NEPOOL Markets Committee: FERC Order 755 Compliance Design Changes

1. January 8, 2013 | NEPOOL markets committee Jonathan Lowell Principal analyst | market development Changes to the April 30th Design to Comply with November 8, 2012 FERC Order Regulation Market (Order 755) Compliance

2. Background • FERC Order 755 requires regulation market design changes to provide • Two Part Bidding – capacity (MW) and service (mileage) • Energy opportunity costs included in market clearing • Uniform clearing prices and two-part payment • Unfortunately, this is not possible without sacrificing economic efficiency (least cost) and/or incentive compatibility (optimal bidding strategy is to offer true costs) • The ISO filed a design that provided economically efficient outcomes and incentive compatibility • The ISO proposed to publish “approximate clearing prices” to enhance market transparency

3. FERC Decision • On 11/8/12 FERC issued an order rejecting the ISO’s proposed tariff revisions: • Did not provide uniform clearing prices • Did not provide a two-part payment • Did not meet the burden of proof to demonstrate that a deviation from Order No. 755’s requirements was warranted • ISO must submit a new compliance filing by February 6th • The rejection did not address economic efficiency or incentive compatibility issues, but rather was narrowly drawn, based on the specific language of the original order.

4. ISO Compliance Proposal Objectives • Meet FERC requirements for uniform clearing prices • To the extent possible: • Minimize potential loss of economic efficiency • Preserve incentive compatibility • Avoid bid skewing • Avoid potential incentives to not follow AGC dispatch • Minimize the need for uplift or make-whole payments • Make no changes not directly related to the incorporation of clearing prices

5. Compliance Design in a Nutshell • Select least cost resources to meet capacity and mileage requirements (unchanged) • Offered capacity and mileage prices (unchanged) • Estimated mileage (unchanged) • Estimated energy opportunity cost (unchanged) • Calculate incremental cost savings provided by the resource (unchanged) • For convenience, let us describe the efficient bundled payment for each resource as the “Vickrey Payment”, defined as: Vickrey Payment = Estimated As-Bid Cost + Incremental Cost Savings • Determine uniform mileage price (new!) • Maximum of the mileage offers of all selected resources • Determine uniform capacity price (new!) • Highest of the capacity prices each selected resource would require in order for its compensation to equal its Vickrey Payment

6. Compliance Design in a Nutshell Unchangedfrom the April 30 Filing NEWfor the Feb. 6 Compliance Filing

7. Compliance Design Advantages • Simple modification to April 30th design • High confidence the design meets Order 755 requirements, as reinforced in the November 8th order • Uniform prices used for settlement • Largely preserves economic efficiency by selecting least cost resources and compensating those resources at prices based on true value to the system • Minimizes the need for uplift payments • Preserves the “no risk to participation” feature of the April 30th design • Important for reliability: encourages participation

8. Compliance Design – Other Details • Offer Price caps and floors (New!) • Limits potential for bid skewing • Make-whole payment to ensure compensation for selected resources covers as-bid cost of actual performance and actual energy opportunity cost • Prices >= 0 • Publication of market results will include the actual prices • No calculation or publication of proxy prices

9. Next Steps • Present final language to MC in late-January • PC review at February 1st meeting • File with FERC on February 6th

10. appendix

11. Price Calculation Example – Part 1

12. Price Calculation Example – Part 2 $0.6/Mile

13. Price Calculation Example – Part 3 Given a mileage price of $0.6/mile, the capacity price required for resource D to receive expected compensation equal to its Vickrey Payment of $289 is: 18 MW x Capacity Price + 234 miles x $0.6/mile = $289 Therefore, Resource D Capacity Price = $8.3/MW Similarly, Resource K Capacity Price = $11.4/MW Uniform Capacity Price = Max[$8.3/MW, $11.4/MW] = $11.4/MW

14. Price Calculation Example – Part 4 • Compensation at the uniform prices ($0.6/mile, $11.4/MW) is represented by the upward-sloping plane • As-bid compensation generally exceeds the uniform price compensation for non-selected resources (shown by the ◊ icons) • For selected resources, price-based compensation will always be greater than or equal to the resource’s: • efficient bundled payment (the blue X icons) • as-bid cost of capacity, expected mileage and expected opportunity cost ((the magenta ◊icons)

15. Design Options Considered But Not Pursued • “Best Fit” pricing over a range of requirements • “Best Fit” pricing for those resources selected as least cost • Several compliance options were considered that did not meet threshold criteria • Select based on capacity price, dispatch based on mileage price • Highest selected prices • Include opportunity cost in current pricing design