Overview of LMP Markets

Features of ISOs / RTOs

David WithrowSenior Market Economist

Fall 2007 Meeting of the

NARUC Staff Subcommittee on Accounting and Finance

Jackson Hole, Wyoming

October 8, 2007

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Independent System Operators / Regional Transmission Organizations in North America

(see www.isorto.org)

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Typical Reliability and Market Components of ISOs / RTOs

Day Ahead Market Schedules for injections and withdrawals Market Power Mitigation Optimized Network Model for all Schedules Locational Marginal Pricing Commitment of generation for reliability reasons Financial Transmission Rights Existing Transmission Contracts

Real Time Imbalance Market Ancillary Services

Resource Adequacy

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Background on the California ISO

Began Operations March 31, 1998 Not-for-profit California corporation Five-member Governing Board appointed by the Governor Serves peak load in excess of 50,000 MW Operates over 25,000 circuit miles of transmission, covering over

125,000 sq.miles. Oversees the dispatch of over 700 generating units Market re-design to begin March 31, 2008

Mission

Operate the grid reliably and efficiently

Provide fair and open transmission access

Facilitate effective markets and promote infrastructure development

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Core Functions of the California ISO

24 x 7 Grid Operations for Reliable and Non-discriminatory Transmission Service

CAISO Operates Markets:-- Transmission (Day Ahead and Hour Ahead)-- Real-time Imbalance Energy Market-- Ancillary Services

CAISO performs:-- Day-ahead scheduling-- Congestion management-- Market Oversight / Market Monitoring -- Coordinated Transmission Planning

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Key Market Players in the California ISO

Transmission Owners Pacific Gas &Electric Southern California Edison San Diego Gas & Electric Other entities owning transmission assets operated by

the California ISO

Generators

Load-Serving Entities Municipally-owned Electric Systems State Department of Water Resources

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California ISO’s New Day Ahead Process

Market Power Mitigation analysis Analyzes each generator bid to determine market power

Integrated Forward Market” – transmission model that optimizes Energy schedules (bids), manages transmission congestion, Procures ancillary services Procurement Produces:

• feasible schedules for Real Time • LMP prices at each node

Residual Unit Commitment Commits additional capacity, if needed, based on Demand forecast

Congestion Revenue Rights (CRRs) Point-to-point rights to revenues from transmission congestion

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What is LMP?

The marginal cost of serving the next increment of Demand at that node consistent with transmission constraints.

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Locational Marginal Pricing

LMP determines transparent prices at all price locations on the grid.

LMP prices generally consist of three components: Energy Congestion Losses

In California, generators are paid the LMP; load pays the averaged LMP in an area These Load Aggregation Points (LAPs) align with the three major

IOUs’ service areas.

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(A) How LMP makes congestion costs transparent

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(B) How LMP makes congestion costs transparent

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Why LMP?

LMP manages ALL congestion in the Day Ahead to create physically feasible schedules prior to real-time operations.

Locational price patterns indicate areas where additional generation and transmission upgrades are needed.

Within the CAISO: Generation is paid the LMP at the generator node. Demand pays the average price within each IOU service area.

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Understanding Financial Transmission Rights

Different terminology: PJM/ ISO-NE/ MISO: “Financial Transmission Rights” (FTRs) NYISO: “Transmission Congestion Contracts” (TCCs) California ISO: “Congestion Revenue Rights” (CRRs)

Definition: Rights to the hourly congestion revenue between two points – a

Source and a Sink. • Does not require scheduling energy between any two points• Allows hedging of congestion risk under LMP• Within CAISO, allocation / auction for terms of one month, one

season (four per year) and 10-years.

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Financial Transmission Rights

A financial instrument (similar to a forward contract) that entitles the holder to a revenue stream (positive or negative) Most CRRs are obligations, not options

Revenues are based on the difference between the marginal congestion component of the Day-Ahead LMPs at the Source location and Sink location. The revenue stream is not based on the marginal loss component of

the LMP.

Provide a hedging mechanism that can be traded separately from transmission service. FTRs are not necessarily linked to scheduling practices. FTR markets encompass several hundred million dollars.

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Convergence (Virtual) Bidding:

What is it?What is it?

Allows market participants to make financial sales (or purchases) for energy in the Day Ahead market, with the explicit requirement to buy back (or sell) that energy in the Real Time market.

Possibly profit from the differences between Day Ahead and Real Time prices.

Virtual bids pressure DA and RT prices to move closer together.

Requires careful credit standards for virtual bidders.

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How is it done?How is it done?

Example:Virtual Demand Bid in the Day Ahead Market

0

10

20

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60

10 20 30MW

$/M

Wh

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60

Bid_Price

Actual_DA_Price

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How is it done?How is it done?

Example:Virtual Bids are Liquidated as price takers in Real

Time

0

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10MW

$/M

Wh

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Cleared Bid Price Profit

Actual_DA_Price Actual_RT_Price

Actual RT Price ($55)

Actual DA Price ($34)

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Stable prices upon which parties can base contracts -- based on convergence of Day Ahead and Real Time prices.

Minimizes incentives to under-schedule in the Day Ahead.

Provides mechanism for generators to hedge risk of outages or be guaranteed the Real Time price.

Common feature in many ISOs and RTOs. CAISO will introduce convergence bidding no later than

April, 2009.

Convergence (virtual) bidding: Potential Benefits

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Summary

Overview of LMP markets, FTRs, virtual bidding and other financial mechanisms.

Organized markets permit financial practices within the scheduling and settlement of physical energy.

ISOs and RTOs work closely with state regulators in the design and monitoring of markets.

CAISO training modules on market processes, CRRs and other features are located at:

http://www.caiso.com/docs/2005/10/07/200510071157559066.html