Market Evolution Program Update

1. Market Evolution Program Update Drew Phillips/Edward Arlitt Leonard Kula/Jason Chee-Aloy Market Advisory Council of the IMO

2. Environmental Information Tracking • Awaiting passage of regulation Market Advisory Council of the IMO

3. Multi-Interval Optimization • Progress • Finalizing detailed design • Software development is underway • Work is underway internally on Market Rule amendments to support MIO modifications • Technical Panel submission expected in November Market Advisory Council of the IMO

4. Multi-Interval Optimization • Stakeholdering • 11 Working Group Sessions to date • Next Working Group Sessions • October 8 with ITSC representatives • October 28 • MOSC - October 22 • Technical Panel presentation - October 14 Market Advisory Council of the IMO

5. Multi-Interval Optimization Market Advisory Council of the IMO

6. Wholesale/Retail Integration Edward Arlitt Market Advisory Council of the IMO

7. Wholesale/Retail Integration • Wholesale/Retail Integration is being shaped by the activities of other MEP initiatives and the OEB initiative regarding the delivery of Demand Side Management and Demand Response activities • IMO monitoring developments in these forums Market Advisory Council of the IMO

8. Wholesale/Retail Integration • IMO wants to ensure that the strategy components in each of these issues align with the evolutionary plan being developed in the other MEP stakeholder working groups. For example: • The future of the “buy” side of the market and Load Serving Entities • The Day Ahead Market (financial exposure, participation, etc.) Market Advisory Council of the IMO

9. Day Ahead Market Leonard Kula Market Advisory Council of the IMO

10. DAM Overview • Working Group • Benefits • Design • Pricing Methodology • Next Steps Market Advisory Council of the IMO

11. Day Ahead Market Working Group • Over 30 members (with diverse membership) • Meets every 10-14 days (24 meetings held since March) • Substantial consensus to develop a comprehensive DAM consistent with that implemented or planned for neighbouring markets • security constrained unit commitment model • LECG (consulting firm) provides expert advice At the June 11 MAC meeting, unanimous consensus was reached: • Acknowledgement that DAMWG stakeholdering process is effective • Agreed with recommendation to continue to develop the DAM design until the end of the year, with a view to specifying design details, resolving issues raised by stakeholders, defining benefits and resolving funding issues Market Advisory Council of the IMO

12. Day Ahead Market - Benefits • Improved reliability • Allows for direct participation of all loads in market • Additional opportunity for demand-side response • Improved commitment process • Allows IMO to commit sufficient resources to meet forecast demand • Drivers to ensure committed resources ‘show-up in real-time’ • Utilizes 3-part offer construct • Imports and exports priced and scheduled day-ahead • Moves intertie transactions from real-time to DAM and reduces intertie trading uncertainty • Should reduce number of failed intertie transactions • Should reduce Intertie Offer Guarantee (IOG) uplift payments Market Advisory Council of the IMO

13. Day Ahead Market - Benefits • Improved point of convergence for forward products • DAM provides a transparent and predictable price that converges on the real-time market price • Lower volatility - DAM price volatility lower than real-time market price • Greater liquidity - DAM explicitly allows non-dispatchable load bids and ‘virtual’ participation • Price convergence - ‘virtual’ participants in DAM encourage price arbitrage between DAM and real-time market • DAM price better than real-time market price as an index - facilitates forward price curve development  contracting Market Advisory Council of the IMO

14. Day Ahead Market – Proposed Design Key features: • A financial market administered by the IMO, which accepts supply offers and demand bids and clears the market at day-ahead prices. • Creates a 2-settlement system, with the real-time market (RTM) a “balancing” market. • Integrates a 3-part bid process to optimize unit commitment for: • Supplies available to the DAM to meet loads buying in the DAM • Supplies available to the RTM to meet RTM forecast load • A multi-pass process for committing units, arranging DAM schedules, and defining DAM prices, plus indicative schedules for the RTM. • The use of uplifts to cover commitment costs not recovered from market revenues. • The simultaneous optimization of energy and operating reserves, and the optimization of the market over the 24 hour period. Market Advisory Council of the IMO

15. Day Ahead Market - Pricing Methodology • Work began on the DAM with the intention of designing a DAM consistent with the current pricing mechanism of the Real-Time Market (RTM) - uniform pricing • reflected in the DAM objectives and guiding principles • a number of DAMWG sessions discussed how a DAM based upon a uniform pricing methodology would be settled • Conclusions of DAMWG (August 2003): • A day-ahead market under a uniform pricing regime would be costly to implement and maintain, complex and confusing, and is not recommended • To be effective, a nodal pricing model must be used Market Advisory Council of the IMO

16. Why not use uniform pricing in the DAM? • Issues with uniform pricing in real-time market amplified in DAM • Complex system of congestion management payments (CMSC) in real-time market  multiplied with DAM • very difficult (impossible?) to settle • obscures DAM price • Uniform price sends incorrect locational signals for supply and demand-side investments  reinforced in DAM • ‘Strategic bidding’ issues will substantially increase • constrained-off generators have incentive to decrease offer $ to maximize CMSC for not running • constrained-on generators have incentive to increase offer $ to capture the value of their energy (paid as bid) • more prevalent with DAM because of settlement complexity • Still not convinced that we can generate a set of schedules in the DAM under uniform pricing that are consistent with real-time schedules Market Advisory Council of the IMO

17. A Nodal Pricing Model for DAM • Most of the problems associated with the use of uniform pricing in the DAM and real-time market disappear with nodal pricing • Nodal pricing eliminates the need for CMSC side payments. • All the ‘strategic bidding’ incentives created by CMSC disappear. • And the DAM would function better: • Simpler to administer settlements • More transparent and intuitive prices • Consistent results with the RTM, making the DAM prices more useful references for other forward markets • Nodal price sends correct locational signals for supply and demand-side investments Market Advisory Council of the IMO

18. Nodal pricing - what is it? • The nodal price at any location is the offer/bid-based cost of redispatching the system to supply energy to the next increment of load at that location... • Given the security-constrained dispatch • Given the binding constraints and contingencies • Given the offers/bids of the participants • Nodal prices are market-clearing prices (not “pay as offered/bid”) Market Advisory Council of the IMO

19. Nodal pricing – possible design • Dispatchable facilities would be settled based upon nodal pricing • generators/importers would receive the nodal price • dispatchable loads/exporters would pay the nodal price • Remaining (most) loads would receive a ‘uniform’ price consisting of a weighted average of the Ontario nodal prices for loads • The difference between the nodal prices at the receipt and delivery locations provide a set of congestion rents that are paid to the holders of internal transmission rights Market Advisory Council of the IMO

20. Nodal Pricing - Next Steps • No decision has been made by the DAMWG or IMO on nodal pricing recommendations • Investigation by the IMO and involvement of the DAMWG will continue in parallel with a broader stakeholdering process • A position needs to be formulated by the IMO and the industry by the end of Q1 2004 if market enhancements, including nodal-based Day Ahead and real-time markets, are to be implemented in a timely manner Market Advisory Council of the IMO

21. DAM Design - Next Steps High level design concepts • internal transmission rights • settlement timelines and prudentials Market Advisory Council of the IMO

22. Nodal Pricing Stakeholder Process Drew Phillips Market Advisory Council of the IMO

23. Nodal Pricing: The Context • Investigation of a nodal pricing model has implications beyond the Day Ahead Market and will attract interest from a broader set of stakeholders • Education, analysis and consultation are the pieces needed to allow IMO and stakeholders to develop grounded positions Market Advisory Council of the IMO

24. Nodal Pricing: The Stakeholder Plan • Continue to use the DAMWG to discuss nodal price issues • Engage broader stakeholder audience through workshops and self-study material that will be made available on the IMO website • Utilize MOSC as additional forum to discuss issues as they arise Market Advisory Council of the IMO

25. Workshops Workshop #1 (early December) • How nodal prices are determined (theory) • The role of transmission rights • How the current dispatch algorithm determines nodal (shadow) prices • Economic arguments for nodal pricing • Experience in other markets Workshop #2 (early January) • Analysis of nodal prices to date Market Advisory Council of the IMO

26. Long-Term Resource Adequacy Jason Chee-Aloy Market Advisory Council of the IMO

27. Overview • Stakeholdering • Long-Term Resource Adequacy Working Group Draft Strawman Conclusions and Recommendations • Long-Term Resource Adequacy Working Group Consensus Points and Issues • Next Steps Market Advisory Council of the IMO

28. Long-Term Resource Adequacy Stakeholdering Long-Term Resource Adequacy Working Group (LTRAWG): • Over 25 members (w/ diverse membership) • Meets every 2 weeks (18 meetings have been held since March) • Completed Feasibility Assessment (June 2003) • agreed on objectives, evaluation criteria, paths/options, conclusions and recommendations • LECG (consulting firm) has provided and continues to provide expert advice At the June 11 MAC meeting, unanimous consensus was reached: • Acknowledgement that LTRAWG stakeholdering process is effective • Agreed with conclusions and recommendations contained in Feasibility Assessment Market Advisory Council of the IMO

29. LTRAWG Draft Strawman Conclusions and Recommendations Long-term resource adequacy encompasses all interrelated aspects of the Ontario electricity market The following draft LTRAWG recommendations contain necessary elements that will help Ontario move toward a complete and workable approach to addressing long-term resource adequacy within a competitive market framework Market Advisory Council of the IMO

30. Draft Strawman Conclusions and Recommendations The principle recommendations contained in the Strawman are: 1) Work to introduce more realistic prices better reflecting their scarcity value, in conjunction with the implementation of some form of nodal pricing, the development of greater price-sensitive demand-response, and increased competition amongst suppliers 2) LSEs (multiple) should be created and authorized to undertake the function of supplying energy to default customers (who do not choose an alternate supplier, e.g. retail marketer) • These LSEs would not have capacity procurement obligations Market Advisory Council of the IMO

31. Draft Strawman Conclusions and Recommendations 3) Ontario should continue to meet at least the NERC ‘one day in ten years’ reliability standard; however, Ontario and neighbouring US jurisdictions should work with NERC to introduce a more economic approach to defining this reliability standard 4) IMO should develop a resource adequacy (capacity) forward auction market to better ensure compliance with NERC reliability standards and to achieve appropriate levels of resource adequacy Market Advisory Council of the IMO

32. Draft Recommendations RECOMMENDATION (1): Work to introduce more realistic prices better reflecting its scarcity value in conjunction with the implementation of some form of nodal pricing, the development of greater price-sensitive demand-response, and increased competition amongst suppliers The following elements need to be in place: • Prices should more accurately reflect shortage and near-shortage conditions, accounting for locational differences • All loads must be represented by many active ‘market buyers’ • Sufficient price-responsive demand • Competitive suppliers • Liquid contracting markets • Market power mitigation without unnecessarily suppressing competitive prices necessary to induce new entry Market Advisory Council of the IMO

33. Draft Recommendations RECOMMENDATION (1): Continued • Work to put some of these elements in place has begun (e.g. increased price-responsive demand, Pricing Team initiatives, etc.) • This work should continue and expanded to include the missing elements • Acknowledgement that investigations of nodal pricing are just beginning • Some missing elements require changes outside of the IMO-administered markets Market Advisory Council of the IMO

34. Draft Recommendations RECOMMENDATION (2): LSEs (multiple) should be created and authorized to undertake the function of supplying energy to default customers (who do not choose an alternate supplier, e.g. retail marketer) • The implementation of Bill 210 effectively removed 50% of the loads (mainly default supply customers) from the market (as these loads pay a fixed electricity charge and have no incentive to be price-responsive) • It is essential for default supply customers to be represented by active ‘market buyers’ (with ability and incentives to participate in spot and contracting markets) • Therefore, LSEs should be created with the obligation to supply energy to all default supply customers; and thus, all loads would be represented by active ‘market buyers’ (e.g. industrial loads, LSEs, retail marketers) Market Advisory Council of the IMO

35. Draft Recommendations RECOMMENDATION (2): Continued Creation of multiple LSEs can provide the following market benefits: • Necessary counterparties to bilateral contracts and participation in the spot markets • Incentives for more demand-response, demand-side management and conservation • Incentives to develop distributed generation to serve their load customers • OEFC no longer has to finance differences between spot prices and fixed charge • Multiple LSEs provide greater buy-side competition, as opposed to one single buyer • Default customers would be hedged from wholesale spot price volatility through fixed-rate contracts Market Advisory Council of the IMO

36. Draft Recommendations RECOMMENDATION (2): Continued LSEs should not be obligated to procure forward resources (capacity) on behalf of their load customers: • Experience in the Northeast US markets (NYISO, PJM and ISO NE) has shown the following problems: • Complication with retail access creates significant risks for LSEs to procure forward resources • Difficulties in determining appropriate deficiency charges to be levied on LSEs when resource obligations are not met • Difficult to use actual performance and actual consumption measures • Complexity associated with locational constraints • Difficult to value installed capacity requirements in response to prices • It is likely that Ontario would experience most of these problems if LSEs were to have the obligation of procuring forward resources (capacity) Market Advisory Council of the IMO

37. Draft Recommendations RECOMMENDATION (2): Continued LSEs will be able to co-exist with LDCs (in their existing role) and retail marketers: • Criteria could be developed to allow large LDCs to establish an affiliate LSE • Some markets have LSEs with default supply responsibilities alongside a competitive retail market • Issues have not been fully addressed - OEB involvement has begun Market Advisory Council of the IMO

38. Draft Recommendations RECOMMENDATION (3): Ontario should continue to meet at least the NERC ‘one day in ten years’ reliability standard; however, Ontario and neighbouring US jurisdictions should work with NERC to introduce a more economic approach to defining this reliability standard • At the present time, Ontario is in compliance with the NERC standard administered through NPCC • However, to better ensure future compliance with NPCC reliability criteria, Ontario should develop an explicit mechanism to help address resource adequacy Market Advisory Council of the IMO

39. Draft Recommendations RECOMMENDATION (4): IMO should develop a resource adequacy forward auction market to better ensure compliance with NERC reliability standards and to achieve appropriate levels of resource adequacy • In theory, a properly functioning market should result in an economically efficient level of resources. However, it is likely that this level of resources would be, on average, lower than the level called for under the present NERC reliability standards (and more likely lower than socially and politically acceptable levels). Therefore some form of explicit mechanism of assuring resource adequacy is required. • The preferred method is a resource adequacy forward auction, this is consistent with the direction of the Northeast US markets and could provide for increased efficiencies towards addressing reliability on a regional basis Market Advisory Council of the IMO

40. Draft Recommendations RECOMMENDATION (4):Continued • A forward auction (e.g. auction held in 2005 would oblige sufficient capacity to come to market in 2008 via must-offers for energy and ancillary services in the real-time or day-ahead market) allows planned resources (that have passed their permitting stage but do not have ‘iron in the ground’) to participate and ensure their future in-service date • Incumbent generation, planned generation, demand-side resources/programs, and maybe transmission upgrades/expansion could qualify as resource adequacy providers within this market • IMO could set different locational requirements for resources • Implementation of a ‘demand curve’ would mitigate market power and could appropriately value resource adequacy (i.e. capacity) • Preliminary results from NYISOs demand curve and ICAP procurement are encouraging Market Advisory Council of the IMO

41. Issues for Draft Recommendations Going Forward The following additional issues have been noted as impediments to achieving long-term resource adequacy in Ontario. These must eventually be addressed: • Lack of competitive suppliers • Barriers to investment (from Feasibility Assessment) Market Advisory Council of the IMO

42. Long-Term Resource Adequacy Working Group Level of Consensus Consensus regarding the draft recommendations: Acceptance of the notion of a comprehensive and holistic approach is required. Specifically with respect to the recommendations the following have consensus: • Recommendation (1): Improvements to the IMO-Administered Markets (e.g. more efficient pricing, increased demand-response, increased competition amongst suppliers, etc.). Nodal pricing should be investigated but note that comprehensive nodal pricing analysis is still required prior to making any decisions whether it should be implemented. • Recommendation (2): Acceptance of the concept of creation of LSEs as active ‘market buyers’ for energy on behalf of default customers • Recommendation (3): Ontario must meet at least the NERC ‘one day in ten years’ reliability standard and should work with neighbouring jurisdictions and NERC to introduce a more economic approach to defining this reliability standard Market Advisory Council of the IMO

43. Long-Term Resource Adequacy Working Group Level of Consensus Non-consensus regarding the draft recommendations: • Recommendation (2): Exact nature of and design of LSEs and coordination with LDC and retailers still to be explored • Recommendation (4): Not all members agree that an explicit mechanism is required. If it is required, most members would prefer a forward auction-based approach to procuring capacity • Some members prefer contracting obligations placed directly on loads (e.g. LSEs) • Some members would like other central procurement options to be assessed (e.g. RFP or auction for new capacity) Market Advisory Council of the IMO

44. Stakeholdering the Strawman and Next Steps • LTRAWG has scheduled biweekly meetings until the end of this year • LTRAWG is assessing the need and scope for interim / transitional mechanisms that could be made operational in 2004 • LTRAWG is assessing issues of high level design that can make resource adequacy mechanisms workable • e.g. is it sufficient to incent new investment over the long-term These recommendations, in conjunction with clear and stable policies, must create sufficient conditions for greater long-term contracting in order to support new investment Market Advisory Council of the IMO