Modifying The Carry-Forward Rule

1. Modifying The Carry-Forward Rule September 2013

2. Summary • The Carry-Forward Rule is part of “package” of capacity rules related to new entry pricing and, as currently structured, this package can produce capacity prices that are unreasonably low and discriminatory for existing supply as compared to new supply. • These low prices will send inefficient price signals to the market which can result in early exit of existing generation – this uneconomic exit, in turn, can trigger additional multi-year, high-priced contracts with new entrants and a cycle of bipolar prices • We have proposed modifications to the ISO New England rules, primarily to the Carry-Forward Rule, which eliminate these problems and are consistent with previous FERC rulings Modifying The Carry-Forward Rule

3. Current Carry-Forward Rule - Problems • No size threshold – given the last “new” leaving the auction will determine the clearing price, a 100 KW energy efficiency resource or 1 MW DR resource can set the price. These are unlikely to be reflective of the price necessary to provide enough new resources to offset a MW need • “In-Between” MW Issue – current rule could force existing units out of the auction when they would have remained at the eventual zonal clearing price since it is impossible to determine when the last “new” leaves during the auction process itself • Uncertain or Insufficient Duration – It is unclear whether the current rule ends after one year or when the “lumpy” MW have been offset • Price Discrimination – rule is likely to cause a very significant price difference between the new resource and existing generation Modifying The Carry-Forward Rule

4. Inefficient Price Signals The current Carry-Forward rule results in inefficient price signals to the market: • This can lead to uneconomic exit of existing generation, the subsequent need to pay high capacity prices for more new entry, and bipolar prices • Existing generation is paid a fraction of the new supply price because the new supply depresses the price for all existing resources • As a result, existing generation may exit the market creating a resource need in subsequent years • To fill this need, a five year contract with a second new supplier may be required • But this second new entrant will again depress the price for existing generation, so this cycle could continue • These inefficient outcomes increase costs for the entire system. • And may undermine reliability, as well. Modifying The Carry-Forward Rule

5. Long-term Market Efficiency • Current rules, in concert with low/no load growth are likely to cause problems: • All new entrants will choose the NEPA option, as Footprint has done.  To do otherwise would expose the new entrant to depressed prices starting in the year following the initial year they cleared. • Economic existing generation will periodically retire; because they will only receive a depressed priced which will be a small fraction of the NEPA price.  This will cause a need for additional new entry prematurely perpetuating the bipolar and New NEPA pricing. • But additional new entry will not necessarily occur even at the NEPA price cap (starting price of the auction), because the entrant knows that capacity revenues will be very low when the NEPA contract expires: • At the expiration of the 5 year price assurance period, the new entrant could have low capacity prices so long as there is surplus in the zone, which with low load growth or transmission expansion could be for a prolonged period. • Even when subsequent new entry is periodically required due to the retirement of existing generation, capacity prices will not rise to the level of the next new entrant’s bid, but only to the “last competitive price level” which, as we have seen, can be well below 50% of the new entry price (current Insufficient Competition Rule). • Even this price increase would last only for a year. In subsequent years, the CF rule with its “last new” provision could again produce much lower prices. • The consequence of this package of rules will cause any new entrant to bid in such a manner to recover most of their costs within the 5 year NEPA period but this may be hampered by existing price cap Modifying The Carry-Forward Rule

6. Proposed Modifications To address the problems with the current approach, we propose the following modifications: • Carry-Forward Rule: if an entrant receives New Entry Pricing, then that resource must have a shadow price bid for all associated MWs for the term of the New Entry Pricing equal to the lower of: • Its new entry bid price • ORTP for a combustion turbine* Note: The shadow delist bid is for setting the clearing price of the zone, but the New Entrant will retain its CSO and new entrant pricing • New Entry Pricing Rule: not available to resources in a Zone with excess capacity caused by an entrant that bid new entry pricing in a previous auction which triggered the Carry Forward Rule. These modifications alleviate all of the problems associated with the current rule and are consistent with FERC policy. * A new entry bid price in excess of this level does not necessarily suggest insufficient competition Modifying The Carry-Forward Rule

7. What Would/Should Happen • Prices under the Exelon proposal are less than the actual cost of new entry required to meet reliability requirements in the constrained zone – and these prices only result because the zone had a need that required new entry. • The changes proposed by Exelon make the new entry provisions much more viable because of a credible opportunity for cost recovery in subsequent periods over the life of the new asset. Modifying The Carry-Forward Rule

8. Inadequate Supply and Insufficient Competition • Current Rule states that, when insufficient competition is determined, the capacity price paid to existing supply in the Zone when the new entrant receives its initial CSO will be the lower of: • New entrant bid price • A pre-defined threshold level (1.1 x “last competitive auction” price in FCA 8) • ISO has recognized that a new Offer Review Trigger Price for a combustion turbine is a more appropriate benchmark in the case of Inadequate Supply and Insufficient Competition • Proposed Insufficient Competition Rule: threshold equal to 1.1 x ORTP of Combustion Turbine Modifying The Carry-Forward Rule

9. Summary and Next Steps Summary of Request • Carry-Forward Rule: if an entrant receives New Entry Pricing, then that resource must have a shadow de-list bid entered for all associated MWs for the term of the New Entry Pricing equal to the lower of its new entry bid price or the ORTP for a combustion turbine • New Entry Pricing Rule: not available to resources in a Zone with excess capacity caused by an entrant that bid new entry pricing in a previous auction which triggered the Carry Forward Rule. • Insufficient Competition Rule: with a threshold equal to 1.1x ORTP of Combustion Turbine Next Steps • Exelon will continue to work with stakeholders to refine the proposal • Participants Committee Vote October 4th Modifying The Carry-Forward Rule

10. Appendix Modifying The Carry-Forward Rule

11. Examples – Scenario 1 (FCA 8) • Assumptions: • Zonal LSR 3400 MWs • Existing resources 3700 MWs • New Entrant from FCA 7 (included in existing)  - 700 MWs • New DR resource 50 MWs • Resource A- 600 MW existing  with $3 Delist • 10 MWs of New DR plans to leave the Market at $2 • Resource B - 5 MWs of existing leave $4 • Results: • - Under the current rule - the zone clears 3695 MWs at $3.00 but it pays $10.00 (ORTP for a CT) because no new left prior to resource A’s delist and Resource B does not get a CSO • - Under Exelon proposal– The zone clears 3700 MWs at $10.00 (ORTP for CT) and resource B receives a CSO. • - Note: the lumpy resource receives its clearing price • - Under the ISO’s proposal New Entrant(s) in FCA 8 are eligible to receive 5 year New Entry pricing Modifying The Carry-Forward Rule

12. Examples – Scenario 2 (FCA 8) • Assumptions: • Zonal LSR 3400 MWs • Existing resources 3700 MWs • New Entrant from FCA 7 (included in existing)  - 700 MWs • New DR resource 50 MWs • Resource A- 600 MW existing  with $3 Delist • 10 MWs of New DR leaves the Market at $5 • Resource B - 5 MWs of existing leave $4 • Results: • - Under the current rule - the zone clears 3685 MWs at $3.00 but it pays $5.00 when the last new left and Resource B does not get a CSO • - Under Exelon proposal– The zone clears 3700 MWs at $10.00 (ORTP for CT) and resource B receives a CSO. • - Note Footprint receives its clearing price and is paid by the NEMA zone • - Under the ISO’s proposal New Entrant(s) in FCA 8 are eligible to receive 5 year New Entry pricing Modifying The Carry-Forward Rule