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  1. May 14-15, 2013 | Westborough, ma Matthew White Senior Economistmarket development A Strategic Planning Initiative FCM Performance Incentives Andrew Gillespie Principal analyst Market development Ron Coutu MANAGER, Bus. Tech. & Solutions

  2. Presentation Topics • Overview • Balancing Ratio & Application to Zones • Maximum Loss Limit (or Stop-Loss) • Impact Analysis Update

  3. Overview

  4. FCM Performance Incentives - Overview • Capacity resources with uncertain performance present a risk to system reliability if too many resources cannot ‘perform’ when needed most – during a capacity deficiency • In this context, ‘perform’ means delivery of either energy or reserves during a capacity deficiency • The current FCM construct provides insufficient incentives for resources to make investments to improve performance • FCM Performance Incentives provides market signals and investment incentives for resources to improve performance i.e., deliver energy or reserves during a capacity deficiency

  5. Future Topics (approximate dates) • Elaboration on the details of this proposal will be the topic of future presentations to the Markets Committee, including but not limited to: • Balancing ratio & application to zones ~ May • Maximum Loss Limit (or stop loss) ~ May • Financial Assurance impacts (w/B&F committee) ~ June • Establishing the Performance Payment Rate ~ June • Bilateral trading ~ July • Reliability rejection of de-list bids ~ July

  6. Balancing ratio For the system and zones

  7. Balancing Ratio? • As part of the Pay-for-Performance proposal the ISO introduced a need for a Balancing Ratio • The following slides intend to focus on that Balancing Ratio to explain the need for it and the mechanism for calculating the Balancing Ratio • Explain the application of the Balancing Ration to System deficiency events • Explain the application of the Balancing Ratio to Reserve Zone deficiency events

  8. When do we need a Balancing Ratio? • During a “Deficiency Condition” (DEFCON) when we have a shortage of certain operating reserve requirements a “Pay-for-Performance (PFP)” measurement will be triggered • DEFCONs are a refinement of today’s Shortage Events triggers • Need to determine the amount of obligation for each resource with a CSO during a PFP DEFCON • Each resource’s CSO will, in essence, be scaled to a pro-rata share of the load plus reserves requirements

  9. Deficiency Conditions? • There are 3 basic Deficiency Conditions: • DEFCON #1 – System Shortage of Total Operating Reserves • DEFCON #2 – System Shortage of Total 10 Minute Reserves (but not short of Total Operating Reserves) • DEFCON #3 – Shortage of Reserve Zone Requirements

  10. Deficiency Conditions #1 • During this type of shortage all Resources will be measured towards meeting the system requirements of Load + Total Operating Reserves • This measurement will be calculated every 5-minutes • Load + Total Operating Reserves is the “requirement” the ISO is trying to meet for that timeframe DEFCON #1 – System Shortage of Total Operating Reserves

  11. Balancing Ratio • Goal of the Balancing Ratio: • Define a capacity resource’s financial obligation as a pro-rata share of the system’s needs (load + reserve requirements) whenever these needs are not satisfied. • This implementation has the (intended) effect that ‘under-performers’ are charged total payments that are sufficient to cover the credits paid to ‘over-performers’.  • The use of this Balancing Ratio means an individual resource’s financial obligation is less than its CSO during deficiencies, because the ISO does not need all capacity resources to perform to their full CSO if system’s total needs (load + reserves) are less than that during the deficiency. 

  12. Balancing Ratio • Balancing Ratio will be calculated for each 5-minute interval where a shortage of load plus reserves occurs (DEFCON) • Balancing Ratio = (Load* + Total Reserve Requirement) Total CSO • *Load = (Gen + Net imports + DR provided)

  13. Balancing Ratio – Load vs. Total Supply • Load is not a “measured” quantity on the system • Generation and Ties are what are measured to develop “Load” in Operations • One difference between Load (as billed) and Generation (as credited) in Energy Market is physical losses • DR “provided” (i.e., interrupted) increases the numerator to include the impact of the Demand Resources on the energy supply

  14. DEFCON #1 - System Shortage of Total Operating Reserves

  15. Balancing Ratio – Details – DEFCON #1 • System Balancing Ratio denominator component: • Total CSO = Equal the sum of CSO of all resources • This is close to but not necessarily equal to ICR • Due to “lumpy” offers causing the FCA to clear CSO > ICR • Due to Intermittent Resources having different monthly CSO • Due to ICR changing downwards from FCA • Total CSO is what load is getting to get charge for procuring

  16. Balancing Ratio – Details – DEFCON #1 • System Balancing Ratio numerator components (each 5-minute interval): • Generation (as measured by 5-minute RQM) • Demand Response provided (as measured by Baseline Calculations or measured estimates for unmetered assets like passive) • Net Imports per Participant (for the 5-minute interval) • Total Reserve Requirement (Requirement that was violated ) • Total Reserve Requirement (TMSR + TMNSR + TMOR) • Does not include Supplemental Reserve Requirement (when active) • Will be indicated by TMOR RCPF (currently $500) activation

  17. Balancing Ratio - Details • Net Imports per Participant (across all external interfaces) • Max(0,Import MW-Export MW) for each Participant • Netting to remove credit to those “wheeling” through New England • Limit those simultaneously importing and exporting at the same interface to the net of those transactions • Generators that are on providing energy to support net exports, are inherently included in Generation sum • During longer-term deficiencies exports may get “cut” based on Operation priorities, but not always during very short-term deficiencies

  18. Balancing Ratio Balancing Ratio = (Load + Total Reserve Requirement) Total CSO Example: Load (translates to Gen + Net imports + DR provided) = 21,757 MW Total Reserve Requirement = 2,078 MW Total CSO = 33,322 MW Balancing Ratio = (21,757 + 2078) / 33,322 = 0.715

  19. Impact of the Balancing Ratio Consider the following five different 1 MW resources, each at different output levels during the same period (i.e., the same balancing ratio) Score = Actual – (Balancing Ratio x CSO)

  20. Additional Points to Consider • Since the amount of CSO should always be expected to be greater than any potential load + reserve requirement this ratio should always be less than 1 • The ratio leads to a slight over-collection from under-performers, equal to the Performance Payment Rate times the reserve deficiency, since the reserve requirements are used in the numerator • This over-collection will fund the stop-loss reserve, which will be described further in the Stop Loss portion of the presentation

  21. DEFCON #2 - System Shortage of Total 10 Minute Reserves

  22. Deficiency Conditions #2 • During this shortage all Resources will be measured toward meeting the system requirements of Load + Total 10 Minute Reserves • Note: During this Deficiency Condition 30 Minute Reserve Requirement is being met, so no incentive applies for 30 minute Reserves DEFCON #2 – System Shortage of Total 10 Minute Reserves

  23. Balancing Ratio – Details – DEFCON #2 • System Balancing Ratio numerator components (each 5-minute interval): • Generation (as measured by RQM) • Demand Response Provided (as measured by Baseline Calculations or estimates for passive) • Net Imports per Participant (for the interval across all external interfaces) • Total Reserve Requirement (Requirement that was violated for the interval) • Total Reserve Requirement (TMSR + TMNSR + TMOR) • Total Ten-Minute Requirement (TMSR + TMNSR) • System Balancing Ratio denominator component: • Total CSO = Equal the sum of CSO of all resources (Same as DEFCON #1)

  24. Impact of the DEFCON # 2 Balancing Ratio Consider the following five different 1 MW resources, each at different output levels during the same period (i.e., the same balancing ratio). The Balancing Ratio has changed from DEFCON #1 because the Numerator has changed. Score = Actual – (Balancing Ratio x CSO)

  25. DEFCON #3 – Reserve Zone SHORTAGE of Reserves

  26. Deficiency Conditions #3 • During this shortage Reserve Zone Resources will be measured towards meeting the Reserve Zone specific requirements of Load + Reserve Zone Operating Reserves DEFCON #3 – Reserve Zone Shortage of Operating Reserves

  27. Balancing Ratio – Details – DEFCON #3 • Reserve Zone Balancing Ratio numerator components (each 5-minute interval): • Reserve Zone Generation (as measured by 5-minute RQM) • Reserve Zone Demand Response Provided (as measured by Baseline Calculations or estimates for passive) • Net Imports per Participant (for the 5-minutes interval for external interfaces that only connect to that Reserve Zone) • Net Reserve Zone Requirement (Reserve Requirement that was violated for the interval) • Note: The numerator will depend on the need for Reserve Zone resources to provide energy & reserves due to limitations of the transmission interface into the Reserve Zone

  28. Balancing Ratio – Details – DEFCON #3 • Net Reserve Zone Requirement equals: • Reserve Reserve Requirement (TMOR) minus Reserve Support from Outside the Zone through unloaded capacity on the transmission interface into the Reserve Zone • For example, if the Reserve Zone Requirement was 500 MW and the interface into the Reserve Zone was unloaded by 300 MW then 300 MW of that 500 MW requirement are being met from outside. So only 200 MW is needed from inside the zone, the 200 MW would be the reserve MW number used in the numerator.

  29. Balancing Ratio – Details – DEFCON #3 • System Balancing Ratio denominator component: • Total Reserve Zone CSO = Equal the sum of CSO of all Resources within the Reserve Zone

  30. Balancing Ratio – DEFCON #3 Balancing Ratio = (RZ Supply* + RZ Reserve Reqt – Ext. Resv) Total Reserve Zone CSO *Reserve Zone (RZ) Supply = (Reserve Zone Gen + Net Reserve Zone specific imports + Reserve Zone DR provided)

  31. What about the energy and reserves coming into the Reserve Zone across the transmission interface ? DEFCON #3 • Although some of the Reserve Zone energy and reserve requirements are being met with energy and reserves from outside the area, if another MW of energy or reserves outside the area would not help the Reserve Zone area, it has no marginal value in solving DEFCON #3 • If the Reserve Zone requirement being violated does not impact LMPs or Reserve Market Clearing Prices (RMCPs) in the other areas of the system, no PFP is calculated for those other areas

  32. Balancing ratio Wrap-Up

  33. Wrap Up – points to take away • Different shortages (DEFCONs) will trigger the use of slightly different Balancing Ratio calculations • Balancing Ratio – During DEFCON, adjusts the CSO of resources to determine the resource’s Performance Payment • Those delivering more than Balancing Ratio Adjusted CSO get a positive Performance Payment • Those delivering less than Balancing Ratio Adjusted CSO get a negative Performance Payment

  34. STOP-LOSS PROVISIONS Conceptual Design and Main Elements

  35. Liability Limits: Purpose and Rationale • Issue. It is not economically reasonable for suppliers to face ‘unlimited’ risk of loss in commercial relationships • Markets commonly employ liquidated damages (‘LD’) provisionsto address losses from non-performance • Concern occurs when a Participant cannot ‘trade out’ of its CSO • Solution direction. Provide a liability limit on a capacity supplier’s financial loss exposure for non-performance during the commitment period • A ‘stop-loss’ system

  36. Conceptual Framework • The stop-loss is a mutual insurance system among capacity suppliers: • Suppliers’ performance payments contribute to a Reserve Fund • Provides each supplier with some financial protection (capped maximum losses for non-performance) • What makes it ‘mutual’? • Costs are borne by capacity suppliers’ contributions • Potential beneficiaries are the pool of capacity suppliers • Actual beneficiaries are the capacity supplier(s) with non-performance charges that exceed the stop-loss amount

  37. Objectives and Principles • Transparency. System should be transparent, succinct, and easy to specify in the tariff • Maintain performance incentives. A good stop-loss design should minimally distort: • Incentives to perform during DEFCON events • Incentives to trade-out or replace a non-performing CSO resource • Insure against extreme loss scenarios for a resource owner. • Suppliers still face some net-loss exposure for non-performance on FCM obligations (how insurance works generally)

  38. Mechanics: Three Major Components • At the Resource-Level: How the stop-loss works • At the Pool-Level: How the money flows • Reserve Fund accruals and disbursements • The Stop-Loss amount • Current ISO thinking and considerations

  39. 1. Resource-Level: Main Features • Annual cap on total loss exposure for FCM obligations • Limits apply monthly during commitment period • Cap applies to sum of Base and Performance payments • Intent: Limit total financial consequences from FCM participation • Cap is per CSO MW (not per-participant) • Design features maintain (some) performance incentives even if a resource reaches the stop-loss limit

  40. Examples: The Basics For simplicity, in the following example the numbers have been scaled down to demonstrate the concept • Use a PPR = $1/MWhResource has a 1MW Capacity Supply Obligation • A stop-loss amount of $10 is used for demonstration purposes only

  41. Resource-Level: Simple Example For entire commitment period: Base payments total = $8 Performance payments total = ($21) Net financial position = ($13) Effect of stop-loss is to limit net financial position:(using a stop-loss of minus $10, for example) Pre stop-loss net financial position = $8 Stop-loss limit = ($10) Post stop-loss net financial position = ($10)

  42. Resource-Level: Examples Example 1 – shows the same simple example, but over discrete periods over the entire commitment period • ‘Severe’ event occurs during last period Example 2 – shows the same simple example as in Example 1, but in reverse • The ‘severe’ event occurs during the first period Example 3 – is nearly the same as Example 2, but the event is not as severe • The first period is ‘stopped-out’ • But the net financial position at the end of the entire commitment period is not stopped out

  43. Example 1 – Stop-Loss For demonstration purposes only, a $10 Stop-Loss amount is used

  44. Example 2 – Stop-Loss For demonstration purposes only, a $10 Stop-Loss amount is used • Here, the cumulative pre-stop-loss calculation will continue, and the stop-loss limits monthly payments • The same annual performance (as in Example 1) leaves the resource with the same annual net financial outcome

  45. Example 3 – Stop-Loss For demonstration purposes only, a $10 Stop-Loss amount is used • Similar to Example 2, the pre-stop-loss cumulative net will continue to be calculated, and evaluated against the stopped amount ($10) • The resource’s cumulative net by Period 2 is the same pre- and post-stop-loss • Here, the second period Monthly Net has been reduced to ‘repay’ the stop-loss reserve fund

  46. 2. Pool-Level Settlements • How does the money flow to cover a stop-loss limit? • Issue: • ISO uses money from under-performers to pay the over-performers • If an under-performer reaches its loss-limit, where does the money come from to pay the over-performers? • Solution direction: • There is a ‘natural’ ISO revenue surplus that can cover some of this • If necessary, capacity suppliers would then have performance payments adjusted (downward), so settlements balance • This is the mutual insurance aspect of the stop-loss design

  47. The ‘Natural’ Revenue Surplus under PFP • During any DEFCON, more resources are under-performing than are over-performing • That is why the system is deficient • The reserve deficiency (in MW) equals the difference between total under- and over-performance • At the pool level: This means suppliers’ total performance debits exceed total credits in PFP settlement • The difference is a net revenue surplus in ISO Settlement • Detailed Example: FCM PI White Paper, Example 5 (p. 17)

  48. Pool-Level Stop-Loss Effects: Example • Assume: • A one-hour DEFCON #1 (system-level total-30 deficiency) • Reserve deficiency magnitude is 200 MW (average over event) • PPR = $5,000 / MWh • If no one’s stop-loss limit is reached, there’s a net surplus of: $5,000 / MWh x 200 MW x 1 hour = $10 million • But: If a supplier has reached its stop-loss limit, and under-performs by (say) 80 MW, the net surplus would be less: $5,000 / MWh x (200 – 80) MW x 1 hour = $6 million The ISO does not collect $4 million from the stop-loss underperformer

  49. Implications • Stop-Loss Reserve Fund. ISO proposes to accrue the ‘natural’ PFP revenue surplus in a stop-loss reserve fund • Purpose. The reserve fund would be used to cover payments to over-performers (to maximum extent possible) when an under-performer has reached its stop-loss limit • Reserve fund balance would accumulate (potentially) each DEFCON event during the commitment year

  50. Two Issues • What if the Reserve Fund reaches zero? • Capacity suppliers payments would have to be adjusted (downward), to ensure it does not go negative (i.e., ISO settlements balance) • Disbursement of ‘excess’ Reserve Fund balance (if any)? • Beneficiaries • Timing