An Assessment of Peak Energy Pricing In New England During Summer 2001

1. An Assessment of Peak Energy Pricing InNew England During Summer 2001 Presented to: Restructuring Roundtable David B. Patton, Ph.D. Independent Market Advisor January 18, 2001

2. Purposes and Objectives of the Study • The study is intended to evaluate the energy prices that prevailed in the peak hours during the Summer 2001. • In particular, a number of participants have raised concerns that the energy prices during many of the peak hours were unjustifiably low. • The peak load conditions occurred in late July (24th and 25th) and early August (6th through the 10th) – the timeframe studied for this report is from July 23 to August 10. • The report focuses on those peak hours in which the energy prices were the lowest. • Establishing efficient prices under peak conditions is critical. The revenues generated under these conditions represent a large share many generators annual revenue and provide the primary incentive to invest in new units. • The study seeks to explain the prices during these periods and to evaluate the extent to which they were influenced by: • ISO actions under the existing market rules and procedures • ISO actions that were not consistent with market or procedures • Participant actions

3. Factors Contributing to the Peak Price Levels • A number of factors substantially affect the ECP in New England during the peak demand conditions, including: • Transmission congestion and the procedures of the ISO to manage it. • Self-scheduling by participants. • Out-of-merit generation to provide reserves or satisfy bid parameters. • The effects of these factors are shown in the following supply curves for August 9 at 6:00 pm. • The analysis is illustrative and the size of the price effects shown for each factor would change depending on the order of the supply curves. • The analysis begins by plotting an “unconstrained” supply curve that does not reflect any influence of the factors listed above. The figure also shows the estimated “unconstrained” price based on the load in the hour (net of external transactions that are assumed fixed). • These supply curves are energy only – resources selected for reserves have been removed.

4. Summary of Out-of-Merit Resources • The following table summarizes the quantities of out-of-merit generation that fall in each category described above. • The hours shown were selected due to the relatively low prices they exhibit relative to the unconstrained estimated price based on the load. (i.e., these are the most anomalous prices) • Each of these categories was analyzed in the report to determine the portion of these quantities that could have been dispatched in-merit.

6. Effects of Transmission Congestion • The ISO manages congestion on the system by reducing the output of generators that would otherwise be economic in some areas (congested down units) and raising the output of more expensive units in other areas (congested up units). • When resources are congested down because their power cannot be delivered to load without exceeding the transmission limits, supply is removed from the market at the ECP will increase. This effect is shown on the following figure. • Alternatively, resources dispatched out-of-merit to resolve a transmission constraint will displace less expensive resources that would otherwise be at the margin and setting ECP. The effects of this out-of-merit dispatch are shown on the subsequent figure. • It is important to understand that the ECP represents the market price outside of the constrained area. Hence, it is expected that transmission constraints will cause the ECP to fall, just as prices do locational pricing system when constraints are binding.

7. Recommendations: Congestion Management Procedures • Excessive amounts of generation are designated out-of-merit to resolve congestion, ranging between 425 MW and 1109 MW in selected peak hours that were analyzed. • The manual congestion management procedures cause generation that would be selected to run in merit to be dispatched out-of-merit and disqualified from setting the ECP. • In the longer-term, SMD will provide a more efficient re-dispatch of generation to manage transmission constraints, and all generators, even those in constrained areas, will contribute to setting energy prices. • In the short-run, the report recommends that the ISO review its flagging procedures to identify any procedural improvements that would allow smaller quantities to be flagged and to allow resources to be unflagged more quickly.

8. Effects of Self-Scheduling • Roughly half the resources dispatched during the peak periods were self-scheduled, which is the equivalent of bidding zero to force the ISO to dispatch the resource. • Most of these units were economic (infra-marginal) and would not have been on the margin setting the energy prices if they were not self-scheduled. • However, the self-schedule of some of the units caused them to be dispatched out-of-merit, displacing lower cost resources at the margin and reducing the ECP.

9. Other Out-of-Merit Resources • A large quantity of other resources were also out-of-merit in the peak hours examined. • The vast majority of these resources were running at their LOL value. • These resources may be out-of-merit because they are: • Needed to maintain reserves; • Bid inflexibly and, therefore, can not set the ECP; • Dispatched to accommodate minimum run time or down time parameters; • Outside the 1% tolerance band around the dispatch signal and, therefore, can not set the ECP.

10. Price Effects Analysis • The following table summarizes the effects of the various factors identified in the report that may have inefficiently affected the ECP. • The estimated ECP (4) is the ECP that I calculate given the scheduled generation level and incorporating the out-of-merit resources. • The adjusted ECPs (5 – 8) show the estimated ECP when each given type of out-of-merit resources are considered for in-merit dispatch (i.e., re-inserted into the supply stack).

11. Recommendations: Other Out-of-Merit Resources • The vast majority of this capacity is committed at LOL to provide for adequate operating reserves, to satisfy minimum run-times or other bid parameters, or needed to meet other system requirements. • The LOL values bid for these units are generally much higher than technically justified. The high LOL values significantly reduce the ISO’s flexibility in meeting its dispatch requirements, including the procurement of spinning reserves. • Suppliers may have a disincentive to be selected as reserves when the energy market is more profitable due to the lack of opportunity costs for some suppliers and their adequacy for others – may explain the high LOLs and self-schedules. Hence, the report recommends that proper opportunity costs be paid to all suppliers of reserves. • If replacement reserves in the real-time are required to meet the NERC reliability requirements, ISO should adjust its reserve requirements to allow the ISO to procure these reserves in the reserves markets, and compensate suppliers accordingly. • Some units are prevented from setting the ECP when they fail to operate sufficiently close to their DDP. This market rule is being revised to widen the tolerance band, which is supported by the analysis in this report.

12. Recommendations: Peak-Load Pricing Provisions • Even with the other changes, large quantities of out-of-merit generation will remain dispatched at LOL in the peak hours, resulting in continued price effects. • These effects are likely to be the largest when the system is in shortage – unable to meet its energy and reserve requirements. Thus, the report proposes the following: • The flagging procedure related to out-of-merit commitment of resources to provide reserves should be revised to allow all units committed intraday in reserve shortage situations to contribute to setting energy clearing prices. • Second, peaking generators (generally gas turbines) that are not flagged for congestion relief or voltage support should set the energy clearing price. • However, the units at LOL that become eligible to set the ECP under these proposals should be periodically reviewed to determine whether they are still needed by the system. If they are not, but they must remain on to satisfy their minimum run-time or other bid parameters, they should at that point become ineligible to set the energy clearing price.