Incorporating Opportunity Cost in Massachusetts Greenhouse Gas Emissions Regulation

1. September 13, 2017 | Westborough, MA Gregg Bradley (413) 540-4012 | gbradley@iso-ne.com Including Opportunity Cost in IMM Reference Levels Massachusetts Green House Gas Emissions Regulation Donal O’Sullivan (413) 540-4478 | dosullivan@iso-ne.com

2. New Massachusetts CO2 regulation will limit generator run hours from 2018 onward • IMM will calculate an opportunity cost adder to allow each affected generator to incorporate the cost of the regulation into their energy offer • Methodology discussed today applicable to 2018 andwill be modified to reflect changes in regulations that are effective in 2019

3. Agenda for Today • Outline of regulation 310 CMR 7.74: Reducing CO2 Emissions from Electricity Generating Facilities • Incorporation of opportunity cost adder into generator reference levels • Method of calculation of opportunity cost

4. MassDEPRegulation 310 CMR 7.74: Reducing CO2 Emissions from Electricity Generating Facilities • Regulation goal is to reduce greenhouse gas emissions by establishing declining annual aggregate CO2 emissions limits for electricity generating facilities • Operators of generating facilities will offset their CO2 production with allowances where an allowance is a limited authorization to emit one metric ton of CO2 in a calendar year • Allowances allocated directly in 2018 based on historical generation; For 2019 onward, allowances will be auctioned • Allowances may be traded between facilities and a limited quantity may be banked from year to year

5. 310 CMR 7.74Which facilities are subject to new regulation? • At present, 310 CMR 7.74 will apply to 21 existing facilities in Massachusetts • If regulation is applicable to your resource but you are not identified in the regulation, please contact IMM with documentation • Regulation detail can be found at: http://www.mass.gov/eea/docs/dep/air/climate/3dregf-electricity.pdf

6. 310 CMR 7.74 How will generators be affected? • Opportunity cost is the loss of potential financial gain when one alternative is chosen over another • Subject to a limit on production, generators incur an opportunity cost when they generate in a particular hour and in doing so forego more profitable generation at a later time • Existing ISO Tariff language allows inclusion of opportunity cost to account for emissions limitations when determining a resource’s incremental energy costs ..opportunity costs may include, but are not limited to, economic costs associated with complying with: (a) emissions limits; (b) water storage limits; and, (c) other operating permits that limit production of energy. - ISO Tariff Section III.A.7.5.1 • This language allows the IMM to incorporate opportunity costs into generator reference levels without a revision to Appendix A

7. IMM Reference LevelOverview • Currently, IMM calculates generator reference levels based on resource specific parameters (VOM, Heat Rates etc.) and market fuel prices • IMM use fuel price indices from 3rd party vendors to represent the current market price • IMM allow for participants to enter Fuel Price Adjustments (FPAs) when the market price does not represent the fuel price they expect to pay at their location

8. IMM Reference LevelOpportunity Cost • IMM will calculate an opportunity cost for each resource identified in the new regulation • IMM will update the opportunity cost for each resource on a weekly basis • The opportunity cost will be visible to applicable participants in the new IMMAC software in CAMS

9. IMM Reference LevelParticipant Proposed Opportunity Cost • If IMM’s calculated opportunity cost method does not fully value the opportunity cost of your resource, please propose an alternative • Participants who propose a methodology will be required to provide a detailed explanation of their methodology, including the underlying principals, along with the model • IMM will provide a detailed description of our model, the participant’s explanation should include the same level of detail • Once the participant’s methodology is approved, IMM will perform the calculations and update the opportunity cost for the resource going forward

10. Opportunity Cost Simplified Solution at Onset • Forecasting energy margins requires a complex optimization model that considers relevant operational constraints (e.g., minimum run and down times, ramp rates, etc.) • Time frame too short to develop and implement optimization approach as solution for 2018, 2019 • For 2018, IMM will calculate opportunity cost with a simplified approach based on historical profit margins

11. Opportunity Cost Calculation Approach Conceptually, the approach uses historical margins during run hours and evaluates the impact of the emissions limitation (as an output limitation) on profit Calculation Steps • Compute margin (revenue – cost) for each historical run of the asset and the energy produced during that run • Create a “duration curve” of margins (revenue – cost) against output • Set lost opportunity cost (LOC) at the margin corresponding to the lowest output value before reaching the emissions output limit shown on the “duration curve” • Calculate LOC for each of the previous three years and average the results to obtain LOC for use in the reference price • Update calculation weekly to: (i) include only margins that occurred historically in the same weeks as the remaining weeks of the current year, and (ii) update emissions output limit by subtracting previous week’s output

12. Opportunity CostComments • IMM solution to incorporate costs associated with new CO2 regulation can be developed quickly for Jan 1 implementation • Model will be amended for 2019 to adjust for auction based method of allowance allocation and valuation • Plan to develop more comprehensive model to calculate opportunity costs for a wider range of use limitations for future implementation (beyond 2019)

13. Next Steps • Participants that (a) are impacted by the regulation and (b) want an opportunity cost adder in their reference curve need to contact IMM • Timeline: • Sept. 22, 2017: Participants to contact IMM to notify interest • Oct. 20, 2017: Release of IMM methodology white paper • Nov. 3, 2017: Deadline to submit an alternative method • Dec. 15, 2017: Preliminary LOC adder provided to participant • Dec. 31, 2017: LOC adder included in energy reference bid for DAM • Jan. 1, 2018: LOC adder included in energy reference bid for RTM

14. Donal O’Sullivan (413) 540-4478 | dosullivan@iso-ne.com Gregg Bradley (413) 540-4012 | gbradley@iso-ne.com