S E P T E M B E R 3 - 4 , 2 0 1 4 | M A R K E T S C O M M I T T E E M E E T I N G

Catherine McDonough C M C D O N O U G H @ I S O - N E . C O M | 4 1 3 - 5 3 5 - 4 0 2 7

Summary of ISO Proposal & Response to GDF Suez Proposals

Peak Energy Rent (PER) Adjustment Mechanism

2

Summary

• ISO proposes to increase the daily PER strike price by $250 to reduce the impact of the FERC-ordered increase in Reserve Constraint Penalty Factors (RCPFs) on the PER Adjustment – ISO will likely only file the proposal if there is at least 60% support

from stakeholders.

3

FERC Ordered Impact Increase in RCPFsMay Shift Revenue from Resource Owners to Load via PER Adjustment

• To comply with the May 30, 2014 FERC Order ER14-1050 , ISO will increase the Reserve Constraint Penalty Factors (RCPFs)– Coincident with the Hourly Offers project, which is currently scheduled for Dec.

3, 2014

• Higher RCPFs may increase energy and reserve market revenue and the PER Adjustment.– Higher RCPFs will have a bigger impact on the PER Adjustment (a deduction

from FCM payments) than the increase in real-time energy and reserve market revenue

• Day-Ahead Locational Marginal prices (DALMPs) and Forward Reserve Market (FRM) prices will also rise but impact is hard to accurately predict

– Resource owners were not able to factor the revenue impact of higher RCPFs into bids for Forward Capacity Auctions (FCA) associated with CCP5-CCP8.

• So, the increase in RCPFs could transfer revenue from resource owners to load between December 2014 and May 2018

4

ISO ProposalRaise the PER Adjustment Strike Price by $250

• ISO proposes to recalibrate the PER Adjustment to minimize the Real-time (RT)revenue impact of higher RCPFs on resource owners by raising the daily PER strike price by $250 – Adjusting the PER strike price is a simple way to reduce the impact of higher

RCPFs on the PER Adjustment and can be done by December 3, 2014– With a higher PER strike price in place, the RT revenue impact of higher

RCPFs on resource owners would have been close to zero in CCP4 • See Appendix slide 17

– Reducing the impact of higher RCPFs on the PER Adjustment does not impact economic efficiency

• Because the ISO proposal addresses revenue allocation issues that raise equity issues and does not address reliability or economic efficiency concerns, the ISO likely would only file the proposal if there is at least 60% support from stakeholders.

ISO RESPONSE TO GDF SUEZ AMENDMENTS

6

Highlights

• ISO does not support GDF Suez Proposal to eliminate the PER Adjustment in CCP5-to-CCP9– Higher RCPFs do not change the rationale for the PER Adjustment under

existing FCM market rules – Clearing results for FCA5 to FCA-8 already factor in the existing PER

Adjustment– Bids for FCA-9 already factor in the existing PER Adjustment and Higher RCPFs

• ISO does not support GDF Suez Proposal to Change the PER Adjustment– Alternative calculation proposed by GDF Suez changes DAEM bidding

incentives in a way that will effectively eliminate the PER Adjustment– If the ISO review shows that the PER Adjustment plays no useful role in FCA10

and beyond, then it would be preferable to simply eliminate the PER Adjustment

7

ISO Does not Support GDF Suez Proposalto the Eliminate PER Adjustment: CCP5-CCP9

• GDF Suez proposes that the PER Adjustment be eliminated

• ISO does not support the elimination of the PER Adjustment in CCP5-to-CCP9– Higher RCPFs do not reduce the rationale for the PER Adjustment under

the existing FCM design– FCA bids and clearing results for FCA5-to-FCA-8 already factored in the

existing PER Adjustment calculation.– Bids for FCA-9 already factor in the existing PER Adjustment and Higher RCPFs

• ISO may support eliminating the PER Adjustment for FCA-10 and beyond if an internal review demonstrates that the PER Adjustment no longer serves a useful role and this determination is made prior to running the auction for FCA-10

8

ISO Does not Support GDF Suez Proposal for an Alternative PER Adjustment Calculation

• If the PER Adjustment is not eliminated, GDF Suez proposes that the PER Adjustment be calculated differently: – Hourly PER for MWs cleared in DAEM and delivered as energy,

reserves or regulation in real time should be based on DALMP– Hourly PER for MWs that do not clear in the DAEM but are delivered

as operating reserve in real time should be based on lower of the real-time operating reserve price or RTLMP

– Hourly PER should be zero for all MWs offering regulation service – Hourly PER should be same as existing calculation (RTLMP) for all

other CSO MWs

• ISO does not support the Alternative PER Adjustment calculation proposed by GDF Suez for any commitment period

9

Alternative PER Adjustment Calculation Weakens Existing Energy Price Hedge for Load

• Even with no change in participant behavior, the Alternative PER calculation weakens the hedge to load (See Example on page 10) – Hourly PER associated with MWs that clear in the DAEM (the majority of MWs cleared

in energy market) is effectively zero – DALMP should always be less or equal to the PER Strike

– Hourly PER for MWs that do not clear and provide reserves in real time will be less because reserve prices are sometimes less than RTLMPs

– Hourly PER will be zero for all resources that provide regulation MWs– Monthly PER Adjustment credit to load for CCP-4 would have been at least 54% lower

with Alternative PER Calculation

• Load gets a smaller PER Adjustment credit than what they paid for in the form of higher FCM clearing prices in CCP5-to-CCP9– FCA-5 to FCA-8 clearing prices were based on bids from resource owners that

incorporate the expected PER Adjustment under existing rules which is higher than what the expected PER Adjustment would be under the Alternative PER Calculation proposed by GDF Suez

– Bids for FCA-9 already factor in the existing PER Adjustment

10

Alternative PER Adjustment Weakens Energy Price Hedge For Load (even w/no change in participant behavior): Example

Existing PER Adjustment Creates a Price Cap for Load at the PER Strike Price

Alternative PER Adjustment Weakens this Hedge for Load

Existing PER* Alternative PER**

Assumptions

Resource CSO (MW) 100 100DAEM Clearing Cleared Generation (MW) 90 90 Cleared Decrements (MW) 90 90 DALMP= PER Strike (S) $500 $500 RTEM Clearing Cleared Physical Load (MW) 100 100 RTLMP $800 $800

Settlement

Energy Market Cost to Physical Load $80,000 $80,000 FCM PER Adjustment $30,000 $3,000 Net Cost to Physical Load $50,000 $77,000

*Max(RTLMP-S,0)* PER CSO

**Max (DALMP-S,0)* min(DA CLR MW,PER CSO) + Max ((RTLMP-S),0)*max(PER CSO- DA CLR MW),0)

11

Alternative PER Adjustment Changes DAEM Bidding Incentives in a Way that Effectively Eliminates the PER Adjustment

• Alternative PER Adjustment changes DAEM bidding incentives in a way that will effectively eliminate the PER Adjustment – CSO resources that clear in the DAEM will not pay any PER

Adjustment because DALMP < or = to PER strike price – CSO resources that do not clear in the DAEM can avoid the

PER Adjustment by submitting the following• Supply offer at the floor price in the DAEM • Decrement (DEC) bid for same amount of power at same location at high price• Supply Re-offer at MC in the RTEM (See example on slide 12)

• If the ISO evaluation indicates that the PER Adjustment serves no useful role in FCA-10 and beyond, it is preferable to eliminate the PER Adjustment than to implement an Alternative Calculation of the PER Adjustment that essentially has the same effect.

12

Alternative PER Adjustment Changes DAEM Bidding Incentives in a Way that Effectively Eliminates PER Adjustment : Example

(a) (b) (c) (d)

Existing PER Existing PER Alternative PER Alternative PER

Assumptions Adjustment * Adjustment * Adjustment ** Adjustment **Resource Owner Bidding Strategy Offer Resource @ MC Offer Resource @ low-price DAEM Offer Resource @ MC Offer Resource @ low-price DAEM

in DAEM DEC @ High price in DAEM in DAEM DEC @ high-price in DAEM

Re-Offer Resource @ MC in RTEM Re-offer Resource @ MC in RTEM

Resource MC $400 $400 $400 $400Resource CSO (MW) 100 100 100 100DAEM Cleared Supply MW 0 100 0 100Cleared DEC MW 0 100 0 100RTEM Cleared Supply MW 100 100 100 100 PER Strike Price (S) $500 $500 $500 $500DALMP $200 $200 $200 $200RTLMP No Shortage $50 $50 $50 $50 Shortage $800 $800 $800 $800

PER Adjustment No Shortage $0 $0 $0 $0 Shortage $30,000 $30,000 $30,000 $0

Variable Profit = Revenue-Cost- PER Adjustment No Shortage $0 $0 $0 $0 Shortage $10,000 $10,000 $10,000 $40,000

* Max(RTLMP-S,0)* PER CSO

**Max (DALMP-S,0)* min(DA CLR MW,CSO) + Max ((RTLMP-S),0)*max(PER CSO- DA CLR MW),0)

13

Summary and Next Steps

Date Action

July 2014 Introduction

August 2014 Discussion of ISO Proposal to Address Impact of Higher RCPFs

September 2014 MC Vote on ISO Proposal

October 2014 PC Vote and Filing with FERC, pending support by participants

December 2014 Implementation of Higher RCPFs & ISO Proposal to raise PER Strike price, if filed and approved by FERC

• May 30, 2014 FERC Order ER14-1050 has implications for the PER Adjustment • RCPFs will be increased, coincident with the Hourly Offers project,

independent of any action taken to modify PER Adjustment rules for CCP5 and beyond

• ISO is proposing to increase the PER strike price by $250 to reduce the impact of the increase in RCPFs on the PER Adjustment for the interim CCP5-CCP8 period

APPENDIX Background Material

Simulated Revenue Impact of Higher RCPFs

16

Reserve Market Impact of FERC-ordered Increase in RCPFs: Simulated Back-cast for CCP3 and CCP4 (June 2012-May 2014)

Simulated Increase in Revenues (millions)

Year TMSR TMNSR TMOR Total

CCP3 $ 0.79 $ 1.90 $ 0.64

$ 3.34

CCP4 $ 8.55 $ 11.66 $ 4.47

$ 24.68

Annual Average $ 4.67 $ 6.78 $ 2.56

$ 14.01

Reserve Market Revenue would havebeen $25M greater in CCP4, and $14M greater on average in CCP3 & CCP4

17

Some Revenue Impacts of FERC-ordered Increase in RCPFs: Simulated Back-cast for CCP4 (June 13-May 14)

•If the FERC-ordered increase in RCPFs had been in place in CCP4:

• Reserve market revenue would have been $25M higher• RT peak energy rents would have been $7M higher • PER Adjustment would have credited $99M more back to load. • RT impact on resource owners net of the PER Adjustment would have been

= $25M +7M- $99M = -$67M•Excludes the potential impact of higher RCPFs on DAEM revenue, which is likely positive, but difficult to predict

Years Capacity Commimtent Period Reserve Market Revenue

RT Peak Energy Rents

PER Adjustment Revenues

2010-2011 CCP1 13.6$ 12.1$ (188.1)$

2011-2102 CCP2 6.9$ 0.2$ (36.3)$

2012-2013 CCP3 34.8$ 0.3$ (1.6)$

2013-2014 CCP4 63.7$ 1.4$ (25.2)$

2013-2014 CCP4 Estimate w/ Higher RCPFs 88.4$ 8.4$ (124)$

Estimated Impact of Higher RCPFs CCP4 24.7$ 7.0$ (99.0)$

Summary of Participant Input

19

Summary of Participant Comments Near Term Issue

• Several Participants suggested that nothing be done. – The impact of higher RCPFs on the PER Adjustment was not

unexpected and NEPOOL previously voted down proposals to change/eliminate the PER Adjustment when they voted to increase the RCPFs as part of the NEPOOL alternative to the FCM PFP.

– Participants also observed that the increase in the PER Adjustment due to higher RCPFs could be offset by higher energy and reserve market revenue.

• Several participants suggested ‘re-calibrating’ the PER Adjustment to neutralize impact of higher RCPFs (on the PER Adjustment).

• Some participants recommend that the PER Adjustment use an Adjusted RTLMPs that ‘nets out’ the increase in the RCPFs when they take effect on December 3, 2014.

20

Summary of Participant Comments & ISO ResponseNear Term Issue

• Some participants suggested that the PER Adjustment be eliminated in CCP5-CCP8, indicating that: – PER Adjustment is not necessary to curb the incentive to exercise market

power in the energy market because IMM has other means to do so via the actions detailed in Appendix A.

– PER Adjustment is an imperfect hedge for load; commercial retailers can also provide hedges.

– Previously proposed during the debates of on the FCM PFP and NEPOOL’s Alternative

• ISO does not support eliminating the PER Adjustment in CCP5-CCP9– Higher RCPFs do not reduce the rationale for the PER Adjustment under the

existing FCM design– ISO may support eliminating the PER Adjustment for FCA10 and beyond if an

internal review demonstrates that it no longer serves a useful role.

21

Summary of Participant Comments & ISO ResponseNear Term Issue (continued)

• Some Participants suggested we calculate the PER Adjustment based on a resource’s cleared status in energy/reserve markets – The PER Adjustment calculation should depend on whether a

supplier clears in the Day-Ahead Energy Market (DAEM) or in the Real-Time Energy Market (RTEM)and whether a supplier provides energy or reserves in real time.

– This approach was previously proposed by GDF Suez during debates on the FCM PFP and NEPOOL’s Alternative.

• ISO does not support any proposal to calculate the PER Adjustment based on a resource’s cleared status for any commitment period – Calculating the PER Adjustment in this way distorts DA/RT bidding

incentives (See Examples in Appendix pages 27-30 )

Historical Perspective on PER Adjustment

23

Existing PER Adjustment:Historical View of Key Components

1/1/2

008

5/1/2

008

9/1/2

008

1/1/2

009

5/1/2

009

9/1/2

009

1/1/2

010

5/1/2

010

9/1/2

010

1/1/2

011

5/1/2

011

9/1/2

011

1/1/2

012

5/1/2

012

9/1/2

012

1/1/2

013

5/1/2

013

9/1/2

013

1/1/2

014

5/1/2

014$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

Maximum Daily RT LMP vs. Daily PER Strike Price

24

Existing PER Adjustment : Historical View of Monthly PER and Moving Average of Monthly PER

1/1/2

008

4/1/2

008

7/1/2

008

10/1/2

008

1/1/2

009

4/1/2

009

7/1/2

009

10/1/2

009

1/1/2

010

4/1/2

010

7/1/2

010

10/1/2

010

1/1/2

011

4/1/2

011

7/1/2

011

10/1/2

011

1/1/2

012

4/1/2

012

7/1/2

012

10/1/2

012

1/1/2

013

4/1/2

013

7/1/2

013

10/1/2

013

1/1/2

014

4/1/2

014$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

Monthly PER Average Monthly PER

$/kW

-mon

th

25

Hours when Hourly PER Value Has Been Positive Since December of 2010;

Day Hour PER Strike RT LMP DA LMP RT-DA LMP

 

1/28/2013 18 $ 560 $ 781 $ 209 $ 572

6/24/2013 16 $ 513 $ 569 $ 88 $ 481

7/19/2013 13 $ 558 $ 704 $ 183 $ 521

7/19/2013 14 $ 558 $ 869 $ 196 $ 673

7/19/2013 15 $ 558 $ 709 $ 207 $ 503

7/19/2013 16 $ 558 $ 630 $ 209 $ 421

7/19/2013 17 $ 558 $ 585 $ 219 $ 366

9/11/2013 17 $ 552 $ 592 $ 419 $ 173

11/24/2013 20 $ 548 $ 717 $ 100 $ 618

12/14/2013 18 $ 724 $ 1,290 $ 275 $ 1,015

Average $ 569 $ 745 $ 211 $ 534

•Average RT/DA LMP Differential when Hourly PER Value is Positive = +$535

•RCPFs were activated in all of these hours

Note: All prices and differentials shown in $/ MWh

Existing PER Adjustment DOES NOT DISTORT DA/RT Bidding incentives

27

Existing PER Adjustment Does Not Distort DA/RT Bidding Incentives

• Current PER Adjustment is based on the supplier’s CSO and not on the megawatts that a supplier clears in real time.

• A competitive supplier cannot change the PER Adjustment by bidding more or less in the DA or RT energy market

28

Example

• Assume – Supplier has one unit with MC = $50/MWh and CSO= 300 MW– PER Strike price is $120/MWh– DALMP =$100 – RTLMP =$150

• Case 1 : Clears DA w/ PER Adjustment • Case 2 : Clears RT w/ PER Adjustment • Case 3 : Clears DA w/ No PER Adjustment • Case 4 : Clears RT w/ No PER Adjustment

– Table on slide 24 shows calculation of total variable profit for each case with the existing PER Adjustment

– Table on slide 25 compares the relative profit of clearing DA or RT with the existing PER Adjustment

29

Existing PER Adjustment Mechanism Example (continued)

MW Revenues VC PER ADJ Total

Case 1: Clears DA w/ PER Adjustment DA 300 30,000$ (9,000)$ 21,000$ RT 300 (15,000)$ (15,000)$ RT-DA 0 -$ Variable Profit 6,000$ Case 2: Clears RT w/ PER Adjustment DA 0 -$ -$ RT 300 (15,000)$ (9,000)$ (24,000)$ RT-DA 300 45,000$ 45,000$ Variable Profit 21,000$ Case 3: Clears DA w/ no PER Adjustment DA 300 30,000$ 30,000$ RT 300 (15,000)$ (15,000)$ RT-DA 0 -$ Variable Profit -$ 15,000$ Case 4: Clears RT w/ no PER Adjustment DA 0 -$ -$ RT 300 (15,000)$ (15,000)$ RT-DA 300 45,000$ 45,000$ Variable Profit -$ 30,000$

30

Existing PER Adjustment Mechanism: Example (continued)

Existing PER Adjustment Does Not Change the Profitabilityof Clearing in DA versus Clearing in Real Time

Summary of Total Variable Profit

PER Adj. No PER Adj

Clears DA 6,000$ 15,000$

Clears RT 21,000$ 30,000$

Difference 15,000$ 15,000$

Calculating the PER Adjustment Based on A Resource’s Cleared Status DISTORTs DA/RT Bidding incentives

32

Alternative Calculation of PER Adjustment

• Calculate PER Adjustment based on whether a participant clears in the DAEM or RTEM

Max (DALMP-S,0)* min(DA CLR MW,CSO) +

Max ((RTLMP-S),0)*max(PER CSO- DA CLR MW),0)

• NEPOOL voted down a variant of this approach proposed by GDF Suez – Hourly PER for MWs cleared in DAEM and delivered as energy, reserves or

regulation in real time should be based on DALMP– Hourly PER for MWs that do not clear in the DAEM but are delivered as operating

reserve in real time should be based on lower of real time operating reserve price or RTLMP for

– Hourly PER should be zero for all MWs offering regulation service – Hourly PER should be same as existing calculation (RTLMP) for all other CSO MWs

• ISO does not support any approach that makes the calculation hinge on how a resource clears because to do so would interfere with bidding incentives as shown in the following example

33

Example: Alternative PER Adjustment Calculation MW Revenues VC ALT PER ADJ Total

Case 1: Clears DA w/ PER Adjustment DA 300 30,000$ -$ 30,000$ RT 300 (15,000)$ (15,000)$ RT-DA 0 -$ Variable Profit 15,000$ Case 2: Clears RT w/ PER Adjustment DA 0 -$ -$ RT 300 (15,000)$ (9,000)$ (24,000)$ RT-DA 300 45,000$ 45,000$ Variable Profit 21,000$ Case 3: Clears DA w/ no PER Adjustment DA 300 30,000$ 30,000$ RT 300 (15,000)$ (15,000)$ RT-DA 0 -$ Variable Profit -$ 15,000$ Case 4: Clears RT w/ no PER Adjustment DA 0 -$ -$ RT 300 (15,000)$ (15,000)$ RT-DA 300 45,000$ 45,000$ Variable Profit -$ 30,000$

34

Example: Alternative versus Existing PER Calculation

Existing PER Adjustment Does Not Change the Profitability of Clearing DA versus in Real Time

Summary of Total Variable Profit

PER Adj. No PER Adj

Clears DA 6,000$ 15,000$

Clears RT 21,000$ 30,000$

Difference 15,000$ 15,000$

ALT PER Adj. No PER Adj

Clears DA 15,000$ 15,000$

Clears RT 21,000$ 30,000$

Difference 6,000$ 15,000$

Alternative PER Adjustment Changes the Profitability of Clearing in DA versus Real Time

PER Adjustment Mechanism: The Details

36

Existing PER Adjustment Mechanism: Details • Hourly PER = (RTLMP-S)* Scale Factor*Availability Factor

– RTLMP: for each Load Zone associated with particular capacity zone – S: variable cost of marginal generating proxy unit (22,000 BTU/kWh) * daily cost

of gas or oil whichever is higher– Scale factor: creates lower weighting for hours when load is low relative to

forecasted peak• Calculated as the actual hourly integrated load divided by the summer

50/50 predicted peak forecast – Availability Factor: marginal proxy unit = 0.95

• Monthly PER = Sum of Hourly PER values for the month.

• Average Monthly PER = 12 month moving average of Monthly PER values prior to the obligation month.

37

Existing PER Adjustment Mechanism Details (continued)

• PER Adjustment = Average Monthly PER * PER CSO

– PER CSO = minimum [CSO, (CSO – Self Supply Obligation)] – Monthly PER Adjustment is capped at the FCA Payment adjusted to

account for obligations acquired or shed for the same commitment period after the FCA

– PER CAP = FCA Payment + [(ARA CSO+MRA CSO+IBTCSO) *FCA Clearing Price*)]

– FCA payment is payment received for activity in the Forward Capacity Auction– [ARA CSO +MRA CSO +IBT CSO] are obligations acquired or shed – FCA clearing price * is adjusted for price collar (This price is used as a proxy price to

prevent opportunities to manipulate the PER CAP such as could be done with a bilateral at zero contract price)

– ARA is annual reconfiguration auction, MRA is the monthly reconfiguration auction and IBT is internal bilateral transactions