August 5-6, 2014 | Markets Committee Meeting

1. August 5-6, 2014 | Markets Committee Meeting Catherine McDonough cmcdonough@iso-ne.com | 413-535-4027 Summary of Participant Comments and ISO Proposal Peak Energy Rent (PER) Adjustment Mechanism

2. Highlights • ISO proposes a change to the PER Adjustment in response to the FERC Ordered Increase in RCPFs • ISO proposes to increase the daily PER strike price by $250 to reduce the impact of the FERC-ordered increase in RCPFs on the PER Adjustment • ISO will evaluate whether the PER Adjustment serves a useful role once the two-settlement FCM is implemented and whether any changes might be warranted for FCA10 and beyond. ISO will consider the ‘hedging’ role of the PER Adjustment as part of that evaluation

3. How FERC Order Impacts PER AdjustmentIssues Discussed at Last MC Meeting • To comply with the May 30, 2014 FERC Order ER14-1050 , ISO will: • Increase the Reserve Constraint Penalty Factors (RCPFs) coincident with the Hourly Offers project, which is currently scheduled for Dec. 3, 2014 • Implement the Pay-for-Performance (PFP) design in the Forward Capacity Market (FCM) beginning with Capacity Commitment Period (CCP) 2018/2019 (CCP9) • Near-term: Higher RCPFs may increase energy and reserve market revenue and the PER Adjustment. • Resource owners are concerned that they were not able to factor these changes into bids for the Forward Capacity Auctions (FCA) associated with CCP5-CCP8; December 2014-to-May 2018. • Longer-term: The FCMPFP design is expected to markedly improve resource owner incentives to perform and may therefore reduce the need for the PER Adjustment to curb supplier incentives to exercise market power in the energy market.

4. Summary of Participant Comments & ISO Response Longer Term issue • Participants indicated that the ISO should evaluate whether or not the PER Adjustment will still serve a useful role once the FCM PFP is implemented and whether any changes might be warranted including the possible elimination of the PER Adjustment. • ISO should also consider the hedging role of the PER as part of that evaluation—not just the need for the PER Adjustment to curb the incentive to exercise market power. • ISO supports this evaluation for FCA10 and beyond • Stakeholders had an opportunity to reflect the higher RCPFs and current PER Adjustment in their static (de-list) bids for FCA9  

5. ISO ProposalNear Term Issue • ISO is proposing to recalibrate the PER Adjustment to minimize the RT revenue impact of higher RCPFs on resource owners by raising the daily PER strike price by $250 • Adjusting the PER strike price is a simple way to reduce the impact of higher RCPFs on the PER Adjustment and could be done by December 3, 2014 • With the higher PER strike price in place, the RT revenue impact of higher RCPFs on resource owners would have been close to zero in CCP4 instead of the -$67M shown on slide 8

6. Case for Reducing the Impact of FERC-ordered Increase in RCPFs on the PER Adjustment • Higher RCPFs will have a bigger impact on the PER Adjustment (a deduction from FCM payments) than the increase in real-time energy and reserve market revenue • Impact of higher RCPFs on DALMPs is difficult to accurately predict • Resource owners cannot factor the higher cost of the PER Adjustment into their FCA bids for auctions that have already occurred (FCA5 - FCA8) • Administrative floor/ceiling prices may have been different if the FERC-Ordered increase in RCPFs had been in place and FCM-clearing prices may have been higher. • Reducing the impact of higher RCPFs on the PER Adjustment does not impact economic efficiency

7. Reserve Market Impact of FERC-ordered Increase in RCPFs: Simulated Back-cast for CCP3 and CCP4 (June 2012-May 2014) Reserve Market Revenue would have been $25M greater in CCP4, and $14M greater on average in CCP3 & CCP4

8. Some Revenue Impacts of FERC-ordered Increase in RCPFs: Simulated Back-cast for CCP4 (June 13-May 14) • If the FERC-ordered increase in RCPFs had been in place in CCP4: • Reserve market revenue would have been $25M higher • RT peak energy rents would have been $7M higher • PER Adjustment would have credited $99M more back to load. • RT impact on resource owners net of the PER Adjustment would have been • = $25M +7M- $99M = -$67M • Excludes the potential impact of higher RCPFs on DAEM revenue, which is likely positive, but difficult to predict

9. Summary of Participant Comments Near Term Issue • Several Participants suggested that nothing be done. • The impact of higher RCPFs on the PER Adjustment was not unexpected and NEPOOL previously voted down proposals to change/eliminate the PER Adjustment when they voted to increase the RCPFs as part of the NEPOOL alternative to the FCM PFP. • Participants also observed that the increase in the PER Adjustment due to higher RCPFs could be offset by higher energy and reserve market revenue. • Several participants suggested ‘re-calibrating’ the PER Adjustment to neutralize impact of higher RCPFs (on the PER Adjustment). • Some participants recommend that the PER Adjustment use an Adjusted RTLMPs that ‘nets out’ the increase in the RCPFs when they take effect on December 3, 2014.

10. Summary of Participant Comments & ISO ResponseNear Term Issue • Some participants suggested that the PER Adjustment be eliminated in CCP5-CCP8, indicating that: • PER Adjustment is not necessary to curb the incentive to exercise market power in the energy market because IMM has other means to do so via the actions detailed in Appendix A. • PER Adjustment is an imperfect hedge for load; commercial retailers can also provide hedges. • Previously proposed during the debates of on the FCM PFP and NEPOOL’s Alternative • ISO does not support eliminating the PER Adjustment in CCP5-CCP9 • Higher RCPFs do not reduce the rationale for the PER Adjustment under the existing FCM design • ISO may support eliminating the PER Adjustment for FCA10 and beyond if an internal review demonstrates that it no longer serves a useful role.

11. Summary of Participant Comments & ISO ResponseNear Term Issue (continued) • Some Participants suggested we calculate the PER Adjustment based on a resource’s cleared status in energy/reserve markets • The PER Adjustment calculation should depend on whether a supplier clears in the Day-Ahead Energy Market (DAEM) or in the Real-Time Energy Market (RTEM)and whether a supplier provides energy or reserves in real time. • This approach was previously proposed by GDF Suez during debates on the FCM PFP and NEPOOL’s Alternative. • ISO does not support any proposal to calculate the PER Adjustment based on a resource’s cleared status for any commitment period • Calculating the PER Adjustment in this way distorts DA/RT bidding incentives (See Examples in Appendix pages 27-30 )

12. Summary and Next Steps • May 30, 2014 FERC Order ER14-1050 has implications for the PER Adjustment • RCPFs will be increased, coincident with the Hourly Offers project, independent of any action taken to modify PER Adjustment rules for CCP5 and beyond • ISO is proposing to increase the PER strike price by $250 to reduce the impact of the increase in RCPFs on the PER Adjustment for the interim CCP5-CCP8 period

13. Appendix Background Material

14. Historical Perspective on PER Adjustment

15. Existing PER Adjustment:Historical View of Key Components

16. Existing PER Adjustment : Historical View of Monthly PER and Moving Average of Monthly PER

17. Hours when Hourly PER Value Has Been Positive Since December of 2010; • Average RT/DA LMP Differential when Hourly PER Value is Positive = +$535 • RCPFs were activated in all of these hours Note: All prices and differentials shown in $/ MWh

18. Existing PER Adjustment DOES NOT DISTORT DA/RT Bidding incentives

19. Existing PER Adjustment Does Not Distort DA/RT Bidding Incentives • Current PER Adjustment is based on the supplier’s CSO and not on the megawatts that a supplier clears in real time. • A competitive supplier cannot change the PER Adjustment by bidding more or less in the DA or RT energy market • Key Point: Existing PER Adjustment has no impact on the profitability of clearing DA versus RT whereas the Alternative PER Adjustment distorts DA/RT bidding strategies.

20. Example • Assume • Supplier has one unit with MC = $50/MWh and CSO= 300 MW • PER Strike price is $120/MWh • DALMP =$100 • RTLMP =$150 • Case 1 : Clears DA w/ PER Adjustment • Case 2 : Clears RT w/ PER Adjustment • Case 3 : Clears DA w/ No PER Adjustment • Case 4 : Clears RT w/ No PER Adjustment • Table on slide 24 shows calculation of total variable profit for each case with the existing PER Adjustment • Table on slide 25 compares the relative profit of clearing DA or RT with the existing PER Adjustment

21. Existing PER Adjustment Mechanism Example (continued)

22. Existing PER Adjustment Mechanism: Example (continued) Existing PER Adjustment Does Not Change the Profitability of Clearing in DA versus Clearing in Real Time

23. Calculating the PER Adjustment Based on A Resource’s Cleared Status DISTORTs DA/RT Bidding incentives

24. Alternative Calculation of PER Adjustment • Calculate PER Adjustment based on whether a participant clears in the DAEM or RTEM Max (DALMP-S,0)* min(DA CLR MW,CSO) + Max ((RTLMP-S),0)*max(PER CSO- DA CLR MW),0) • NEPOOL voted down a variant of this approach proposed by GDF Suez • Hourly PER is based on DALMP for MW cleared in DAEM and delivered as energy, reserves or regulation in real time • Hourly PER is based on RTLMP (same as existing calculation) for MWs that clear and provide energy in the RT energy market resources • Hourly PER is zero for any resource that does not clear in DAEM and provides only reserves in real time • ISO does not support any approach that makes the calculation hinge on how a resource clears because to do so would interfere with bidding incentives as shown in the following example

25. Example: Alternative PER Adjustment Calculation

26. Example: Alternative versus Existing PER Calculation Existing PER Adjustment Does Not Change the Profitability of Clearing DA versus in Real Time Alternative PER Adjustment Changes the Profitability of Clearing in DA versus Real Time

27. PER Adjustment Mechanism: The Details

28. Existing PER Adjustment Mechanism: Details • Hourly PER = (RTLMP-S)* Scale Factor*Availability Factor • RTLMP: for each Load Zone associated with particular capacity zone • S: variable cost of marginal generating proxy unit (22,000 BTU/kWh) * daily cost of gas or oil whichever is higher • Scale factor: creates lower weighting for hours when load is low relative to forecasted peak • Calculated as the actual hourly integrated load divided by the summer 50/50 predicted peak forecast • Availability Factor: marginal proxy unit = 0.95 • Monthly PER = Sum of Hourly PER values for the month. • Average Monthly PER = 12 month moving average of Monthly PER values prior to the obligation month.

29. Existing PER Adjustment Mechanism Details (continued) • PER Adjustment = Average Monthly PER * PER CSO • PER CSO = minimum [CSO, (CSO – Self Supply Obligation)] • Monthly PER Adjustment is capped at the FCA Payment adjusted to account for obligations acquired or shed for the same commitment period after the FCA • PER CAP = FCA Payment + [(ARA CSO+MRA CSO+IBTCSO) *FCA Clearing Price*)] • FCA payment is payment received for activity in the Forward Capacity Auction • [ARA CSO +MRA CSO +IBT CSO] are obligations acquired or shed • FCA clearing price * is adjusted for price collar (This price is used as a proxy price to prevent opportunities to manipulate the PER CAP such as could be done with a bilateral at zero contract price) • ARA is annual reconfiguration auction, MRA is the monthly reconfiguration auction and IBT is internal bilateral transactions