Net CONE for the ISO-NE Demand Curve

1. Net CONE for the ISO-NE Demand Curve Response to Stakeholder Questions NEPOOL Markets Committee Sam Newell, Brattle Christopher Ungate, Sargent & Lundy February 6, 2014

2. Agenda • Reference Technology • Cost of Capital • E&AS Methodology

3. Reference Technology Questions • What criteria should be considered in selecting the reference technology? • What are the plant specifications and performance characteristics for the reference technologies? • Does the relatively larger E&AS offset for CC mean greater uncertainty in Net CONE? • Why is DR not considered as a potential reference technology? • Have we considered an oil-only unit?

4. Framework for Selecting a Reference Technology • Objective • Estimate Net CONE that supports prices just high enough to attract sufficient new investment to maintain the long-term target reserve margin • Criteria for selecting the Reference Technology to meet the objective • Likely to be economic • Complies with all environmental regulations • Lowest or near-lowest estimated Net CONE • Demonstrated commercial interest by developers • Can estimate Net CONE accurately • Cost estimates based on established technologies • Low E&AS uncertainty

5. Rating the Candidates Against the Criteria *We have not yet fully examined forward reserve market revenues which add uncertainty to CT E&AS estimates

6. Reference Technology Plant Specifications • All candidates can meet environmental requirements in New England

7. FERC Order on F Class Frame CT w/ SCR in NYISO • On January 28, FERC accepted the simple cycle F-class frame CT with Selective Catalytic Reduction (SCR) as “economically viable” and its use as the reference technology for several NYISO capacity zones • “[W]e find the record of evidence presented in support of the frame unit with SCR is adequate in order to find that NYISO reasonably concluded that the F class frame with SCR is a viable technology and able to serve as proxy unit in NYC, LI, and the G-J Locality” • Several protestors argued that F class frame CT with SCR is not considered “commercially accepted” as there are no proposed units in the queue, however FERC found this argument misplaced as economic viability determinations are a “matter of judgment” • “While protestors argue that ‘market acceptance’ is material to the question of economic viability, we find that NYISO’s method of judging economic viability is a reasonable one. NYISO provided information sufficient to conclude that the F class frame unit with SCR can be practically constructed in each Locality and is economically viable.”

8. Tariff Requirements in NYISO and PJM • NYISO: Market Administration and Control Area Services Tariff, Section 5.14 • The periodic review shall assess…the current localized levelized embedded cost of a peaking plant in each NYCA Locality, the Rest of State, and any New Capacity Zone, to meet minimum capacity requirements. • For purposes of this periodic review, a peaking unit is defined as the unit with technology that results in the lowest fixed costs and highest variable costs among all other units’ technology that are economically viable, and a peaking plant is defined as the number of units (whether one or more) that constitute the scale identified in the periodic review. • PJM: OATT Attachment DD – Reliability Pricing Model • “Reference Resource” shall mean a combustion turbine generating station, configured with two General Electric Frame 7FA turbines with inlet air cooling to 50 degrees, Selective Catalytic Reduction technology in CONE Areas 1, 2, 3, and 4, dual fuel capability, and a heat rate of 10.096 MMbtu/MWh.

9. Reference Technology Plant Performance

10. Most Recent and Proposed Builds • CCs are the dominant technology recently installed and proposed • Very few frame CTs • ISO-NE queue has 1,048 MW of CCs and 415 MW CTs (all LMS100s) Source: Ventyx Energy Velocity Generating Unit Capacity Dataset

11. Accuracy of E&AS Revenue Offset • Good demand curve performance depends on estimating an administrative Net CONE that equals the Net CONE developers need • The EAS offsets is one of the most uncertain components, and the degree of uncertainty varies by technology • One indication of relative uncertainty is the higher variability of CCs’ historical revenues • Another indication is that our CC E&AS revenue estimate is quite sensitive to small changes in the assumptions in our method (see next slide) • Sources: • NYISO State of the Market Annual Report • PJM State of the Market • ISO-NE Confidential Revenue Data

12. Sensitivity of E&AS Revenue Offset • To capture the most recent market conditions and futures prices, we updated the E&AS revenue estimates with ISO-NE data through September 2013 • The change in timeframe of historic revenues has a significant impact on CC E&AS but a limited impact on the CTs E&AS • CC E&AS increased by $1.46/kW-mo to $5.67/kW-mo • Frame CT E&AS decreased by $0.04/kW-mo to $2.08/kW-mo • LMS100 E&AS decreased by $0.05/kW-mo to $2.88/kW-mo • If we use just the past 12 months of revenue data, the CC E&AS revenue increases an additional $2.01/kW-mo resulting in a Net CONE that is $1.59/kW-mo lower than the Frame CT

13. Forward Reserve Market Revenues (for CTs) • Recent changes in the Forward Reserve Market add uncertainty to the E&AS revenues for the CT technologies • In 2012 ISO-NE increased its system-wide 10-minute operating reserve requirements, effective Summer 2013 • The change increased the corresponding FRM requirements and caused FRM system-wide prices to increase from less than $1/kW-mo in 2011 & 2012 to greater than $3/kW-mo beginning with the Summer 2013 FRM auction • ISO-NE introduced a more stringent penalty structure • Going forward, FRM revenues will apply similarly to the LMS100 and Frame CT if they are able to meet similar capacity levels in 10 and 30 min while meeting environmental restrictions • While we are still estimating the impact of FRM revenues on the CT E&AS revenues, the following items will be considered • How representative current prices are of future prices • How deep is the market and how sensitive will prices be to new capacity additions • How much capacity can a CT offer in the FRM • How much do the FRM revenues impact the energy and real-time reserve revenues

14. Units Not Considered as Reference Technology • Demand Response • Demand response capacity resource costs are asset-specific with a wide-range of costs of new entry, creating a supply curve of DR assets • There is no reasonable way to identify the single type of DR asset that would be expected to clear the FCM to meet the ISO-NE reserve margin objectives over the long term • Capacity prices need to reflect the cost of capacity, not the price where the highest-cost DR asset that clears the market was willing not to “buy” • Oil-Only Units • Net savings of an oil-only unit would be small, if not negative • Likely complications for permitting • No oil-only units have been or are under consideration in New England, even if some have been burning only oil lately

15. Cost of Capital Question • How does the NYISO DCR cost of capital value compare to the ATWACC for the ISO-NE proposed demand curve? • The cost of capital estimated for the NYISO Demand Curve Reset assumed a higher Return on Equity, which results in an ATWACC that is 0.3% higher than our estimate for the ISO-NE proposed demand curve

16. E&AS Revenue Offset Questions • Are forward reserves considered in the E&AS offset? • How will the recent winter fuel price volatility be captured? • Can you average futures prices over a period of time instead of using a single day? • Can you provide more information on how you estimated the E&AS offset? • What is included in the Ancillary Services? • The previous slides have answered these questions except for the basic methodology which is outlined in the appendix slides

17. Updated Net CONE Estimates • We have estimated Net CONE for three potential reference technologies • The estimates below are the same as in the January meeting, but with updated E&AS revenues based on most recent market data • These estimates do not yet include • FRM revenues • Refined electrical interconnection costs

18. Appendix Slides

19. Historic Net E&AS Revenue Offsets • We estimate 1st year E&AS revenue offsets based on historical revenues for like units then adjust the revenues forward to 2018/2019 using gas and electricity futures prices • We calculated historical market revenues by asset with data provided by ISO-NE Markets Analysis and Settlements department for March 2003 to January 2014 • We first calculated total revenues for CC and LMS100 based on like-units • We then calculated net revenues by subtracting fuel (Ventyx) and variable O&M (S&L) costs • Due to limited data availability, we calculated Frame CT net revenues as a percentage of LMS100 revenues based on the results of a virtual dispatch of the two technologies against historical electricity prices • Ancillary services include: • Net Commitment Period Compensation (NCPC) • Regulation • Real Time Reserves • Blackstart • VAR Capacity • Forward Reserve Market revenues were not included in our initial analysis but we are currently examining whether and how much they should be included (see slide 12)

20. FCA9 Net E&AS Revenue Offsets • We adjusted historical net revenues for like units to 2018/2019 based on the most recent 30-day average of gas and electricity futures prices • 2018/2019 E&AS Margin = Historical E&AS Margin / Historical Electricity Price * 2018/2019 Electricity Price • 2018/2019 MA Hub On Peak Electricity Price = 2014 Market Heat Rate * (2018 Henry Hub + 2014 Algonquin City Gates Adder) • This is a proxy for a forward energy price that accounts for the effect of rising gas prices. It does not account for how market heat rates might increase as generation reserve margins tighten nor does it fully account for the growing discount one would expect for forward prices relative to expected spot prices for longer forward periods. Projected Gas and Electricity Prices Projected Future Year E&AS Revenues