Changing the System TMOR Reserve Constraint Penalty Factor

1. Changing the System TMOR Reserve Constraint Penalty Factor Aleks Mitreski Markets Committee November 10 2011

2. Presentation Overview System TMOR RCPF Change Problem statement Proper pricing of system TMOR during reserve deficiency RCPF analysis and recommendation Estimated Cost Impact Analysis Summary Proposed timeline Appendix - Tabular representation of estimated cost/compensation

3. Problem Statement System TMOR RCPF Change • The ISO has observed operational and economic inefficiencies when the system real-time Thirty Minute Operating Reserve (“TMOR”) price reaches its ceiling value (i.e., the RCPF) of $100 • Improper pricing of the TMOR product during shortage periods • Failure to follow incentive is created when resource’s lost opportunity cost is not compensated • The ISO must manually (in most cases inefficiently) re-dispatch resources to supply reserves • Lack of market transparency and understatement of system TMOR price • In addition, the External Market Monitor recommended increasing the system TMOR RCPF

4. Problem Statement cont. - Economic & Operational Inefficiencies System TMOR RCPF Change • Improper pricing of the TMOR product during shortage periods • The ISO has a requirement to maintain TMOR requirement at all times • Failure to properly price this product prohibits automatic dispatch and maintaining of the reserve requirement • Failure to follow incentive is created when resource’s lost opportunity cost is not compensated • Resources can have a counterintuitive incentive to not follow the ISO’s dispatch instruction to provide reserves • These incentives appear when system reserves are already deficient which further exacerbates reserve shortage problems in real-time • Inefficient dispatch of resources by UDS/manual actions • The UDS automatically halts dispatching resources to provide reserves when a resource’s opportunity costs exceeds the RCPF • ISO is reserve deficient and operators must manually dispatch resources to meet energy and reserve requirements • Pricing and transparency • The real-time reserve price does not reflect the true cost for providing the product • Price of manual actions are not transparent to the market

5. The current energy and reserve co-optimization algorithm can not properly price the system TMOR product during reserve shortage events when the RCPF is activated Proper Pricing of reserves during reserve Deficiency System TMOR RCPF Change

6. Energy and Reserve Co-Optimization System TMOR RCPF Change • Each hour of each day, the ISO has a requirement to carry TMOR reserves (in addition to Ten minute reserves) • TMOR requirement is 50% of the second largest contingency • As system load increases and/or contingency occurs UDS re-dispatches resources to ensure reserves and energy needs are met • The cost of this re-dispatch is reflected in the real-time System TMOR Price (please refer to October presentation for detail discussion on co-optimization pricing) • However, the System TMOR price can only increase up to its RCPF price cap of $100

7. Energy and Reserve Co-Optimization System TMOR RCPF Change • When the System TMOR price reaches $100 and we continue to experience TMOR shortage then: • The system TMOR price does not reflect the true cost of providing the product • Failure to follow incentive arises since resources are not compensated their full opportunity cost for providing the TMOR • The UDS halts its co-optimization process (reverts to energy only solution) and no longer attempts to cure the deficiency • Operators attempt to manually re-dispatch the system • In most cases reserve deficiencies continue until load decreases

8. Energy and Reserve Co-Optimization System TMOR RCPF Change Key principles that must be adhered for efficient operation of the energy and reserve co-optimization: • Resources dispatched for reserves must be compensated for their lost opportunity cost for not providing energy. • Otherwise, there are financial incentives to not follow dispatch • The UDS should be allowed to perform its co-optimization algorithm • Otherwise, operators are forced to perform manual re-dispatch actions which are not transparent to the marketplace • Price formation must be transparent and efficient • Otherwise, inefficient price determination fails to attract resources with desirable characteristics to provide reserves

9. Questions asked during our analysis: How frequent is the system TMOR RCPF activation? How severe is the problem? Does it have negative reliability implications? Can it be fixed by increasing the RCPF? What would be the best appropriate new RCPF value? RCPF Analysis and recommendation System TMOR RCPF Change

10. RCPF Analysis System TMOR RCPF Change • Since 2008, there have been 252 approved Unit Dispatch System (UDS) cases where: • There was TMOR shortage and, • The real-time system TMOR price reached the RCPF value of $100 and, • The lost opportunity cost of a resource that provided reserves instead of energy exceeded $100 • For each UDS case, the ISO calculated the marginal opportunity cost for providing reserves instead of energy (nodal LMP – offer block in which a resource was dispatched), as system was actually run • The largest observed marginal lost opportunity cost in these UDS cases was $386

11. RCPF Analysis System TMOR RCPF Change

12. RCPF Analysis System TMOR RCPF Change According to the previous graph, the new RCPF value should not be lower than $386 if we want UDS to properly co-optimize reserves and energy However, the calculation of the opportunity cost in that graph is with existing reserve deficiency in each UDS case As we increase the RCPF value, UDS will dispatch additional resources to cure the deficiency, which will increase the LMP to send the correct price signal In turn, the opportunity cost for providing reserves will be higher than $386 and should be reflected in the real-time TMOR price

13. RCPF Analysis - Recommendation System TMOR RCPF Change • ISO is proposing to increase the RCPF value to $500 • Our simulation of 231 actual UDS cases with TMOR deficiency using a RCPF value of $500 cured the reserve deficiency in all but 40 cases • Increasing the RCPF value to $500 will: • Allow UDS to co-optimize the system for reserves and energy • Reduce the frequency and severity of reserve shortages • Properly price the cost for providing the TMOR product • Make resources indifferent to providing energy or reserves • Decrease the amount of manual actions by operators • Enable efficient and transparent pricing of the cost of providing reserves • There is added cost associated with the ability for the ISO to carry the required reserves in more instances

14. We estimated how the total cost/compensation would change for TMOR RCPF value of $100, $200, $400, $500 and $1,000 Estimated Cost impact analysis System TMOR RCPF Change

15. System TMOR RCPF Change

16. Estimated Cost Impact due to RCPF Increase System TMOR RCPF Change Increasing the RCPF value will allow UDS to dispatch additional resources to cure the reserve deficiencies In turn, the system will experience higher real-time reserve prices and higher LMPs We re-ran the 231 UDS cases at various RCPF values to observe potential cost impact The UDS cases occurred on 75 distinct hours (38 distinct days) in the January 1st 2010 to August 31st 2011 timeframe These after the fact re-calculations are approximations using various assumptions and should be considered as estimates for reference purpose only

17. Estimated Cost Impact due to RCPF Increase System TMOR RCPF Change

18. Estimated Cost Impact due to RCPF Increase System TMOR RCPF Change We observe that as RCPF value increases to $200, $400, and $500 the UDS cases with reserve deficiency are cured within reasonable cost increase At an RCPF value of $1,000, 197 (85%) UDS cases with reserve deficiency are cured (i.e., curable UDS cases) through price increase, but cost increased unreasonably 34 UDS cases (15%) remain uncured even at an RCPF value of $1,000 indicating reserves are physically unavailable at any price (i.e., incurable UDS cases)

19. Estimated Cost Impact due to RCPF Increase System TMOR RCPF Change While large number of UDS cases are cured at an RCPF value of $400, there are three issues that prompt the ISO to recommend increasing the RCPF value to $500 instead: • We have observed a strong correlation between high opportunity cost for providing reserves and oil prices. • Having an RCPF at $500 provides a reliability margin over the $400 value to account for future oil price volatility • The cost analysis shows that cost increase between $400 and $500 provides “value” in terms of curing reserve deficiency cases • At an RCPF value of $500, UDS was able to resolve 97% curable UDS cases with cost increase of roughly $2.4 million, compared to resolving 90% of curable cases at an RCPF value of $400 • An RCPF of $500 does not mean real-time reserve prices will always reach $500 during reserve deficiency. The $500 serves as an upper boundary to allow UDS to cure reserve deficiencies through price

20. Estimated Cost Impact due to RCPF Increase System TMOR RCPF Change At an RCPF of $500 additional 7% of curable UDS cases with reserve deficiency are resolved while cost increased by 6% compared to having an RCPF value of $400 *Excludes NCPC Adjustments

21. Cost Impact due to RCPF Increase System TMOR RCPF Change • The current RCPF value of $100 does not allow for proper pricing of this product in reserve deficiency situations • Our operators may perform certain manual actions to cure the deficiency, which in turn prohibits market transparency • By increasing the RCPF value, and consequently having higher LMP, there will be a reduction of NCPC compensation to certain resources, which in turn will decrease out of market payments

22. Estimated Decrease in NCPC Compensation System TMOR RCPF Change

23. Estimated incremental changes in cost/compensation as RCPF increases System TMOR RCPF Change

24. Summary System TMOR RCPF Change • Currently the ISO experiences reserve deficient situations when the $100 RCPF TMOR is reached because at that time our software cannot optimize and dispatch for energy and reserves • The recommendation for increasing the RCPF value is reliability based where our system can dispatch resources to meet the existing reserve requirements • While there will be cost increase, the change of the RCPF will not translate into consistent real-time TMOR prices of $500, but only during isolated “tight reliability conditions” when reserves are rapidly depleting and very valuable • The increase of the RCPF will enable: • Properly price the product that is provided by the resources • Create transparent and appropriate market and dispatch incentives • ISO to carry the reserves that are specified in our operating procedures

25. Tentative Timeline System TMOR RCPF Change Stakeholder action – December/January MC Stakeholder action – January/February PC Regulatory filing – Q1 of 2012 Implementation – Q2 of 2012

26. Appendix 1 – Total cost/compensation at various RCPF values* System TMOR RCPF Change *Data between January 1st 2010 and August 31st 2011 **Calculated for the 38 distinct days with UDS cases with TMOR reserve deficiency

27. Appendix 2 – Incremental cost/compensation at various RCPF values* *Data between January 1st 2010 and August 31st 2011 **Calculated for the 38 distinct days with UDS cases with TMOR reserve deficiency System TMOR RCPF Change

28. Appendix 3 – Hours used to calculate cost estimates System TMOR RCPF Change • The 231 UDS cases used to develop the cost estimates occurred on 75 distinct hours (38 distinct days) between January 1st 2010 and August 31st