Topics

1. California ISO'sComprehensive Market Redesign(MRTU Project)Lorenzo KristovPrincipal Market ArchitectDepartment of Market and Product DevelopmentPresentation for WECC Market Interface CommitteeOctober 26, 2006

2. Topics • Background and Motivation • CAISO Core Functions • Original California Design • Problems With Original Design • MRTU Market Redesign Proposal • Some Details of MRTU Design • Congestion Revenue Rights (CRRs) • Hour Ahead Scheduling Process (HASP) • Current Status + Next Steps MIC MRTU Presentation

3. Background ISO Core Functions • Reliably operate, as a single control area, the combined transmission grids of California's three major IOUs and other transmission owners. • Provide non-discriminatory access to the grid for wholesale buyers and sellers of electricity. • Wholesale buyers = load-serving entities (LSEs), large consumers • Wholesale sellers = generators, marketers MIC MRTU Presentation

4. Background (2) Performing ISO core functions entails: In Real Time - • Real-time dispatch of supply resources to serve instantaneous demand (via Real-time Imbalance Energy Market) • Reliable real-time operation - observe grid constraints, respond to contingencies, comply with WECC/NERC operating criteria Day-ahead, hour-ahead - • Scheduling - non-discriminatory allocation of limited transmission capacity for intended power flows • Congestion management - to ensure feasible forward schedules • Procurement of Operating Reserves and Regulation (AGC) • Dispatch Reliability Must Run (RMR) generation - to ensure local grid reliability in constrained areas • Unit Commitment - to ensure adequate supply resources are on-line to meet forecasted load & reserve requirements MIC MRTU Presentation

5. Background (3) Performing ISO core functions entails: Prior to Day Ahead - • Assess and publish expected grid conditions (status of grid facilities) • Assess adequacy of supply resources to meet forecasted demand • Generator outage coordination; generator maintenance standards Medium to Long Term - • Conduct Firm Transmission Rights (FTR) Auctions (year-ahead) • Contract with Reliability Must Run (RMR) Generators • Transmission Planning - to ensure adequacy of grid facilities, in coordination with transmission owners and state authorities • Economic assessment of proposed transmission projects General - • Monitor performance of ISO systems and markets • Monitor compliance of ISO participants with Tariff and Protocols • Provide information to participants, public, regulators, etc., • Identify problems and take corrective actions as appropriate. MIC MRTU Presentation

6. Background (4) Areas in need of redesign • Forward Congestion Management - correct flaws in original "zonal" design • Infeasible schedules, due to ignoring intra-zonal constraints, create real-time operating burden • Became more severe with new generation in Mexico & Southwest • The "DEC Game" - strategic over-scheduling by generators to profit from real-time decremental (DEC) re-dispatch • Unit Commitment - Original ISO design provided no ability to commit generators day-ahead (except RMR) • Day-to-day Supply Adequacy • Resource Adequacy Requirements being developed by CPUC for regulated LSEs (Investor-owned Utilities) • ISO engaged in RA proceeding to define local area capacity requirements, obligations on RA resources, etc. MIC MRTU Presentation

7. Original California Design Separation of Wholesale Energy Markets from the Transmission Provider • ISO was created to provide reliable, non-discriminatory transmission service, operating markets only for: • Ancillary Services (regulation & operating reserves) • Congestion Management (DA & HA scheduling, RT re-dispatch) • Real-time Balancing Energy • All energy markets & transactions were to be conducted outside & independent of ISO • Use of ISO transmission grid to be scheduled by Scheduling Coordinators (SCs), who must submit balanced schedules • Power Exchange (PX) – Operated day-ahead & day-of pool markets, submitting results to ISO as balanced SC schedule. MIC MRTU Presentation

8. Original Design (2) ISO's Congestion Management (CM) Approach • Zonal network model • 3 internal Zones connected in a radial fashion • DA/HA CM enforces only inter-zonal constraints and inter-ties with adjacent control areas • "Intra-zonal" constraints not enforced in DA/HA CM • Local Reliability needs provided by annual contracts with Reliability Must Run (RMR) units in critical locations • Balanced adjustments to SC schedules keep SC schedules balanced • "Market Separation Rule" prevents ISO from making economic trades among SCs • Real-time imbalance energy dispatch based on zonal merit-order bid stack • No “Economic Re-Dispatch” • Intra-zonal transmission constraints relieved in real time by manual "out-of-sequence" dispatch instructions. MIC MRTU Presentation

9. Original Design (3) • Divestiture of utility-owned thermal generation • No contractual supply obligations on plant buyers • Utilities required to buy & sell through PX • Offer all retained generation to PX markets • Buy for all load-serving needs from PX markets • Recovery of stranded utility investment costs • Via flexible "Competition Transition Charge" • CTC = [frozen retail rate – utility cost of service] • Retail "Direct Access" for all customers • Direct Access energy credit = wholesale energy component of utility cost of service MIC MRTU Presentation

10. Problems With Original Design • Zonal Forward Congestion Management • Allows infeasible schedules to be established day-ahead, even though they cannot flow in real time (source of the "DEC Game"). • Requires real-time re-dispatch, complicating grid operation. • Does not provide transparent, non-discriminatory mechanism to manage congestion associated with new generation • ISO cannot perform congestion management before real time for several generation pockets today • Significant new generation connecting in areas where congestion will be exacerbated – an impediment to state's objective of bringing new generation on-line. • Zonal Real Time Dispatch • Requires frequent manual operator intervention (I.e., out of merit order dispatches) for intra-zonal congestion. • Inefficient use of resources in real time. MIC MRTU Presentation

11. Reform Efforts Pre 2000-01 Crisis • Jan. 2000 FERC Order to Redesign Congestion Management, in which FERC: • Rejected ISO's proposed new gen. interconnection policy, which assessed new generators for impacts on intra-zonal congestion (Am. 19) • Rejected real-time bid mitigation for local market power arising from intra-zonal congestion (Am. 23) • ISO was attempting to eliminate the "DEC Game" and to prevent opportunistic exercise of local market power • Identified inter/intra-zonal distinction as root of problem and ordered congestion management redesign • ISO initiated "Congestion Management Reform" (CMR) project => Jan. 2001 Proposal MIC MRTU Presentation

12. Impacts of 2000-01 Crisis • Diverted attention from Congestion Management • ISO market design flaws not a significant factor in crisis • Led to identification of more fundamental problems • Underlying capacity scarcity condition, due to • Inadequate incentives for market investment in new capacity • Lapse of state-wide resource planning process • Excessive reliance by load-serving utilities on spot markets • Elimination of traditional "Obligation to Serve" • Requirement to buy/sell through PX (PX died when requirement was abolished), plus disincentives for forward contracting • Frozen retail rates and CTC structure • Eliminated incentives to enhance demand responsiveness • Severely reduced viability of retail competition • Led to utility bankruptcy when wholesale prices shot up • Opportunities for exercise of supplier market power • Exacerbated by supply scarcity, buyers' reliance on spot markets, and weak demand-side responsiveness. MIC MRTU Presentation

13. Market Design 2002 (MD02) Project • Initiated at end of 2001, to • Address underlying causes of crisis, to the extent these are amenable to ISO market design changes • Look beyond the crisis, and develop comprehensive program of ISO market design changes to enhance performance of ISO core functions (reliable, non-discriminatory transmission) • Fix previously identified flaws in ISO market design (e.g., Congestion Management Reform & "seams" issues) • Develop a package of market design changes for October 1, 2002, when FERC's June 2001 market mitigation order was set to expire • Emphasis on continuity of market & operational stability • Timetable dictated by FERC Dec. 2001 Order • Required May 1 filing of Congestion Management Redesign and ISO Day-ahead Energy Market MIC MRTU Presentation

14. Other Motivating Factors • Need for a transparent, forward spot market • Limited opportunities today for buyers and sellers to match next day needs and supplies. • Day-ahead hourly spot price will enhance demand response capability. • BUT – Creation of a forward spot market on ISO's existing zonal design would likely increase infeasible schedules. • Systems and Software Problems • Legacy systems now have over 350 patches, need to be updated to ensure reliable, timely running of ISO scheduling procedures and markets, and publication of final schedules. MIC MRTU Presentation

15. Scope of MRTU (MD02) • MRTU addresses only the redesign of ISO markets – not the entire California electricity industry. • Contributes to solutions of broader California energy problems, but does not by itself solve them • State policies required to address long-term generation and transmission adequacy • New generation & transmission planning will benefit from transparent, accurate, "nodal" spot energy prices (LMPs) • Investment climate will benefit from certainty about market design and regulatory framework. • Focuses on ISO core functions • Reliable operation of transmission system • Non-discriminatory, bid-based access to the grid. MIC MRTU Presentation

16. Scope of MRTU (2) • Clearly delineate causal factors of California crisis that ISO market redesign can and can not address • ISO can improve investment signals, but capacity adequacy for California requires further state policy action • ISO can improve incentives for forward contracting, but CPUC regulates procurement by investor-owned utilities • ISO can create wholesale price signals, but CPUC and load-serving entities implement most demand response programs • ISO can monitor & mitigate market power abuse, but above factors reduce market power opportunities. • Ensure flexibility to coordinate with evolving energy markets & transmission organizations in the West. • Adopt/adapt market design elements that work well in other ISOs. MIC MRTU Presentation

17. MRTU – an Integrated Design • Original driver of ISO market redesign (Jan. 2000) was need to revise zonal congestion management • The MRTU Solution: Use a Full Network Model (FNM) in forward congestion management, to address constraints before real time and create feasible forward schedules. • Integrated Forward Market (IFM) based on LMP is demonstrated way to implement congestion management redesign. • Creating an integrated forward market, using the FNM for congestion management, results in: • Locational Marginal Pricing (LMP) as the basis for valuing supply resources at various locations and assessing grid usage charges • A forward energy pool market that trades energy to meet spot needs and clear congestion. MIC MRTU Presentation

18. Benefits of LMP • Forward scheduling using accurate network model ensures feasible schedules and efficient use of resources to serve load, eliminates the DEC game, clears congestion ahead of real time. • Pricing supply resources (including demand response) at nodal prices provides financial incentives for scheduling and real-time generator behavior consistent with reliable grid operation. • Nodal energy prices (LMPs) for all hours and real-time dispatch intervals provide key information for new generator location decisions, investment in demand response, and transmission planning. • LMP facilitates connection of new generation to the grid, thus supporting the State's efforts to ensure resource adequacy. • Pricing loads at large-area aggregate prices addresses equity concerns by insulating loads from locational price impacts. MIC MRTU Presentation

19. Major Design Elements • Day Ahead Integrated Forward Market (IFM) • Integrated congestion management, energy market, ancillary services procurement, unit commitment • Locational Marginal Pricing (LMP) • Congestion management using accurate detailed model of the transmission grid (Full Network Model or FNM) => "nodal pricing" • Nodal prices (LMPs) reflect congestion and transmission losses • Congestion Revenue Rights (CRRs) • Source-to-sink, to enable parties to hedge congestion cost risks • Residual Unit Commitment (RUC) • Day Ahead reliability backstop to meet real-time load forecast • Hour Ahead Scheduling Process (HASP) • Allows changes to resource and inter-tie schedules without creating a complete third settlement market • Market Power Mitigation • Damage control bid cap; Local Market Power Mitigation (LMPM) MIC MRTU Presentation

20. Some Design Details • Load Aggregation • Three IOU-based aggregation zones (PG&E, SCE, SDG&E) for all non-ETC load scheduling & settlement • Real-time demand response can earn locational price • Scheduling Priorities & Self Scheduling • "Self Schedules" = submitted preferred schedule quantities (supply and demand) with no prices • IFM gives higher priority to self schedules in clearing energy market and managing congestion • No "balanced schedule" requirement for individual SCs (except when submitting ETC & wheel-through schedules) • Congestion Revenue Rights (CRRs) • Financial Rights Only - No Physical Scheduling Priority • Annual release of 4 seasonal CRRs, plus monthly true-up. MIC MRTU Presentation

21. CRR Details • Allocation to loads within ISO control area • Source-sink pattern and quantity of CRRs estimated to keep LSEs financially whole with respect to annual congestion charges • LSEs with external load eligible to participate in CRR Allocation via prepayment equivalent to access charges • Allocation to sponsors of new transmission who do not receive regulated cost recovery • Auction open to all participants, following each allocation process (annual and monthly) • CRRs are settled based on Day Ahead LMPs • Market in which parties schedule use of transmission grid • Incentive to schedule in DA rather than procure RT energy • CRRs do not cover transmission losses. MIC MRTU Presentation

22. Further Design Details • Integration of Market Power Mitigation and RMR dispatch in IFM • Pre-processing runs of IFM software determine local MPM and RMR needs based on load forecast • "Final" IFM run uses MPM/RMR results as inputs and clears market based on load schedules and bids • Honoring Existing Transmission Contract rights • Today ISO reserves transmission capacity to serve ETC rights by withholding it from the DA market, without regard to actual ETC DA schedules • MRTU will reserve DA transmission for ETCs on inter-ties but not on internal grid • Post-DA ETC changes are accommodated in HA if possible, otherwise fully accommodated in real time • ETCs exempt from DA and RT congestion charges MIC MRTU Presentation

23. Further Design Details (2) • Hour Ahead Scheduling Process (HASP) • Original ISO structure incorporated three settlements - • day-ahead, hour-ahead and real-time • Original MRTU proposal preserved three-settlement system • ISO proposed "simplified" HA market in spring 2004; FERC approved in 6/17/04 Order; then re-opened in 9/20/04 Order • ISO made crucial modifications and re-submitted as HASP • Two-settlement system instead of three • RT bids and HA bids and schedule changes accepted up to T-75 (instead of T-135 as today) • IFM software clears HA supply schedules and bids against load forecast, enforcing all FNM constraints • Cleared HA import supplies and self-schedules get real-time "pre-dispatch" instructions • Deviations from DA schedules - including accepted HA changes but excluding inter-ties - are settled at RT prices. MIC MRTU Presentation

24. Status & Next Steps • Implementation date November 1, 2007 • Implementation activities with stakeholders in progress • MRTU Tariff filed February 9, 2006 • FERC Order September 21 approved MRTU tariff, subject to numerous compliance requirements • Business Practice Manuals under development • 12 “users guides” to MRTU markets • Drafts released July 31, will be revised prior to start of Market Simulation, and finalized prior to Go-Live • FERC Technical Conference will assess need to move some BPM content into Tariff • CRR Allocation and Auction Dry Run • In progress, will run through early 2007 • Realistic test of CRR rules; full analysis to be filed at FERC • Ongoing LMP studies simulate nodal price variation under full range of system conditions. MIC MRTU Presentation

25. Status & Next Steps (2) • Resource Adequacy • CPUC "Phase 1" Ruling in June established Local Capacity Requirements for 2007 and defined a tradable capacity product • "Phase 2" began September to develop Capacity Market or alternative design for implementation 2008-9 time frame • Post Release 1 MRTU Enhancements • 20+ enhancements identified, some required by FERC Order • CAISO now developing revised work plan • Long Term Firm Transmission Rights • Per July 20 FERC Final Rule, CAISO initiated stakeholder process, to culminate in January 2007 compliance filing • Seams Issues • CAISO has already been meeting with external parties • FERC Technical Conference in Dec. will better define issues and facilitate west-wide collaborative effort • Three-year Market Initiatives Roadmap released in June provides overview of ongoing and future efforts. MIC MRTU Presentation