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Net CONE for the ISO-NE Demand Curve

Net CONE for the ISO-NE Demand Curve. Summary of Initial Analysis. NEPOOL Markets Committee. Sam Newell, Brattle Christopher Ungate , Sargent & Lundy. January 14, 2014. Agenda. Net CONE Objectives and Approach Review of Key Factors for Net CONE Analysis

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Net CONE for the ISO-NE Demand Curve

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  1. Net CONE for the ISO-NE Demand Curve Summary of Initial Analysis NEPOOL Markets Committee Sam Newell, Brattle Christopher Ungate, Sargent & Lundy January 14, 2014
  2. Agenda Net CONE Objectives and Approach Review of Key Factors for Net CONE Analysis Factors that Differ from Offer Review Trigger Price Analysis Choice of Reference Technology Cost of Capital Capital Cost Components E&AS Margins Locational Screening Analysis Schedule
  3. Net CONE Objectives and Approach Our objective is to determine the Net Cost of New Entry (Net CONE) parameter for helping to establish pricing parameters in ISO-NE’s proposed demand curve Net CONE is the capacity revenue a new resource would need in its first year to be economic, given reasonable assumptions about first year energy and ancillary services (E&AS) margins and revenues in later years Our starting point for analyzing Net CONE will be the 2013 Offer Review Trigger Prices (ORTP) Study methodology with the following differences Analyze only a few potential “reference technologies” and recommend one for use in the demand curve Assume an expected competitive entrant instead of the “low end of competitive entrants” Do not assume a power purchase agreement (PPA) for non-capacity revenues Assess differences in Net CONE in several capacity zones
  4. Adjustments in Methodology from ORTP Example Net CONE Calculation Based on ORTP Combined Cycle We propose to adjust only the items underlined and in red,as well as performance variables (capacity, heat rate) that depend on the selected plant location We will consider Combined Cycle (CC), LMS100 and Frame-Type Combustion Turbine (CT) technologies, then recommend one as the reference technology
  5. Relative Importance of Adjusted Factors Note: For illustrative purposes, this table shows the Net CONE impact based on the reference CC
  6. Choice of Reference Technology Possible criteria for setting demand curve reference technology Lowest Net CONE over time (vs. Lowest CONE)? Most common technology being built? Easiest to calculate, or most stable over time? Initial recommendation is 2×1 CC or 2×0 Frame CT Frame CT Net CONE appears less than CC, but CC could become more economic in the medium to long term if gas prices rise CC dispatch profile is better suited to using 5x16 on-peak futures to estimate a weather-normalized, forward-looking E&AS margin No Frame CT has been built in ISO-NE in simple-cycle mode; only one F-class nationally with SCR, but working well so far NYISO is seeking FERC approval for demand curves based on Frame CTs with SCRs in SENY; generator interveners argue commercial viability unproven
  7. Cost of Capital Adjustment We recommend the after-tax weighted average cost of capital (ATWACC) for the Net CONE analysis to be 8.0% We have reviewed a broader range of sources to estimate the cost of capital for a pure-play merchant generator with no PPA We updated the analysis of publicly traded companies such that NRG is now 6.1% and Calpine is 7.8%; we put more weight on Calpine as it has less hedging We considered additional data points based on previous estimates, fairness opinions for merchant generation divestitures, and analyst estimates; 2011 and 2012 data points have been adjusted forward to Nov 2013 based on changes in the risk-free rate (2011 = -0.9%, 2012 = +0.7%) As most of these companies have some level of hedging, a pure-play merchant generator with no PPA would be expected to be at the higher end of the range Cost of Capital Estimates for Merchant Generation Companies Note: 2011 and 2012 estimates have been adjusted based on changes in the risk-free rate. The risk-free rates were 4.3% in April 2011, 2.7% in July 2012, and 3.4% November 2013. Sources noted in Appendix slides.
  8. Labor Rates and Plant Performance As the Net CONE for demand curve is for an expected competitive entrant and not a “low end” competitive entrant, we reviewed the assumed location of the plants to ensure it is representative of labor rates and plant performance for the Rest of Pool (ROP) capacity zone Based on our review, we recommend Worcester County, MA Labor rates are representative of the ROP capacity zone (Construction Labor is 9% higher than Hampden County, and Other Labor is 3% higher) Worcester County has access to gas and electrical interconnections Worcester County is located at a higher elevation (450 ft) than the ORTP location of Hampden County (70 ft), which reduces net capacity of similarly configured plants
  9. Gas Interconnection Costs To reflect the costs of an expected competitive entrant (not strictly the “low end”), we updated our analysis of gas lateral costs based on gas pipeline projects with 16 – 24” diameter in ISO-NE (since 2007) and the U.S. (since 2011) The gas lateral length was calculated based on the estimated distances of existing gas plants from gas pipelines The reference technologies are assumed to have equal gas interconnection costs Note: See appendix slides for gas interconnection cost data.
  10. Electrical Interconnection Approach To reflect costs for an expected competitive entrant, we are conducting a bottom-up analysis of electric interconnection costs that is similar to the approach used by S&L in the NYISO Demand Curve Reset study ISO-NE is providing data on interconnection requirements for previously built gas plants (SIS studies, interconnection agreements) Based on that data, we will develop a reasonable list of items that a typical new unit would need, including transmission lines, substation equipment, substation expansion, and network upgrades S&L will estimate the cost of each line item specified Electrical interconnection costs may differ among potential reference technologies Our initial Net CONE estimates on slide 5 use placeholder values from other relevant studies
  11. Contingency Costs Contingency costs are included in cost estimates for new generation facilities as the actual costs of building the plant are often higher than anticipated during the development phase To reflect the expected costs for a competitive entrant, we have increased contingency rates from the ORTP assumed rates which reflected the “low end” of competitive entrants EPC Contingency: increased from 10% in ORTP to 12% here Owner’s Contingency: increased from 8% in ORTP to 10% here This adjustment is consistent with the range of contingency values observed by S&L for projects where a conceptual engineering design is available, but detailed engineering has not yet been performed
  12. E&AS Margins In the ORTP analysis, we calculated 2018/2019 E&AS margins based on actual 2010 – 2012 E&AS margins for like-units and the relationship between historical spot prices and FCA9 commitment period futures prices For the Net CONE analysis, we updated the E&AS margins for the Combined Cycle and LMS100 based on Jan 6, 2014 gas and electricity futures prices Combined Cycle = $4.21/kW-mo (ORTP CC = $3.75/kW-mo) LMS100 = $2.93/kW-mo (ORTP LMS100 = $2.71/kW-mo) Calculating E&AS margins for the Frame CT requires a different approach given the lack of historical data for similar units We conducted a virtual dispatch of a Frame CT and LMS100 against hourly electricity prices for 2010 – 2012 to compare revenues earned Due to its higher heat rate, the Frame CT earned 28% less revenues than the LMS100 over the time period analyzed Based on this approach, we estimate a Frame CT would earn E&AS margins of $2.12/kW-mo (2018$) during the 2018/2019 commitment period We are considering updating the analysis to incorporate 2013 revenues in the historical data
  13. Locational Screening Analysis The objective of the screening analysis is to identify regions in non-ROP capacity zones where new generation is likely to be sited and Net CONE is 15% greater than ROP value These areas would be candidates for a zone-specific Net CONE Labor cost is the primary factor that could cause a differential of that magnitude We examined the following higher cost labor areas Stamford/Norwalk CT (60-76% higher than Worcester MA) Boston (47% higher) Lowell/Lawrence MA (21% higher) Hartford (15% higher) New Britain/New Haven/Bristol/MeridanCT (10% higher)
  14. Locational Screening Results We recommend evaluating a separate Net CONE for Northeast Massachusetts (NEMA) based on Lowell/Lawrence labor costs to see if the NEMA Net CONE is more than 15% greater than the ROP Net CONE Our review of recent decisions and documentation of the MA Energy Facilities Siting Board showed that there does not appear to be any significant constraints, other than labor wage differential, that would structurally increase Net CONE as compared to ROP While Boston has higher labor costs, there is no specific requirement for in-city generation and reasonable siting options are available in the remainder of NEMA We do not recommend evaluating a separate Net CONE for CT New Britain/New Haven/Bristol/Meridanlabor rates are not significantly (i.e., >> 15%) higher than Worcester MA Not likely to site in Hartford or Stamford/Norwalk due to less expensive options
  15. Net CONE Project Schedule For completing our analysis, we recommend 4 meetings to discuss Net CONE with the NEPOOL Markets Committee over the next six months 1. Initial Analysis: January MC Mtg. 2. Drafts Results: March MC Mtg. 3. Final Results: May MC Mtg. 4. MC Vote: June MC Mtg. We request stakeholder comments to be submitted ASAP Comments received by February 1 will be prioritized for Draft Results meeting in March We request all comments to be submitted by April 1 to ensure sufficient time is available for discussion with stakeholders and additional analysis prior to Final Results meeting and MC vote Please submit comments to be made public to the committee secretary ISO-NE: akuznecow@iso-ne.com All other comments should be submitted confidentially to Brattle Brattle: Sam.Newell@brattle.com, Michael.Hagerty@brattle.com

  16. Appendix Slides

  17. Contents of Appendix Slides Net CONE Calculations CC Net CONE Calculation Frame CT Net CONE Calculation LMS100 Net CONE Calculation Financial Assumptions Cost of Capital Data Other Financial Assumptions Capital Cost Component Data Location Screening Analysis Gas Interconnection Cost Data
  18. CC Net CONECC Technical Specifications We have maintained the same technical specifications for the CC reference plant as the ORTP study and have chosen Worcester, MA as the location of the unit for the Rest of Pool (ROP) capacity zone
  19. CC Net CONECC Capital Costs
  20. CC Net CONECC Capital Costs Comparison to ORTP Labor, contingencies, and interconnection costs are the driver of the differences in capital costs between Net CONE and ORTP analyses Other line items differ from the ORTP analysis as they are calculated as a percentage of the other costs and due to changes in the net plant capacity
  21. CC Net CONECC O&M Costs Labor costs have increased due to the change in location Property taxes and insurance have increased as they are calculated as a percentage of the overnight capital costs
  22. CC Net CONECC Net CONE Calculation (2018 $s)
  23. CT Net CONEFrame CT Technical Specifications We chose the Siemens frame-type combustion turbine in a 2x0 configuration We included an SCR that uses an air tempering system to reduce the turbine exhaust temperature and a high temperature catalyst
  24. CT Net CONEFrame CT Capital Costs
  25. CT Net CONE Frame CT O&M Costs
  26. CT Net CONE Frame CT E&AS Revenue Offset Calculating E&AS revenues for the Frame CT in the same way as the LMS100 in the ORTP study is not possible as there is insufficient revenue data for units with performance similar to the Frame CT Using historic gas and electricity spot prices from 2010 - 2012, we performed a virtual dispatch of a hypothetical Frame CT and LMS100 based on their average heat rates and an assumed VOM ($5.38/MWh) We found that the Frame CT would be expected to receive revenues equal to 78% of the Real Time revenues of an LMS100 and 67% of the Day Ahead revenues To estimate the E&AS revenues for the Frame CT, we applied these percentages (with a 46% weight to RT and 54% weight to DA based on the split of revenues for actual units) to our estimate of the LMS100 E&AS revenue ($2.71/kW-mo ) from the ORTP study Based on this approach, we estimate a Frame CT would earn E&AS revenues of $1.94/kW-mo during the 2018/2019 commitment period
  27. CT Net CONE Frame CT Net CONE Calculation (2018 $s)
  28. LMS100 Net CONELMS100 CT Technical Specifications We have maintained the same technical specifications for the LMS100 simple cyle reference plant as the ORTP study and have chosen Worcester, MA as the location of the unit for the Rest of Pool (ROP) capacity zone
  29. LMS100 Net CONELMS100 CT Capital Costs
  30. LMS100 Net CONELMS100 Capital Costs Comparison to ORTP Labor, contingencies, and interconnection costs are the driver of the differences in capital costs between Net CONE and ORTP analyses Other line items differ from the ORTP analysis as they are calculated as a percentage of the other costs and due to changes in the net plant capacity
  31. LMS100 Net CONELMS100 CT O&M Costs Labor costs have increased due to the change in location Property taxes and insurance have increased as they are calculated as a percentage of the overnight capital costs
  32. LMS100 Net CONELMS100 CT Net CONE Calculation (2018 $s)
  33. Brattle Cost of Capital Estimates Brattle estimates after-tax weighted average cost of capital (ATWACC) for publicly traded companies using the Capital Asset Pricing Model (CAPM) to calculate the Return on Equity and each company’s credit ratings to determine the Cost of Debt We completed an analysis of Calpine and NRG in July 2013 for the 2013 ORTP Study and updated our analysis in November 2013 for the Net CONE study
  34. Cost of Capital Sources July 2012 Financial Advisor Estimates for NRG-GenOnMerger: NRG Energy Inc. and GenOn Energy, Joint Proxy Statement/Prospectus for Special Meeting of Stockholders to be Held on Friday, November 9, 2012, October 5, 2012, pp. 63, 70, and 75; available at http://www.sec.gov/Archives/edgar/data/1013871/000104746912009338/a2211292z424b3.htm#bg74901 April 2011 Brattle Estimates Spees, Kathleen, Samuel Newell, Robert Carlton, Bin Zhou, and Johannes Pfeifenberger (2011), Cost of New Entry Estimates for Combustion-Turbine and Combined-Cycle Plants in PJM,” August 24, 2011. (Spees, et al., 2011) Available at http://www.pjm.com/documents/reports.aspx 2011 Analyst Estimates and 2011 Fairness Opinions: See Bibliography of Spees, et al., 2011
  35. Other Financial Assumptions Inflation = 2.25% Economic Life = 20 years Depreciation CC = 20yr MACRS Frame CT/LMS100 = 15yr MACRS Interest During Construction = 7.0% MA State Income Tax = 8.00% MA State Sales Tax = 6.25% Property Taxes = PILOT agreement at 0.75% of Capital Cost
  36. Regional Labor Rates Use for NEMA Consider for CT, depending on approach Update ROP to Average Basis of ORTP
  37. Gas and Electric Infrastructure Availability Gas Pipelines Electric Transmission Source: SNL Financial Source: SNL Financial
  38. Gas Interconnection Cost Details We estimated gas lateral costs based on a review of FERC data for the projects in New England and the US We estimated the length of the gas lateral to be 2 miles based on a review of the location of gas plants relative to pipelines for plants built in New England since 2003
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