2007 ERCOT SOM Report Recommendations

1. 2007 ERCOT SOM ReportRecommendations Dan L. Jones Vice President Director, ERCOT IMM Potomac Economics ERCOT Wholesale Market Subcommittee Austin, Texas November 19, 2008

2. 2007 SOM Recommendations • Zonal Only • PRR 650 issues (2006 and 2007 SOM Reports) • Re-evaluation of Reserve Discount Factor (done) • Zonal and Nodal • Improve reliability of efficient shortage pricing • Day-ahead load/wind forecast error and interplay with unit commitment and reserve procurement objectives • Revision to Peaker Net Margin calculation (PUCT rule) • Nodal Only • Efficient responsive reserve pricing (nodal) • Real-time co-optimization of energy and reserves (nodal)

3. Specific Recommendations • Replacement for PRR 650 • PRR 601: 15 minute ramp • Improve reliability of efficient shortage pricing • Commitment and insurance

4. PRR 650 Replacement

5. PRR 650 Replacement • 2006 ERCOT SOM Report • Ideally the pricing adjustments should be performed in real-time instead of after-the-fact to send accurate and timely price signals to both resources and loads • The current re-pricing mechanism is rather extreme in that it effectively assumes that the energy from non-spinning reserve units is offered at the system-wide offer cap • It would be more reasonable to employ an ex ante proxy price that is a function of the incremental costs of deploying an off-line gas turbine • We are optimistic that the current efforts related to PRR 776 will result in a reasonable replacement to the PRR 650 methodology

6. PRR 601

7. PRR 601 • Recommendation from the Potomac Economics 2004 Operations Review Report • Changes the BES ramping time from 10 minutes to 15 minutes • PRR 601 was approved by the ERCOT Board on 11/15/05 • PRR 601 remains “boxed” in the Protocols • Priority was reduced due to nodal timeline as expected in 2006 (removed from PPL?) • PRR 601 does not increase the quantity of BES that exists; rather, it increases the quantity of existing BES that is available to be dispatched in an interval

8. Avg. UBES Available for DispatchJan. 1 – Oct. 31, 2008

9. Efficient Shortage Pricing

10. Efficient Shortage Pricing • Currently, when system-wide BES is exhausted (including MWs obtained by violating portfolio ramp constraints), the MCPE is equal to the offer price of the last MW dispatched. This is a long-standing “price administration” process in SPD. • The original price in SPD is actually $5,000,000/MWh • The “administered” price is equal to the highest offer price dispatched • Thus, to the extent an operating reserve shortage results in the depletion of BES, the pricing results are entirely dependent upon the magnitude of the highest offer price dispatched • Experience in ERCOT and other markets has shown that this is not a reliable mechanism to produce efficient prices during shortage conditions • FERC Order No. 719 includes a mandate for FERC-jurisdictional RTOs/ISOs to “ensure that the market price for energy reflects the value of energy during an operating reserve shortage.”

11. FERC Order No. 719 • The Commission continues to find that existing rules that do not allow for prices to rise sufficiently during an operating reserve shortage to allow supply to meet demand are unjust, unreasonable, and may be unduly discriminatory. In particular, they may not produce prices that accurately reflect the value of energy and, by failing to do so, may harm reliability, inhibit demand response, deter entry of demand response and generation resources, and thwart innovation. • Each RTO or ISO is required to reform or demonstrate the adequacy of its existing market rules to ensure that the market price for energy reflects the value of energy during an operating reserve shortage.

12. MCPE During Balancing Energy Depletion2007 – Excluding intervals with zonal congestion or NSRS deployment

15. Effect of Efficient Shortage Pricing in 2007 • MCPE (annual average load-weighted) • Original: $56.35/MWh • Change: $58.88/MWh • Difference: $2.53/MWh (4.5% increase) • Peaker Net Margin • Original • $51,532/MW-yr • 18.2% of annual PNM was during shortage intervals • Change • $71,159/MW-yr (38.1% increase) • 40.8% of annual PNM would have occurred during these shortage intervals

16. System Changes • Create a virtual ERCOT QSE (VQSE) with a virtual resource in each zone • UBES offer from each VQSE of X MW offered at $Y/MWh at zero MW and $Z/MWh at X MW • For example, X = 20, Y = $500, and Z = $2,250 • Ramp rate capable of deploying X MW in 10 minutes (or 15 minutes under PRR 601) • Activate the VQSE resources (i.e., show them online) only when Adjusted Responsive Reserve drops below a defined threshold value • For example, VQSE resources activated when ARR drops below 3,000 MW • Activating a VQSE resource would not necessarily mean that it would deployed. In fact, in most cases when activated, it would not be deployed.

17. Commitment & Insurance

18. Commitment and Insurance • 2007 ERCOT SOM Report • ERCOT’s day-ahead load forecast exhibited a persistent positive bias in 2007 that was particularly high during the summer months, which will tend to lead to an inefficient over-commitment of resources and to the depression of real-time prices relative to a more optimal unit commitment. • In conjunction with the day-ahead load forecast review, ERCOT should explore potential changes to its reserve procurement policies and its day-ahead and supplemental unit commitment procedures in an effort to enhance the efficiency of its unit commitment processes while still satisfying reliability requirements. Additionally, this review should include the effects of the considerable increase in the installed wind generation capacity in the ERCOT region. Substantial addition of more unpredictable and uncontrollable resources has significant implications related to efficient and reliable unit commitment and real-time operations. • 2008 Texas State Energy Plan (Recommendation 7) • The PUCT and ERCOT should study whether an additional operating reserve service to help manage the intermittency of wind energy or other alternative energy sources would be a cost-effective solution to more reliably integrating these energy sources to the grid. Such a service could be provided by quick-start natural gas units, demand-response by customers, or storage solutions.

19. Commitment and Insurance • Review the objectives that are intended to be met by the Non-spin product • The objectives that are intended to be met by NSRS have changed over time from a unit-contingency focus to a load and wind uncertainty focus (i.e., a net load uncertainty focus) • These objectives may be more efficiently met by a revised product definition, or multiple products, while maintaining or even enhancing the reliability value of the product(s) • At this time, it appears most productive to focus this effort on the product(s) as it (they) will be used in the nodal market implementation • Eliminate the Day Ahead load and wind forecast biases • ERCOT procedures currently contain a positive bias in the load forecast, and the intent to have a negative bias in the wind forecast • Combined, these two factors create a bias toward over-commitment in the Day Ahead • In a system with only long lead-time, inflexible resources, DA over-commitment could be optimal • In a system with only short lead-time, flexible resources, DA under-commitment could be optimal • The characteristics resources available in the ERCOT system is a mix of both categories, with the marginal units from a commitment perspective consisting of more units that would fall into the short lead-time, flexible category than in the long lead-time, inflexible category • ERCOT should continue to improve the accuracy of its DA load and wind forecasts to minimize the error in both, and perform unit commitment to the expected values • The residual uncertainty should be managed with the product or products that result from the NSRS review