March 11-12, 2013 | Milford ma

1. March 11-12, 2013 | Milford ma Matthew White Senior Economist A Strategic Planning Initiative FCM Performance Incentives Ron Coutu Andrew Gillespie MANAGER, Bus. Tech. & Solutions Principal analyst

2. Overview • FCM Payment Mechanics • Including Expected Performance in the Capacity Bid/Offer • Effect of Performance Incentives • Effect of Performance Incentives on Intermittent Resources • ISO Follow-up to Participants’ Q&A: Alternatives Considered • Conclusion

3. The Basics • All resources will be eligible for performance payments to the extent the resource is providing energy or reserves • A scarcity condition will be any 5-minute interval when the real-time reserve clearing price includes the Reserve Constraint Penalty Factor (RCPF) • System TMNSR RCPF = $850/MWh • System TMOR RCPF = $500/MWh • Local TMOR RCPF = $250/MWh** (application to zones will be discussed in later presentations)

4. Fcm payment mechanics

5. How the Mechanics (calculations) Work • Calculate the FCM Payment = Base Payment + Performance Payment • Base Payment = FCA Price x Capacity Supply Obligation (CSO) FCA Price ($/kW-mo) – set by the marginal resource (the same as today) • Performance Payment = Performance Payment Rate x Score Performance Payment Rate (PPR) = fixed number Use $5,000/MWh - for demonstration purposes Score = Actual MW – (CSO x Balancing Ratio)

6. Calculation Simplifications Annual Net Payment =  (base payments + performance payments) =  base payments +  performance payments •  base payments = FCA Price x CSO x 12 •  performance payments = PPR x year Score year Score =  year [Actual MW – (CSO x Balancing Ratio)]

7. Balancing Ratio Balancing Ratio = (Load + Reserve Requirement) Total CSO Example: Load (= generation + net imports + interrupted demand) = 21,757 MW Reserve Requirement (total requirement) = 2,078 MW Total CSO = 33,322 MW Balancing Ratio = (21,757 + 2078) / 33,322 = 0.715

8. Impact of the Balancing Ratio Consider the following five different resources, each at different output levels during the same period (i.e., the same balancing ratio) Score = Actual – (CSO x Balancing Ratio)

9. Intervals of Scarcity Conditions • The next three slides show: • The mechanics related to one 5-minute interval within a single month • The mechanics related to twelve 5-minute intervals (i.e., one hour) within a single month • The effect of cumulative performance over the commitment period • These examples demonstrate the effect of scarcity conditions, and how these effects should be considered over the entire commitment period

10. One 5-minute Interval of Scarcity Condition • Assumptions: • FCA price = $2.00/kW-mo (1 MW x $2.00/kW-mo x 1,000 kW/MW) • Payment Performance Rate = $5,000/MWh (e.g., 0.025 x $5000 = $125)

11. Twelve 5-minute Intervals of Scarcity Condition • Assumptions: • FCA price = $2.00/kW-mo • Payment Performance Rate = $5,000/MWh (e.g., 0.30 x $5000 = $1,500)

12. Performance is CumulativeExample: Resource with 1 MW CSO • Some months over performing, some months under performing – but over entire commitment period a net positive performer • Effective average monthly payment approximately $2.02/kW-mo.

13. Putting It All TogetherExample: Effective Annual Payment • First, calculate the total annual score year Score =  year [Actual MW – (CSO x Balancing Ratio)] • To simplify the calculations, assume: Actual MW = 1 MW when resource is ‘on’ = 0 MW when resource is ‘off’ CSO = 1 MW Also assume: 2 hrs x [0 MW – 1 MW x (0.5)] = (1.00) MWh + 7 hrs x [1 MW – 1 MW x (0.7)] = 2.10 MWh + 0.5 hrs x [0 MW – 1 MW x (0.7)] = (0.35) MWh Total Score = 0.75 MWh NOTE: Calculation is done every 5-minute interval, but shown here as hours for simplicity

14. Putting It All Together - Continued • Second, determine effective annual FCM payment Annual payment = base payment + performance payment Base payment = $2.00/kW-mo x 12 months x 1000kw = $24,000 Performance payment = $5,000/MWh x 0.75 MWh = $3,750 Annual payment = $27,750 (equivalent to approx. $2.31/kW-mo) • This resource was a net over performer across the entire commitment period, and consequently received capacity payment in excess of the FCA Price

15. Including expected performance in the capacity bid/offer

16. Demonstration • Using some simple assumptions, calculate the effective annual FCM payment rate for an intermediate resource and a variation of that resource with ‘poor’ performance • Using the resource with ‘poor’ performance, demonstrate how the Performance Payment might be included in a capacity bid/offer • This is not meant to instruct participants how to bid, but to show in simple terms one way to quantify ‘risk’ and the effect on capacity payments if included in the capacity bid/offer

17. Assumptions – Over Entire Commitment Period (1 Year) • For demonstration purposes ONLY • Assume, as a participant, the following

18. Note on Assumptions • For simplicity, consider the following characterization of scarcity conditions Random scarcity conditionsThese are events that happen at random, without warning, and typically not long-lasting Seasonal scarcity conditions These are events that happen when the system is stressed (higher loads for example), and are typically longer lasting

19. Expected Performance Impact:Intermediate Resource (Resource A) • Calculate the effective annual FCM payment rate for an intermediate resource that will miss all random scarcity events, but is likely to be providing energy and/or reserves during seasonal scarcity conditions (per assumptions) • year Score =  year [Actual MW – (CSO x Balancing Ratio)] Random hours Score = 2.5 hrs x [0 MW – 1 MW x (0.5)] = (1.25)Seasonal hours Score = 7.0hrs x [1 MW – 1 MW x (0.7)] = 2.10 Score = 0.5 hrs x [0 MW – 1 MW x (0.7)] = (0.35) Total Score= 0.50 MWh • This resource has a net positive score

20. Expected Performance Impact: Expected Net Negative Score (Resource B) • year Score =  year [Actual MW – (CSO x Balancing Ratio)] Random hours Score = 2.5 hrs x [0 MW – 1 MW x (0.5)] = (1.25) MWh Seasonal hours Score = 3.0hrs x [1 MW – 1 MW x (0.7)] = 0.90 MWh Score = 4.5 hrs x [0 MW – 1 MW x (0.7)] = (3.15) MWhTotal Score = (3.50) MWh • This resource is expecting to have a net negative score over the course of the commitment period

21. Impact of Score on Effective Annual FCM Payment

22. Performance Payment Included in Bid/Offer • Include performance payment expectation in capacity offer • Negative payment expectation would increase offer: • Presuming $2.00/kW-mo is the going-forward cost of resource • Negative payment $17,500/yr is equivalent to $1.46/kW-mo • Capacity bid/offer = $2.00 + $1.46 = $3.46/kW-mo • Only if the FCA payment rate is equal to or greater than $3.46/kW-mo will the resource accept a CSO

23. Impact of Score on Effective Annual FCM Payment, with Adjusted FCA Bids/Offers Presuming actual events and performance turn out as expected

24. Summary • The FCA price is set by the marginal bid/offer • The bid/offer may include resource’s expected performance • This would include events beyond the control of the participant • Resources with lower capacity bids/offers are infra-marginal • The effective rate is based on the higher marginal offer setting the FCA Price

25. Effect of performance incentives

26. Performance Incentive • A supplier would want to keep ‘costs’ low and collect as much in infra-marginal rent as possible • If a resource were to operate for one more hour of scarcity conditions by ‘spending’ $0.20/kW-mo. to improve performance, what then would be the resource’s capacity bid/offer? • Using Resource B as a comparison, modify expectations and develop a capacity bid for an altered resource, Resource C

27. Resource with an Improved (lower) Expected Net Negative Score (Resource C) • year Score =  year [Actual MW – (CSO x Balancing Ratio)] Random hours Score = 2.5 hrs x [0 MW – 1 MW x (0.5)] = (1.25) MWh Seasonal hours Score =4.0 hrs x [1 MW – 1 MW x (0.7)] = 1.20 MWh Score = 3.5hrs x [0 MW – 1 MW x (0.7)] = (2.45) MWhTotal Score = (2.50) MWh • Negative payment $12,500/yr (-2.5 x 5000) is equivalent to $1.04/kW-mo NOTE: This is less than the $1.46 for Resource B • This resource would also add $0.20/kW-mo to its going-forward costs NOTE: This is $0.20/kW-mo higher than Resource B • Capacity bid/offer = $2.00 + $0.20 + $1.04 = $3.24/kW-mo NOTE: This is less than the $3.46/kW-mo bid for Resource B

28. Effective Annual FCM Payment, with Improved Performance Presuming actual events and performance turn out as expected

29. Effect of performance incentives on intermittent resources

30. Intermittent Resource – Different Assumptions • For an intermittent resource consider: • The resource is rarely fully off or fully on, but performing somewhere ‘in-between’; set Actual MW = 0.50 MW • The resource’s qualified amount is determined as a fraction of the nameplate amount; set CSO = 0.15 MW • When determining the expected score, recognize that because resource is intermittent that no distinction between random and season scarcity conditions is important • For this analysis, the total duration of scarcity conditions will remain the same (total 10 hours), but the average (weighted) balancing ratio will be 0.65

31. Score of an Intermittent Resource • year Score =  year [Actual MW – (CSO x Balancing Ratio)] All hours Score = 10 hrs x [0.5 MW – 0.15 MW x (0.65)] = 4.02MWh Total Score = 4.02MWh • This intermittent resource actually has a net positive score • If the qualified amount (CSO) were approximately 0.75 MW (rather than 0.15 MW) the score would be zero • For intermittent resources, evaluating the resource’s expected net performance is an important consideration

32. ISO Follow-up to Participants’ Q&A: Alternatives considered

33. Many Solution Approaches Considered • EFOR’d-based incentive schemes (e.g., PJM’s EFOR-p, XEFOR’d, …) • Technology mandates (e.g., dual-fuel requirement on CC’s) • High RT prices during scarcity hours (‘Texas-sized’ RCPF’s) • FCM ‘Pay for Performance’ (PFP) incentives: Replace existing FCM Shortage Event construct with PFP design. • FCM Tranches for different ‘types’ of capacity (e.g., peakers) Finding: PFP design is most promising approach.

34. About FCM Tranches Approach • Noted as one approach in 2012 ISO memo and SPI paper • ISO conclusions to date: • Key problem is to improve resources’ performance and availability during stressed conditions, reducing potential ‘systemic risk’ events. • New ‘tranches’ alone do not improve performance incentives. • While tranches could increase installed capacity of specified types (e.g., peakers, fast-ramping, etc.), difficult to establish that system is deficient peaking capacity, installed ramping capability, and so on. • Priority SPI challenges are best met by improving resource performance and incentives during stressed system conditions

35. conclusion

36. Next Steps • Further elaboration on the details of this proposal will be the topic of future presentations to the Markets Committee, including but not limited to: • Maximum Loss Limit (or stop loss) • Financial Assurance impacts(Coordination with the Budget & Finance Committee) • Mitigation(To be presented by the Internal Market Monitor) • Establishing the Performance Payment Rate($5,000/MWh value used in this presentation) • Application to zones • Current rules and procedures (impact and conforming changes)

37. Logistics & Timing • ISO Direction: ISO White Paper (October 2012) onFCM Performance Incentives Also at: http://www.iso-ne.com/spi > Materials • Timeframes: • Mar-Sep 2013: Markets Committee • Fall 2013: MC & PC votes • Q4 2013: FERC Filing • Implement: For FCA 9 (FCA held 2015, CCP of 2018/19) • A major initiative: Impact analysis with MC Q2-Q3 2013

38. Andrew Gillespie agillespie@iso-ne.com • Ron Coutu rcoutu@iso-ne.com Matthew White mwhite@iso-ne.com