Designing a Long-Forward Market for Energy Security: Framework Discussion

1. September 3-4, 2019 | MARKETS COMMITTEE Discussion of the framework for developing a forward component to the ESI design Energy Security Improvements: Long-Forward Design Matt Brewster Principal Analyst Chris Geissler Economist

2. Overview The ISO and stakeholders have expressed interest in considering a long-forward market to complement the energy security design improvements Time constraints have prevented a long-forward design proposal from being developed for the October 15th filing The ISO has started considering design approaches and assessing how they align with ESI objectives and principles Today, we will discuss the ISO’s design framework and initial observations, and are seeking stakeholder input ISO anticipates beginning detailed design discussions in 2020

3. Framework for considering a long-forward market to complement the ESI design • A long-forward design that aligns with the day-ahead ancillary services may further the region’s energy security • A long-forward design should further support the ESI design objectives (risk reduction, cost effectiveness, and innovation) and apply the five design principles comparably: • Product definitions should be specific, simple, and uniform. • Transparently price the desired service. • Reward outputs, not inputs. • Sound forward markets require sound spot markets. • Compensate all resources that provide the desired service similarly.

4. The existing FRM will not be compatible with the new day-ahead ancillary services design • There are attributes of the Forward Reserve Market (FRM) that align with our anticipated design approach; for example: • Auctions occur before seasonal delivery periods (but only ~6 weeks) • Forward awards settle against spot prices (but not transparently and with several administrative features) • The FRM buys obligations to make 10-minute or 30-minute reserve capability available in real time • Procuring the new ancillary services in the day-ahead market would conflict with the FRM • Assets could be assigned both FRM designations and day-ahead ancillary service awards (i.e., 1 MWh sold forward twice) • A double forward sale exposes consumers to paying twice and suppliers to potentially uncovered positions

5. Concepts for a long-forward design • The ISO is evaluating several alternative concepts for a long-forward design: • No forward market • Forward sale of the day-ahead ancillary services • Forward procurements of fuel • We will discuss how the ISO currently views these concepts and whether they would further support the ESI objectives • We are interested in stakeholder input about these concepts and other possible alternatives

6. Concept (a)No forward market • ISO would not have a forward market for ancillary services • The FRM would be phased out with the implementation of ESI • ISO would procure ancillary services for the operating day beginning with the day-ahead market • Suppliers and load-servers may be able to hedge their respective revenue and cost uncertainty using forward power contracts and bilateral arrangements • However, whether these instruments are suitable to hedge the new day-ahead ancillary services needs further consideration • Suppliers may forego up-front fixed costs that would allow their resources to more cost-effectively provide ancillary services if they consider spot revenues uncertain

7. Concept (b)Forward sale of the DA ancillary services • Procure the forward sale of day-ahead ancillary services for the duration of a defined delivery period • The FRM design would be adapted to align with ESI • Suppliers would sell forward positions that settle against the day-ahead ancillary service clearing price thereby increasing forward revenue certainty if they expect to sell day-ahead ancillary services • Consumers would achieve some forward certainty about the costs of the day-ahead ancillary service requirements before the delivery period

8. Concept (b) (continued)Forward sale of the DA ancillary services • The long-forward settlement would apply the standard two-settlement framework (i.e., like DA and RT energy) • A supplier that sold the same quantity in the long-forward and day-ahead market receives the forward price, and a supplier that sells a different quantity in the day-ahead market is credited or charged for the deviation at the day-ahead price • The long-forward awards and settlement would have no explicit effect on day-ahead market offers or clearing • Suppliers maximize profits (and social surplus) by reflecting their current costs in the day-ahead market • The long-forward awards also would not impact the real-time closeout settlement of ancillary services sold in the day-ahead market

9. Concept (b) (continued)Forward sale of the DA ancillary services • The forward sale of ancillary services may improve suppliers’ incentives to incur costs in advance, when doing so would be more cost-effective • A technology-neutral approach can help achievethe lowest-cost solutions to provide ancillary services • Some initial considerations about details of a long-forward market that may matter to achieving these outcomes: • Setting demand (ISO-defined, active load participation, differentiation of on-peak and off-peak demand) • Qualifications to sell in the long-forward (resource-specific, portfolio) • Establishing delivery periods (seasonal, monthly, annual) • Timing of the forward auction relative to delivery periods

10. Concept (c)Forward procurements of fuel • Procure the ability to access a resource’s stored fuel during the delivery period • The FRM would be replaced with this new mechanism • Resources with fuel storage or contracting abilities would sell commitments to have fuel and receive some forward revenue certainty for the associated fuel costs • To the extent that the forward fuel procurements serve the day-ahead ancillary services demand, consumers also would achieve some forward cost certainty

11. Concept (c) (continued)Forward procurements of fuel • Rewarding inputs (fuel) rather than outputs (electrical services) raises many concerns, including: • Because it is not technology-neutral (i.e., fuels are largely technology-specific) it may not incent cost-effective or innovative solutions • A requirement to ‘have fuel’ leads to many administrative constructs to monitor fuel, verify contracts, define delivery, etc. • Without a well-defined spot market to settle against, a fuel approach may require administrative (i.e., out-of-market) decisions about how/when to use the fuel and/or ad hoc penalties that are hard to align with a product’s market value • Past experience suggests that mechanisms that value inputs (rather than well-defined and transparently priced services) are challenging to align with market design principles

12. Summary The ISO is in the early stages of developing the framework and evaluating alternative concepts for a long-forward design Finalizing the day-ahead ancillary services design for the October 15th filing is the ISO’s current priority for ESI More detailed discussion of a long-forward design for ESI are expected to begin in 2020 In the interim, stakeholders are encouraged to provide any additional feedback about this topic to the ISO