ISO-NE Offer Review: Generation Costs and Cost of Capital Update

1. ISO-NE Offer Review Trigger Price 2013 Update: Project Update Presented to: NEPOOL Markets Committee Presented by: Sam Newell July 10, 2013

2. Agenda Approach Update and Response to Stakeholder Comments • Energy Efficiency and Demand Response • Generation Costs • Cost of Capital • CONE Calculations • Revenue Offsets and Net CONE • Next Steps

3. Energy Efficiency and Demand Response • For EE, follow similar approach to previous ORTP by reviewing state programs’ cost effectiveness studies • Rely on the studies’ cost data and MWh savings • We will estimate the value of energy savings • For DR, estimate costs for “large C&I” and “mass market” • Large C&I: interviewed merchant DR providers • Assume 1 to 4 MW peak load • The primary cost is sharing 60-80% of capacity revenues with retail customers • For ORTP, assume this cost stays constant in dollar terms, at about $2/kW-mo • Mass Market: rely on a variety of sources

4. Generation Costs • Developing capital and fixed O&M costs for reference plants of these technologies • Simple Cycle Combustion Turbine (GE LMS100) • Combined Cycle Gas Turbine (Siemens SGT6-5000F) • Biomass (Bubbling Fluidized Bed) • On-Shore Wind • Assume a competitive entrant at an unencumbered site • Assume interconnection costs similar to actual entrants, based on system impact studies • For annual updates, ISO-NE would index individual cost components to widely available indices

5. Response to Stakeholder Comments on Generation Costs • Response to Comments • Researched Solar and Off-Shore Wind but found to still have high capital costs with potential ORTP values well above FCA starting price • Existing CC technologies should be competitively priced and have performance characteristics that would be compatible with ISO-NE’s “Performance Incentives” proposal • Dual fuel storage capacity varies, but enough for 3 days of operation is somewhat typical and a reasonable assumption • Wind interconnection costs from system impact studies show substation upgrades but limited network upgrades, at least for past and current projects

6. Cost of Capital • We are estimating the cost of capital based on market data for merchant generators • Assume a PPA on energy revenues only (not capacity), as implied by the tariff • PPA assumption partially reduces ATWACC relative to mostly-unhedged merchant generators but won’t reduce the ATWACC as low as those of regulated utilities • We will present a range but will focus on the low end of merchant companies’ ATWACCs, reflecting the energy-PPA assumption • We will include a 75 bp upward adjustment on the risk-free rate used in the CAPM determination of the cost of equity, due to temporary depression from Fed “quantitative easing” policy

7. CONE Calculations • The Cost of New Entry (“CONE”) is the net revenue a new resource would need in Year 1 to be willing to enter the market, such that the NPV of all cash flows (over 20 years) is zero • A key driver of CONE is whether total net revenues are likely to increase over time (such that lower first year revenues are acceptable) or decrease (such that higher first-year revenues are necessary) • Long-term revenues will be determined by future prices (energy + capacity + other) which, all-in, must equal CONE of future entrants to support investment • Hence, projected cost trends determine revenue trajectories for current entrants • Also need to consider performance differences between current and future units • Revenue trajectories may vary by technology • We assume total revenues for gas entrants will be approximately constant in real terms over time • We are still considering the possibility that total revenues for renewables might decline over time as technology develops, which would increase the amount of revenue a new entrant would need in year 1

8. Revenue Offsets and Net CONE • First year revenues must equal CONE, with revenues coming from several sources, including capacity, energy and ancillary services margins (EAS), and RECs if applicable • “Net CONE” is the 1st year revenue a new resource would need specifically from capacity to be willing to enter the market • Net CONE = CONE – 1st Year Non-Capacity Revenue Offsets • ORTP is Net CONE of a competitive entrant for each technology • Calculating 1st year non-capacity revenue offsets: • 1st year EAS margins will be calculated based on historical average net revenues for like units, adjusted to a 2018/19 forward value based on futures prices • 1st year REC prices will be estimated using the most forward-looking prices available in New England markets, currently 2016

9. Response to Comments on Revenue Offsets • The tariff does not specify a methodology for calculating EAS offsets • How does the EAS offset relate to the PPA assumption? • Our EAS estimate will approximate a “forward” value that should be less than expected spot value, consistent with the PPA assumption • The lower forward EAS offset combined with an ATWACC that accounts for an energy-only PPA should produce the same Net CONE as without a PPA • We are assuming continuation of PTC; this assumption can be modified easily in future annual updates • We are still reviewing whether and how to estimate “Performance Incentive” payments/penalties for the various resource types

10. Next Steps • Calculate bottom up Net CONE estimates for identified technologies • Develop draft report describing ORTP calculations to be reviewed with MC at August meeting • ISO-NE to develop revised Tariff language incorporating recommended ORTPs and indexing methodology to be reviewed with the MC at August meeting