July 8-10, 2014 | NEPOOL MARKETS COMMITTEE

1. July 8-10, 2014 | NEPOOL MARKETS COMMITTEE Matt Brewster 413.540.4547 | Mbrewster@iso-ne.com Conceptual design proposals to accompany system-wide and capacity zone sloped demand curve changes FCM Sloped Demand Curve: Reconfiguration Auctions and CSO Bilaterals

2. Conceptual design proposals to accompany system and capacity zone sloped demand curve changes • Reconfiguration Auctions (slide 3) • CSO Bilaterals (slide 11) • Adequacy Backstop Measures (slide 16)

3. Acronyms used in this presentation • ARA = Annual Reconfiguration Auction • CCP = Capacity Commitment Period • CSO = Capacity Supply Obligation • FCA = Forward Capacity Auction • ICR = Installed Capacity Requirement • LOLE = loss of load expectation • LSR = Local Sourcing Requirement • MCL = Maximum Capacity Limit

4. Reconfiguration Auctions Proposed modification to conduct annual reconfiguration auctions (ARA) with sloped demand curves

5. As they exist currently, the ARAs are conducted similar to the FCA with updated supply and demand • Secondary auctions to adjust capacity obligations prior to the delivery period based on revised supply offers and demand • Suppliers may adjust their capacity obligations (acquire or shed) • After the FCA, suppliers may experience changes in resource capability or their valuations to hold an obligation • Capacity without a CSO may submit “supply offers” to acquire obligations • Capacity with a CSO may submit “demand bids” to shed the obligation • ISO updates demand parameters (e.g., ICR, LSR) and may submit supply offers or demand bids to true-up supply to current demand • Updating demand with most recent ICR studies is done in order to reflect best estimates of requirements • Only the supply obligation MW which are exchanged through the ARA are credited/debited at the ARA clearing price

6. The proposed modifications will not significantly alter the existing structure of the ARAs • ARA modification required for demand curves is simply to include the sloped demand curves in each annual auction (replacing the vertical demand requirements) • Detail on next slide • Applying sloped demand curves continues objective to model demand in the reconfiguration auctions consistent with the FCA • With multiple forward auctions, there must be a consistent model of demand in order to avoid predictable changes in market prices: • Expectations of higher prices in a later auction encourage suppliers to defer acquiring an obligation until they can receive the highest price • Expectations of lower prices in a later auction encourage suppliers to acquire extra CSO to subsequently buy out of the obligation at a profit

7. The inclusion of demand curves in the ARA will occur at the time they are incorporated into FCA • Beginning with Capacity Commitment Period 9 (CCP9) (2018/19), system-wide demand curve included in each ARA • Beginning with CCP10 (2019/20), system-wide and capacity zone demand curves included in each ARA • Demand curve quantity parameters updated consistent with current practice of restudying ICR values • Demand may increase or decrease (i.e., curve may shift left or right) • Demand curve price parameters from FCA are held constant for each ARA (same as current) • Demand curves replace ISO use of bids and offers to true-up supply because demand is no longer set as a fixed requirement amount • For CCP9, current rules for ISO participation remain for capacity zones

8. With demand curves, the ARA will function much the same as today and be more robust for suppliers • ARA continues to allow suppliers opportunity to adjust their capacity obligations prior to delivery period • May submit supply offers (to acquire) and demand bids (to shed) • ISO will update sloped demand curve quantities to ensure the ARA reflects the current determination of demand (same as done now) • Like the FCA, the ARA clears at the intersection of the updated supply stack and sloped demand curve to yield the most efficient allocation of capacity obligations based on the then current conditions • Examples on next slides • With sloped demand curves, resource supply offers and demand bids will not require an offsetting resource offer/bid (counterparty) in order to be cleared in a reconfiguration auction • CSO MW exchanged in the ARA are credited/debited at the ARA auction clearing price

9. Example 1: no change to supply and demand between FCA and ARA • Resources A and B submit their ARA offer at the same price as their FCA offer • Demand has not changed between FCA and ARA • Total quantity of CSO purchased and clearing prices are not changed • PARA = PFCA • QARA = QFCA • Resource A clears in both the FCA and ARA (keeps its CSO) • Resource B does not clear in either the FCA or ARA (no CSO) ARA clearing example 1 ARA demand = FCA demand

10. Example 2: no change to supply, but demand decreases between FCA and ARA • Resources A and B submit their ARA offer at the same price as their FCA offer • Demand has decreased (left-shifted) prior to the ARA • Resource A’s offer cleared in the FCA, but does not clear in the ARA • Buys out of its FCA CSO at the ARA clearing price (PARA) • Updated demand curve indicates consumers are better off because Resource A costs more than consumers value its capacity • The non-zero offer submitted by Resource A indicates it is better off to buy back its CSO if prices are below its offer price • All other resources with a FCA CSO have no change in CSO in the ARA (cleared in ARA by bidding zero) and will be paid the FCA price (PFCA) ARA clearing example 2 ARA demand FCA demand

11. Example 3: no change to supply, but demand increases between FCA and ARA • Resources A and B submit their ARA offer at the same price as their FCA offer • Demand has increased (right-shifted) prior to the ARA • Resource B offer did not clear in the FCA, but does clear in the ARA • Acquires a CSO and is paid the ARA clearing price (PARA) • The ARA demand curve indicates consumers are better off purchasing Resource B at the higher price (PARA) because capacity is now valued at a price at or above B’s offer • Resource B is willing to accept an obligation at the ARA price (PARA), but would not at the FCA price (PFCA) • All other resources with a FCA CSO have no change in CSO in the ARA (cleared in ARA by bidding zero) and will be paid the FCA price (PFCA) ARA clearing example 3 FCA demand ARA demand

12. CSO Bilaterals Proposed rules for CSO bilaterals with sloped demand curves

13. CSO bilaterals allow for resources to exchange supply obligations outside of auctions • CSO bilateral transactions provide an alternative mechanism to acquire or shed a CSO obligation after the primary auction • Two suppliers can exchange a fixed quantity of MW and associated obligations at a privately agreed price outside capacity auctions • Bilateral transactions do not affect load’s cost for capacity; the associated credit and debit are a transfer between the suppliers

14. Current rules for bilaterals between zones allow for acquiring resource to be of equal or greater value • Bilaterals are allowed between resources within the same capacity zone or when the transfer occurs in the direction of the interface constraint between zones (e.g., from rest-of-pool to NEMA/Boston) • Allows transferring of an obligation to an area (zone) where capacity is of equal or greater ‘value’ to consumers • When import zone demand is vertical at LSR, the reliability benefit of local capacity above LSR is not valued • Similarly, capacity within an export zone, up to MCL, has equal value to rest-of-pool • The ISO accepted a participant proposal to allow bilateral trades “against the transmission constraint” based on fixed zonal requirements (LSR, MCL) • Capacity Zone Modeling Conforming Rules project (WMPP ID: 62)

15. Proposed rules for bilaterals with sloped demand curves recognize the value of capacity is determined by sloped demand curves • The use of capacity zone sloped demand curves assigns a positive value to capacity above LSR within a zone • Allowing bilaterals to move CSO MW against the interface transmission constraints outside of the capacity auctions would run counter to concepts underlying sloped demand curves • The import zone sloped demand curves imply that capacity located within the zone is more valuable than in rest-of-system, regardless of where supply is relative to LSR • This is because resources within an import zone can satisfy both the system and local requirements • Suppliers that desire to shed or acquire CSO obligations can price their offers in reconfiguration auctions where market can price the value of locational capacity

16. After capacity zone demand curves are in effect, CSO bilaterals allowed under presently effective rules • Provided the changes proposed by the Capacity Zone Modeling Conforming Rules project (WMPP ID: 62) to allow bilateral trading “against interface constraints” are approved, those rules would remain in effect through CCP9 (2018/19) • Capacity zones continue to have vertical requirements (LSR, MCL) • Beginning with CCP10, bilaterals would be allowed within capacity zones or in the direction of interface constraint between adjacent capacity zones (presently effective rules)

17. Adequacy Backstop measures Proposal to establish mechanisms for responding to market outcomes where supply is below planning criteria

18. Demand curves are consistent with NPCC planning criteria and designed to meet reliability targets • Considerable discussion has focused on ISO response to observing capacity supply below planning criteria • FCM structure with a sloped demand curves satisfies the NPCC requirement to plan to achieve sufficient capacity • NPCC standards define an obligation to conduct studies that evaluate resource adequacy to achieve a 0.1 days/year LOLE • FCM demand curves are designed to provide markets-based incentive for investment in capacity to achieve the NPCC criteria • Simulations conducted by The Brattle Group indicate the approved system-wide demand curve is an improved markets-based mechanism compared to vertical demand of ICR

19. Backstop action may be appropriate when capacity supply is below requirements • FCM is intended to secure resource capacity needed to meet adequacy and reliability requirements on an expected basis • In the event the auctions procure supply at levels significantly below requirements, ISO action may be appropriate • ISO proposes to establish objective triggers to identify supply conditions that are “significantly below requirements” and a measured plan for response • Identifying a condition as “significant” should mean there is a probable threat to system reliability • PJM maintains an adequacy backstop provision

20. Backstop should minimize intervention and provide for measured response to defined triggers • Minimize market intervention: expectations and outcomes of frequent interventions would not be healthy for capacity market • Define objective “shortfall” triggers that are consistent with: • ISO’s obligations to plan for and reliably operate system • Relative size of New England area capacity requirements • Uncertainty inherent in resource planning models • Application of both system-wide and local area requirements • Establish a measured plan for response, for example: • After one FCA with a shortfall, analyze cause and possibly recommend corrective adjustment; e.g., administrative rules, estimates of Net CONE • After consecutive FCAs with a shortfall that has not been remedied by market adjustments, solicit out-of-market purchases of needed capacity

21. Summary and schedule Summary • Reconfiguration Auctions: with demand curves, the ARA will function much the same as today and be more robust for suppliers • CSO Bilaterals: after capacity zone demand curves are in effect, CSO bilaterals allowed under presently effective rules • Adequacy Backstop Measures: establish objective triggers to identify supply conditions significantly below requirements and a measured plan for response Schedule • July MC: design concepts • August MC: detailed design • September MC: completed design and tariff proposals • October MC: vote • Filed with FERC before the end of 2014 (FCA9 and FCA10 milestones occur in February 2015 and FERC expects ISO to file zonal curves by January 2, 2015)