FCM PI Impact Assessment

1. FCM PI Impact Assessment Results Analysis Group July 11, 2013

2. Overview • FCM PI vs. FCM Status Quo (and alternatives) • March 1 Meeting • Overview of impact analysis and role of Analysis Group • Potential additional scope items • April 10 Meeting • Proposed analytic approach • Key elements of scenarios • Expected sources of data and assumptions • June 4 Meeting • Model construct and status • Scenarios and assumptions, data sources • Examples of outputs • Feedback on inputs

3. Today Core results Generator options for mitigating gas shortages Incorporating PI Risk Factors into FCA Bids August Meeting Responses to stakeholder questions Results of NRG proposal impacts Overview

4. Reminder: Model Components • System/Scenario • ICR (base/H/L) • Financial assumptions • Fuel prices • Scarcity hours • Total & timing • Gas shortage hours,performance decrement • Balancing ratio • Perf payment rate • Existing Units • GFC • Avoidable fixed costs • Possible dual fuel invest • Environmental costs • Avg LMP, AS & NCPC revenues, variable costs • Performance • Based on scarcity def’n • Risk premium • New Units • GFC • Investment, otheravoidable fixed costs • Avg LMP & AS revenues,variable costs • Performance • Based on scarcity def’n • Risk premium Model Inputs OfferCalculations Unit Offers with PI, without PI • Market Outcomes • Supply curves • With & without PI (and difference) • Versus ICR (base/H/L) • Clearing price • Cleared & delisted units • With & without PI • Suppliers • Costs • New investment • Dual fuel, environmentalupgrades • Load • Payments • With and without PI • Total, and average per MWh of consumption Model Outputs

5. FCM PI Impact Assessment Scenarios Scenarios • Scenarios focus primarily on FCM PI outcomes: • Variations in factors that affect FCM PI outcomes (but not outcomes of FCM without PI) (e.g., frequency and type of reserve shortages) • But also incorporate key factors affecting future resource availability in both scenarios (e.g., dual fuel capability, environmental compliance costs)

6. Scenarios: Historical Conditions FCM PI Under Historical Conditions FCM Clearing Price: With PI: $1.84 / kW-month Without PI: $1.31 / kW-month

7. Scenarios: Historical Conditions FCM PI Under Historical Conditions

8. Under FCM PI, some resources may remain in the energy market even if FCM bids do not clear The PI design offers potential performance revenue to resources that do not clear in the FCA This may lead some existing resources without CSOs to continue to operate in the energy market “Equilibrium” conditions thus reflect the dynamic between … … the quantity of excess supply that remains in the market under FCM PI (which increases with higher shortage hours) and … the number of reserve shortage hours (which decreases with higher levels of excess supply) All else equal, need to have internally consistent level of excess supply and number of shortage hours Scenarios: Equilibrium Conditions

9. Scenarios: Equilibrium Conditions Equilibrium conditions reflects the balance between excess capacity and reserve shortage hours AG FCM PI Model: As the number of reserve shortage hours increases, the MW of capacity remaining in energy markets (above ICR) increases Hours of Reserve Shortages ISO NE Planning Model: As the quantity of surplus capacity increases, the number of reserve shortage hours decreases H* MW* Surplus Capacity Above ICR (MW) Because the quantity of excess capacity (above ICR) increases with the number of reserve shortage hours, “equilibrium” conditions reflect internally consistent levels of excess capacity (MW*) and reserve shortage hours (H*)

10. AG’s analysis focuses on approaching equilibrium in the near-term, starting with the existing fleet Over the true long-run, some capacity that is currently infra-marginal would be expected to retire, requiring new entry from time to time We have not tried to model this long-run equilibrium Instead, our analysis reviews potential evolution to “near-term” equilibrium conditions (e.g., FCA 9 or so), starting with the existing fleet Near-Term vs. Long-Run Equilibrium

11. FCM PI Under Near-Term Equilibrium Conditions Scenarios: Near-Term Equilibrium Starting From Current Conditions With higher expected reserve shortage hours, ~1,000 MW surplus capacity above ICR remains in-service, that otherwise would not (this is less than current capacity levels) Offers increase to reflect higher expected reserve shortage hours (H)

12. Scenarios: Near-Term Equilibrium Starting From Current Conditions FCM PI Under Near-Term Equilibrium Conditions FCM Clearing Price: With PI: $3.83 / kW-month Without PI: $1.31 / kW-month

13. Scenarios: Near-Term Equilibrium Starting From Current Conditions FCM PI Under Near-Term Equilibrium Conditions

14. Environmental compliance costs due to EPA regulations Analysis reflects costs related to potential compliance with U.S. EPA environmental regulations Environmental regulation could raise the going forward costs of resources subject to compliance requirements Results Presented for moderatecase (approximately 50% of units that could ultimately face compliance costs do include such costs in FCA 9 offers) Scenario chosen to highlight impacts – given compliance obligations and timelines, this may overstate impacts for FCA 9 Environmental compliance costs raise FCM prices with and without PI But, the change in FCM prices is roughly the same with and without PI Scenarios: Environmental Compliance Costs

15. Scenarios: Environmental Costs FCM PI With Environmental Costs FCM Clearing Price: With PI: $2.74 / kw-month Without PI: $2.00 / kw-month

16. Scenarios: Environmental Costs FCM PI With Environmental Costs

17. Evaluation of technical options for mitigating regional natural gas transportation constraints Technical options considered Dual fuel Existing LNG New LNG New pipeline transportation Cost-effectiveness at mitigating reliability concerns Full costs (upfront and annual) of each option evaluated Not all potential benefits evaluated (e.g., system benefits of increased pipeline transportation) Generator Options for Mitigating Gas Shortages

18. Several conclusions from evaluation of technical options Dual fuel identified as likely lowest-cost option for providing reliable fuel service Assumes no administrative barriers to permitting dual fuel Description of analysis provided in following slides Service from Existing LNG Theoretically, this could be cost-effective, but this would depend on the level of demand charge (i.e., daily $ per Dth charge for holding a “call option” on LNG supply), and the nature and cost of the commodity purchase option or obligation However, it is not cost-effective at “illustrative” charges and obligations presented in recent company presentations New pipeline service Not cost-effective at firm tariff charges Generator Options for Mitigating Gas Shortages

19. Three Step Process Identification of operational status of gas-fired units Currently has operational dual fuel capability Mothballed / decommissioned dual fuel capability No dual fuel capability Assign costs for each unit to maintain dual fuel capability Upfront costs (re-commission or install dual fuel capability) Re-commission or install dual-fuel capability Initial testing Annual costs Fixed O&M Fuel carrying costs Annual testing Adopt dual fuel upgrades if there are sufficient revenues from PI Upgrade if: Annualized dual fuel cost < PPR * (MWh incremental output in tight gas periods) (Where incremental output is the product of the quantity of reserve shortage hours related to gas supply (HGAS) and incremental improvement in performance during these outages (DAGAS)) Dual Fuel

20. Dual Fuel Blue = existing dual fuel Red = mothballed/decommissioned units Green = no dual fuel capability

21. Scenarios: Gas Supply Shortages FCM PI with Gas Supply Reserve Shortages FCM Clearing Price: With PI: $2.46 / kw-month Without PI: $1.31 / kw-month

22. Scenarios: Gas Supply Shortages FCM PI with Gas Supply Reserve Shortages

23. Risk Factor • With PI, FCM revenues depend on unit performance and system conditions: • PFCMis the fixed component FCM price (same as a resource’s GFC today) – this price does not vary with operator performance or system conditions • With PI, uncertainty in reserve shortage hours (H), unit performance (A) and the balancing ratio (Br) creates uncertainty in FCM revenues – these factors will depend on both operator performance and system conditions

24. Risk Factor: Risk Management Context • Company-wide, most market participants have multiple revenue streams from multiple assets across multiple markets – FCM typically represents one revenue stream among many • E.g., wholesale market asset portfolios comprise different performance characteristics, different markets and different geographies • Assets – gas/oil/nuclear, dispatchable/intermittent, old/new, fast-start/non-fast-start • New England markets – FCM, Energy, Reserves, Ancillary Services, NCPC, RECs • Markets in other regions – energy, capacity, ancillary services, RECs • Also, energy revenue streams can include transmission, distribution, retail, market-making • Finally, there may be opportunities to hedge risks through transactions with other parties • Important: Our analysis does not consider the broader risk context that extends beyond NE wholesale market assets of market participants

25. Risk Factor: Mitigating Factors Factors that mitigate FCM PI financial risks within NE wholesale market context • Maximum Loss Limit (“Stop loss”) • Hedging opportunities – system conditions • Across ISO-NE, the fleet of assets in total hedges FCM PI risks • Portfolios with multiple assets will have some natural hedging (e.g., mix of units with low and high A’s) • Hedging products across ISO-NE owners – e.g., owners with high performing units can offer “insurance” to units with low-performing units (and vice versa) • Hedging opportunities – fuel supply disruptions • Technical options can mitigate financial risks (e.g., dual fuel; firm/supported supply from LNG, pipelines) • Prices in energy and ancillary services markets rise with reserve shortages driven by high loads/resource limits

26. Risk Factor • Variation in Performance (A) and Balancing Ratio (Br) • Performance (A) and the balancing ratio (Br) are highly correlated for individual units • As Br increases, so does unit performance (A) across the fleet • But, this increase in performance may not be uniform across all units • Even without this hedging, variation in performance (A) creates relatively little risk • For units with low performance (A), poor performance is bounded by no output – for example, the exposure to poor performance for a unit with A=10%, is at most DA = 10% • For units with high performance, likelihood that the minimum offer (PPR*H*Br) does not cover poor performance is small • Minimal bid is PPR*H*E[Br] (based on expected balancing ratio) • Penalties are at most PPR*H*Br, with no output • Net losses are limited to any difference between actual and expected balancing ratio, given H

27. Risk Factor • Variation in reserve shortage hours (H ) • Uncertainty in reserve shortage hours (H) creates uncertainty in PI revenues: • Units with low performance (A) suffer a loss, on average, of PPR*(A-Br) with each hour of reserve shortage • This uncertainty creates a more significant financial risk

28. Risk Factor • Analysis Group estimates of risk factor • Develop an approach to account for risk factor, but not the only approach to estimating financial risk of FCM PI • Approach accounts for the key factor affecting risk – the number of reserve shortage hours • Approach does not account for other factors that could … • … increase financial risk (e.g., performance uncertainty) or • … mitigate financial risk (e.g., stop loss, hedging between market participants, LMP price effects) • All results reported above include risk factor

29. Risk Factor: Analysis Group Approach • Risk Factor reflects a Value at Risk approach • Risk factor is the increase in a resource’s offer needed to ensure it does not “lose money” with a higher-than 5% probability • Losing money defined as negative net revenues including all ISO-NE markets • Assumes a probability distribution for the number of reserve shortage hours in each year 95% Confidence Interval

30. Risk Factor: Analysis Group Approach • In effect, this approach shifts the distribution of market outcomes such that the resource only loses money 5% of the time, but has positive expected returns Risk Factor

31. Risk Factor: Analysis Group Approach • The approach taken toward evaluating risk assumes that market participants are very risk averse • The following example – which compares two options – illustrates this degree of risk aversion • Despite the risky option’s much larger return, these two “gambles” would be equivalent under our risk framework 95% $3.82 / kw-month CSO With Risk Factor (“Risky” Option) Risk Factor = $3.07 / kw-month Expected Return = $3.57 / kw-month 5% – $1.24 / kw-month 95% No CSO (“Less Risky” Option) $0.46 / kw-month Risk Factor = NA Expected Return = $0.50 / kw-month 5% $1.24 / kw-month Example Parameters A = 0.1, Br = 0.75, E[hours] = 12, Hours95% = 25.2, GFC = 1

32. Risk Factor: Analysis Group Approach Final risk factors reflect the incremental risk added by each resource to each market participant’s resource portfolio Risk Factors ($ / kw-month) with and without Portfolio Effects Without portfolio effect, positive risk factor for most units with performance below 0.4, and some resources with higher performance • Portfolio effect eliminates most risk factors for companies with multi-resource portfolios • Remaining risk held by companies with few (poorly-performing) units

33. Appendix Appendix Detailed Scenario Results

34. Scenarios: Equilibrium Conditions FCM PI Under Equilibrium Conditions - No Risk Factor FCM Clearing Price: With PI: $3.83 / kW-month Without PI: $1.31 / kW-month

35. Scenarios: Equilibrium Conditions FCM PI Under Equilibrium Conditions - No Risk Factor

36. Appendix: Scenarios FCM PI Key Scenarios – Core Results

37. Scenarios: High Gas Supply Shortages FCM PI with High Gas Supply Reserve Shortages FCM Clearing Price: With PI: $2.89 / kw-month Without PI: $1.31 / kw-month

38. Scenarios: High Gas Supply Shortages FCM PI with High Gas Supply Reserve Shortages

39. Scenarios: High Gas Supply Shortages, Restricted DF FCM PI with High Gas Supply Reserve Shortages and Restricted DF FCM Clearing Price: With PI: $2.89 / kw-month Without PI: $1.31 / kw-month

40. Scenarios: High Gas Supply Shortages, Restricted DF FCM PI with High Gas Supply Reserve Shortages and Restricted DF

41. Appendix: Additional Scenarios FCM PI Key Scenarios – Core Results

42. Paul J. HibbardAnalysis Group111 Huntington Avenue, 10th Floor Boston, MA 20199phibbard@analysisgroup.com617-425-8171Todd Schatzki, Ph.d.Analysis Group111 Huntington Avenue, 10th Floor Boston, MA 20199tschatzki@analysisgroup.com617-425-8250