Retail Issues Associated With Locational Marginal Cost Pricing

1. Retail Issues Associated With Locational Marginal Cost Pricing Presented by: Laura Manz September 13, 2002

2. Why LMP? LMP works with an open spot market that serves as a solid foundation for retail choice where even small Load Serving Entities without large portfolios can obtain market-priced balancing to manage their contract and delivery risk. LMP makes the balancing prices fair and efficient.

3. Retail Choice Rests on a Solid Wholesale Foundation • LMP provides transparency in spot energy and transmission pricing to provide the platform for retail choice • No hidden congestion uplift • ARRs/FTRs/CRRs for price certainty • Provides short run signals for energy and transmission prices and long run signals for planning and expansion • Provides information that enables choices on how to use the price signals to benefit customers • Economic signals to regulators, market participants, and (ultimately) consumers • For settlements, LMPs can be individual nodes or aggregated blends

4. LMP, Based on Integrated Dispatch Functions RTO Functions Market Support Market Inputs Ensure Reliability Generator Bids Cover Imbalances A/S Markets Co-Optimized Real-Time Balancing Regional Security- Constrained Economic Dispatch Buy and Sell Spot Energy Load Bids Buy Through Congestion (LMPB - LMPA) Bilateral Schedules Congestion Redispatch Calculate Nodal Spot Prices Hedge Congestion (LMPB - LMPA) Self Schedules Allocate & Auction FTRs Market-Driven Decisions Settlements at LMP Prices $$$

5. Value Added Services • LMP prices the security-constrained economic dispatch and thus provides the correct signals for managing and expanding the grid • This efficiency requires retailers to focus on value added services • Once wholesale prices are reasonably reflected to customers, the focus of retailers will necessarily shift away from arbitraging price disconnects and seasonal shifting to capture economic value from wholesale/retail price disconnects

6. Why Fixed Retail Credits Require Restrictions on Switching Retailers will seek and retain customers in these periods Price Fixed shopping credit/default Retailers may dump old and avoid new customers in these months Spot prices Months

7. The Importance of Demand Response • A well-functioning market encompasses bids and offers from supply and demand • Day-ahead markets are very helpful in enabling market-based demand response • Although “jump start” programs may be necessary in the short run, they will distort values over the long run • The correct way to compensate for demand reduction is to not charge for energy not used • Customers with interval meters can be credited and charged for market-based purchases and sales

8. Creating a Level Playing Field Demand - 1 MW @ LMP Supply - 1 MW @ LMP 1 less MW paid at its LMP 1 less MW charged at its LMP Transmission D 1 MW @ LMP

9. Creating a Level Playing Field Demand + 1 MW @ LMP Supply + 1 MW @ LMP 1 more MW paid at its LMP 1 more MW charged at its LMP Transmission D 1 MW @ LMP

10. States play a key role • Transparent market prices at wholesale provide the foundation for states to connect customers to market prices • States can connect customers to markets by basing retail rates on LMP spot prices • Measurement is a key factor to enabling meaningful behavior • Ability to measure response and credit/charge at the real-time price • Interval meters, not necessarily real-time (reliability) meters to measure interval usage

11. LMP is Key LMP pricing provides the correct signals for demand-side response - the most important missing element in most markets Laura.Manz@pseg.com 973-430-3831