vary by unit, its costs, location in gas network, etc. • Other possible investments: Fast-responding DR, greater liquid fuel storage & re-supply chains at non-gas units, and so on. • Problem: Current FCM provides little economic incentive to undertake and maintain these capital investments • Useful for limited hours per year; revenue for incremental capital investments in these solutions is insufficient for a supplier to justify it. • Implication: Markets can motivate suppliers to deliver least-cost solutions, but this requires changes to FCM’s incentives.

8. Problems on day-to-day timeframes • Resources increasingly fail to meet (new or revised) intra-day dispatch schedules. • Often, but not always, for fuel-related reasons • Broad problem: Availability incentives are insufficient. • Efficient energy market: (Very) high RT energy price during scarcity conditions, provides strong incentive for performance & availability. • Actual energy market: RT LMP based on system marginal cost and admin reserve price during scarcity conditions results in a lower price. • See White Paper, Section 2 • Implication: Greater performance incentives are needed during scarcity conditions. They must be provided via FCM.

9. Incentive problems on shorter timeframes • Poor dispatch response in stressed system conditions • ISO analysis: Avg. 60% unit response post-contingency (non-hydro) • Explanations for poor dispatch response are many (vary by generator) • No single technology ‘solution’ to improving performance during scarcity conditions; varies by resource. • Communications, staffing/training, maintenance, operating practices… • Providing stronger financial incentives to perform during scarcity conditions will help address this problem • Enable suppliers to make the business case for actions that improve response performance, and benefit by doing so.

10. Issue Summary • Core problems • System increasingly reliant on resources w/ uncertain availability • Insufficient incentives for suppliers to reduce this uncertainty • ‘Systemic risk’ if too many units cannot perform simultaneously • Manifest in several timeframes and ‘needs’ • Future capacity investments must help reduce system’s risks • Must address incentives now for FCA 9+ outcomes. • Existing resources: Incremental operational-related investment must take place to reduce uncertainty over performance & availability • Operational practices: Stronger incentives for intra-day availability and performance during stressed system conditions.

11. Many Solution Approaches Considered • EFOR’d-based incentive schemes (e.g., PJM’s EFOR-p, XEFOR’d, …) • Technology mandates (e.g., dual-fuel requirement on CC’s) • High RT prices during scarcity hours (‘Texas-sized’ RCPF’s) • FCM ‘Pay for Performance’ (PFP) incentives: Replace existing FCM Shortage Event construct with PFP design. Finding: PFP design is most promising approach (next).

12. ISO Direction: FCM Performance Incentives

13. Design Objectives • Objective 1: Improve resource performance and availability by addressing the reliability risks described earlier (slide 10): • New capacity investments to help reduce system’s risks; • Incremental investments to improve resources’ availability; • Incentives to perform well during stressed system conditions. • Objective 2: Meet resource adequacy criteria overall, using FCM to replace the “missing money” • This objective is the same as today. • Achieve these objectives with most cost-effective solutions

14. Conceptual Approach • Create strong performance & availability incentives that: • An efficient energy market would provide (with very high spot energy prices during scarcity conditions), • The region’s actual energy and ancillary service markets cannot • See White Paper, Section 2 • Insights. We can restore these “missing” incentives via FCM • Pay for Performance (PFP) makes a resource’s FCM revenue (“missing money”) contingent on its performance during scarcity conditions. • Mirrors how markets should work during scarcity conditions. • See White Paper, Section 4

15. Pay for Performance – Major Elements • Standard Incentive Contract • Base Payment, and a Performance Payment • Performance payment • Determined by a resource’s performance during scarcity conditions • May be positive or negative (on top of Base Payment) • Resource Neutral • All resources have same Base and Performance payment rate • During scarcity conditions, performance is what matters • Who pays what? • Loads pay the Base Payment set by FCA clearing price (like today). • Performance payments are transfers among suppliers

16. Primary Incentive Properties • Similar performance & availability incentives to an energy market with very high spot prices during scarcity conditions • Difference is the risk structure. Under PFP: • Loads fully hedged against unexpectedly high performance pmts • Acquiring ‘insurance’ that improves reliability and incentives, for an up-front ‘cost’ set in FCA. • Suppliers receive a base payment (at FCA price), which provides a different risk profile than a spot market w/ high scarcity prices (next). • Also different: Unlike high (uncapped) energy offers, PFP presents no concerns over increases in market power.

17. Consequences: Supply Side • Every supplier faces both new risks and new rewards: • ‘Upside’ reward for performance above (a share of) its CSO • ‘Downside’ risk: Every resource may miss some scarcity conditions • These risks and rewards must be priced into its FCA auction bid • Principle: FCA bids should reflect the price at which the supplier is willing to accept the resource’s performance risk. • Analogy: Suppliers providing ‘insurance’ against reliability risks • Base payment (‘insurance premium’) ensures suppliers receive the “missing money” revenue in years without scarcity conditions. • May lose money in extraordinarily tight years for poor performance. • Incentive to trade-out for ‘at risk’ offline periods (or ‘re-insure’)

18. Consequences: Reliability Improvements • PFP provides strong incentives for suppliers to improve their individual resources’ performance and availability. • Investments or operating practices can increase ‘upside’ performance payments and mitigate non-performance risks: • Dual-fuel capability to protect against fuel shortage • Non-interruptible fuel supply • Staffing improvements • Faster unit startup capability to reduce performance deficiency hours • More rapid price-responsive demand, with more times available • And so on. • See White Paper, Section 3 • Outcome: Suppliers will resolve availability and ongoing performance issues in the most cost-effective ways possible

19. Key Points on PFP Design • Removes all existing ‘shortage event’ exemptions: • Available but not started • Generator on planned outage • Generator not performing due to transmission or forced outage • Intermittent and Demand Resources • Imports available but not scheduled • Mirroring energy market incentives: • Revenue depends on performance; no ‘not my fault’ exceptions. • Non-performance causes are a supplier’s business risks, whether within or beyond a supplier’s control. Risks affect its FCA bid. • Fundamentally different approach than existing FCM.

20. Key Points on PFP design (con’t.) • Performance: Supply energy or RT reserves during scarcity. • Performance incentives apply to all resources during scarcity conditions (using same formulas), not just to CSO MW. Ex.: Supply without any CSO (top of unit or otherwise); Imports with no CSO (some netting may need to be done); Intermittents with CSO less than nameplate MW • Why? • Efficient, non-discriminatory, and provides desirable incentives • Reliability: All resources motivated to respond quickly to reserve deficiencies, reducing duration and severity of these events. • May enable expanded supplier risk management options (see slide 26)

21. Expectations for Resource Mix Evolution • Strong incentives for investment in capacity that is: • Low-cost and highly reliable (nearly always operating); or • Highly flexible and highly reliable (gets online quickly and reliably) • Result: System that is highly reliable at lowest possible cost • Most reliable resources will profit the most from these incentives • Exit: May hasten retirement of non-flexible, non-baseload resources; non-performance risk may price them out of FCM. • Entry: Expect most new capacity would be type (1) or (2) above, with reliable fuel to operate during scarcity conditions • Addresses retirement & future investment concerns (see slides 6-7).

22. Benefits of Performance Incentive Design • Greater operational-related investments to improve resource performance and availability at existing resources • Esp.: Fuel availability and/or secondary fuel supplies • Examples: See slide 18 and White Paper, Section 3. • Increase Resource Flexibility • Reduced start-up times, improved operational flexibility, etc. • New investment in more flexible capacity resources over time • Cost-effective solutions • Rewards suppliers that improve availability in most cost-effective ways • Efficient Resource Evolution • Trend toward more reliable resource mix over time (slide 21)

23. Costs of Performance Incentive Design • FCA clearing prices are likely to increase somewhat • FCA bids will reflect expected net performance payments in CCP • For marginal resource that sets FCA 9 clearing price: • Apt to be a resource that performs worse than the average capacity resource’s performance (given current fleet); • Thus would expect net negativeperformance payments, and reflect that cost in its FCA bid. • PFP may spur earlier entry by new and more reliable resources earlier than would occur without PFP. • ISO will provide greater information on its estimates of FCA impacts in the Major Initiative impact assessment.

24. Costs of PFP, cont’d.: The Big Picture • Plummeting fuel prices have reduced total wholesale costs to load dramatically, falling nearly $6 B (40%) from 2008 peak. • With the shift to a ‘just in time’ fuel delivery system, and future growth in intermittents, we have new reliability risks. • Ensuring reliability in this environment brings some new costs: • Region must acquire ‘insurance’ against fuel non-availability risks, performance uncertainties, etc., that are more likely than in past. • Perspective. This incremental ‘insurance’ cost is a necessary step to sustain the enormous savings from cheaper, cleaner sources and a reliable power system.

25. What’s Next? Prominent Issues, Future Material, Stakeholder Feedback

26. Prominent Issues for Future Discussions • Mitigation treatment of FCA bids under PFP: • How will ISO evaluate ‘pricing’ of resource performance risk? • Financial assurance • Changes may be necessary commensurate with performance risk. • Impact assessment (as a Major Initiative) • Qualitative and quantitative assessment of proposal’s impact • Priced ‘partial de-listing’ of capacity MW • Offering a resource’s MW blocks at different bid prices in FCA • Manage and efficiently price a resource’s performance pmt. exposure

27. Future Material to Facilitate Discussions • Detailed examples and scenarios, including FCA bid impacts • Performance payment rate (PPR): Logic & detailed support • Detailed data for: • Reserve deficiency conditions (duration, frequency, severity, etc) • Balancing ratios during scarcity conditions • Interpretation and examples for assessing resource performance risk • Zonal-level application details and examples • Other suggestions/requests welcome

28. Stakeholder Process (Proposed) • Dec-Jan-Feb: Informal stakeholder feedback • Mar-Sep 2013: Markets Committee • Fall 2013: MC & PC votes • Q4 2013: FERC Filing

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