Local TMOR Reserve Constraint Penalty Factor (RCPF) Re-evaluation

1. Local TMOR Reserve Constraint Penalty Factor (RCPF) Re-evaluation NEPOOL Markets Committee 12 May 2009

2. Outline • Background • Why Reevaluate the Local TMOR RCPF? • What the Data Show… • What is the appropriate RCPF level? • Economic Analysis • Main Findings of the Economic Analysis • Benefits of the Proposal

3. Background • In the real-time co-optimized energy and reserve market, the reserve clearing price reflects the re-dispatch costs that are incurred to maintain reserves. • The reserve clearing price is set at the RCPF if • available reserves are not sufficient to satisfy the reserve requirement; or • the cost of re-dispatch for procuring reserves exceeds the RCPF. • The current RCPF value associated with the local TMOR requirement is $50/MWh.

4. Why Reevaluate the Local TMOR RCPF? • The RCPF levels are important because they determine how the real-time market responds under tight operating conditions. • When it is not possible to meet the reserve requirements, the RCPFs prevent the market from incurring extraordinary costs for little or no reliability benefit. • If the RCPFs are not sufficiently high, the market may not schedule all available resources to meet the reliability requirements. • In such cases, the system operator may intervene to maintain reserves, affecting market prices in the process.

5. What the Data Show…

6. What is the appropriate RCPF level? • The data show that with a local TMOR RCPF of $50/MWh, the ISO must frequently intervene to schedule resources to meet the local TMOR requirement. • The ideal RCPF value should allow the market system to optimize the use of resources within the constrained area and transmission interface capability to most economically meet the local TMOR requirement. • In practice, concerns over market concentration and resulting incentives to strategically offer reserve capability constrained the choice of RCPF to $50/MWh. • The ISO has conducted an analysis to reevaluate the appropriate local TMOR RCPF value going forward.

7. Economic Analysis • OBJECTIVE: • Determine the local TMOR RCPF value that balances mitigation of market power and efficient dispatch consistent with reliability requirements. • RESULT: • Change the local TMOR RCPF from $50/MWh to $250/MWh.

8. Main Findings of the Economic Analysis • The $250/MWh local TMOR RCPF allows the market system to economically schedule resources to meet requirements under the majority of conditions, avoiding the need for frequent market interventions. • No choice of RCPF completely eliminates the incentive for resources to strategically offer their reserve capability. • The RCPF does cap the maximum price the ISO is willing to pay for reserves effectively limiting the impact of any strategic behavior.

9. Benefits of the Proposal • On balance, increasing the local TMOR RCPF from $50/MWh to $250/MWh produces overall market efficiency gains, reducing the cost of maintaining reliability in constrained areas. • The proposed RCPF more accurately reflects the cost of maintaining local reserves in the real-time market, improving incentives for market-based day-ahead commitments in the local areas. • In general, more day-ahead commitments reduce the need for supplemental commitments in the RAA process and shift local reliability costs from NCPC payments to market clearing prices. • Higher RCPFs better reflect the cost of maintaining reserves, potentially improving price signals for capital investment in constrained areas.