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 - “New Entry” Package • The Carry-Forward Rule is one of three rules that dictate how capacity prices will be determined for new entrants and existing supply when new entry is required: • New Entry Pricing Rule • New entrants can bid a fixed price for up to five years • If new entrant clears in the capacity auction, then it receives thatfixed price during those five years regardless of future capacity auction clearing prices • Carry-Forward Rule • Purpose is to correct for price collapse that could result from lumpy resource acquisitions resulting from New Entry Pricing Rule • The capacity price paid to existing supply in the Zone during subsequent year(s) will depend on the size of the new entrant and the bids of other new entrants • If the new entrant results in excess resources in the Zone (accounting for load growth, retirements, and transmission), then the price paid to all existing generation in that Zone will be set by the last “new” MW that leaves the auction regardless of size • Insufficient Competition and Inadequate Supply • The capacity price paid to existing supply in the Zone during the first year in which New Entry Pricing applies will be the lower of: • New entrant bid price • A pre-defined threshold level (1.1x CONE in FCA 7, 1.1x “last competitive auction” price in FCA 8) Modifying The Carry-Forward Rule

4. 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

5. Current Carry-Forward Rule - Potential Prices (4) Zone Price Set at $3 Due to 100 kW DR / 300 MW Existing Forced Out (3) Last Existing Needed at $2.99 (2) Insufficient Resources at $2.98 • As currently structured, the “new entry” package can result in prices that are inefficiently low for existing generation – consider the following example of a previously cleared new entrant: • New entrant gets paid $15/kW-month for an additional four years • 100 kW of new DR sets clearing price and similarly situated existing supply is paid $3/kW-month • Some economic existing generation is forced out of the auction (1) Descending Clock Auction Modifying The Carry-Forward Rule

6. Current Carry-Forward Rule - Potential Prices • This problem exists for any Zones that will need new entry in the future and the price gap could be significant • Consider the following example • Zone needs ~200 MW of new to meet reliability requirements • 200 MW peaker bids $15/kW-month for five years and clears • Existing supply receives under the insufficient competition rule $3.47/kW-month in the first year based on 1.1x the last competitive auction price $3.15/kW-month (FCA -7) • Existing supply receives $1/kW-month thereafter because no additional new resources are required (e.g,, Carry-forward rule does not apply because low load growth and/or transmission eliminate need for additional new resources) Modifying The Carry-Forward Rule

7. Inefficient Price Signals • Both pricing examples demonstrate that 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. Modifying The Carry-Forward Rule

8. 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 de-list 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* • 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

9. Proposed Modifications - Resolves Current Problems (1) Descending Clock Auction For the example on page 4 related to a previously cleared new entrant, these modifications will significantly reduce the price difference between new and existing resources in the Zone and ensure that economic existing generation is not squeezed out of the auction: (2) Zone Price Clears at $10 No Existing Generation Forced Out 10 MW New DR Clears • Fixes Current Problems: • Price based on MWs needed and new entrant bid price • No “In-Between” MW • Defined Duration • Significantly reduces new vs. existing price difference • A small incremental amount of new DR supply may clear in the Zone as compared to the current approach, but this result is significantly more efficient and equitable than allowing the least expensive 100 kW of incremental DR to set the price at a fraction of the new entrant price. Modifying The Carry-Forward Rule

10. Insufficient Competition and Inadequate Supply Rule • Current Rule states that the capacity price paid to existing supply in the Zone during the first year in which New Entry Pricing applies will be the lower of: • New entrant bid price • A pre-defined threshold level (1.1x “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 Insufficient Competition and Inadequate Supply • Proposed Insufficient Competition Rule: threshold equal to 1.1x ORTP of Combustion Turbine Modifying The Carry-Forward Rule

11. Summary and Next Steps • Summary of Request • Carry-Forward Rule: if an entrant receives New Entry Pricing, then that resource must have a de-list bid 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 welcomes the opportunity to work with any stakeholders on the proposal • Exelon will work with NEPOOL counsel to develop tariff language for the September 24th Markets Committee vote Presentation Title

12. Appendix Modifying The Carry-Forward Rule

13. FERC Rulings - Previous PJM Proposals • In 2008, PJM’s rules related to capacity pricing for new entry were as follows: • New entrant can bid a fixed price for up to three years • If selected, new entrant is required to bid into the two subsequent auctions at a price equal to initial bid price or 0.9x CONE • In 2009, PJM proposed to eliminate the minimum bid requirement so that the new entrant could bid zero in the two subsequent auctions • FERC rejected this change and stated that allowing an entrant with New Entry Pricing to bid zero was unjust and unreasonable and unduly discriminatory: • “Second, we affirm our finding that PJM's proposed changes to the bidding limitations for NEPA and MYPO are not just and reasonable and are unduly discriminatory. The original purpose of including the bidding limitations was to ensure that a new entrant in a small LDA will not reduce price to the existing resources by submitting a $0 bid in Years 2 and 3, knowing that it is guaranteed to be paid its first year bid price no matter what it bids. We continue to find that PJM and NRG have not explained why a bid floor is not necessary to protect against such bidding behavior and the resulting discriminatory pricing. That is, the new resource would receive its first-year price for all of the years in which it receives NEPA treatment, while existing resources in the LDA would receive a lower price (reflecting the LDA's surplus of capacity).” (128 FERC ¶ 61,157, at P 112 (2009) Modifying The Carry-Forward Rule

14. FERC Rulings - Applicability to Current ISO New England Rules • FERC’s rejection of the previous PJM proposal is directly applicable to ISO New England’s rules – the current approach: • Allows a new entrant to bid zero (i.e., to remain in the descending clock auction regardless of price) “knowing that it is guaranteed to be paid its first year bid price no matter what it bids” • Does not “ensure that a new entrant in a small LDA will not reduce price to the existing resources” • Does not explain “why a bid floor is not necessary to protect against such bidding behavior and the resulting discriminatory pricing” • Can produce an outcome where “the new resource would receive its first-year price for all of the years in which it receives NEPA treatment, while existing resources in the LDA would receive a lower price (reflecting the LDA's surplus of capacity).” • Based on the standards established by FERC in the previous PJM ruling, it appears that ISO New England’s current approach to new entry pricing is not just and reasonable and is unduly discriminatory. Modifying The Carry-Forward Rule

15. Insufficient Competition and Inadequate Supply Rule • From the FCA Compliance filing in December 2012: “In the Inadequate Supply and Insufficient Competition provisions, as indicated in theISO’s July 1, 2010 filing and as approved by the Commission, references to “1.1 times CONE” are being revised to refer instead to 1.1 times the Capacity Clearing Price for the most recent FCA not having Inadequate Supply (or Insufficient Competition, as applicable). When the ISO proposed this change, the Commission had not yet directed the ISO to implement an offer-floor mitigation mechanism with benchmark prices for different resource types. At that time, the clearing price from the most recent successful auction appeared to be the most appropriate replacement for CONE in the Inadequate Supply and Insufficient Competition provisions. Now that the Offer Review Trigger Price mechanism has been developed and is poised to be implemented, however, the ISO believes that the new Offer Review Trigger Price for a combustion turbine would be a far better estimate of the revenues that a new peaking resource would need to recover from the capacity market. Hence, while the instant filing replaces CONE with the Capacity Clearing Price from the most recent competitive FCA, as directed by the Commission, the ISO believes that the Inadequate Supply and Insufficient Competition pricing provisions for existing resources should instead refer to 1.1 times the Offer Review Trigger Price for a combustion turbine. The ISO intends to initiate a stakeholder process to make this change in the near future, preferably in time to be effective for the eighth FCA.” Modifying The Carry-Forward Rule