December 17, 2003

1. Proposed Regulation Market Changes ISO New England Market Monitoring December 17, 2003 Robert G. Ethier, Ph.D. Director, Market Monitoring

2. OUTLINE • Overview • Background • The Problem With The Current Regulation Market • Data • The Proposed Solution Under The Current Market Structure

3. OVERVIEW • Current Regulation market creates a Day-Ahead floor price paid to all providers • No link between those who set the Regulation Clearing Price (RCP) and those who provide Regulation • Large RT Regulation providers have no incentive to be included in RCP determination • Result: Inefficiently high RCPs • Proposed Solution: Limit self-schedules after RCP determination

4. BACKGROUND • RCP’s are calculated once, prior to the dispatch day • RCP’s are calculated by Regulation Optimizer (REGO) • A RCP is calculated for each hour of the dispatch day • REGO selects the least expensive committed resources required to meet the Regulation requirements • Hourly RCP is the sum of the submitted Regulation offer plus applicable Opportunity Costs of the most expensive unit required • RCP based on offers and self-schedules submitted during Day-Ahead and Re-Offer period

5. BACKGROUND (Continued) • RCP is paid to all RT providers of Regulation • Regulation offers capped at $100/Reg-hr • Additional self-schedules for Regulation are allowed until one-half hour prior to the dispatch hour • In event of excess supply of Regulation, largest providers are selected first, potentially bumping other in-merit resources • All units, including self-schedules, are paid the hourly RCP determined prior to the dispatch day

6. BACKGROUND (Continued) • Note that if a unit with a Regulation offer plus Opportunity Cost exceeding the RCP is selected to provide Regulation in RT, it is paid As-Bid • There is no link between RT Regulation providers and the units included in RCP setting a day in advance • i.e., all Regulation could be provided by RT self-schedules that did not clear during the RCP setting process

7. THE PROBLEM WITH REGULATION • Combination of: • Regulation floor price (RCP) paid to all providers • Self-scheduling after the RCP is determined • Selection of largest Regulation providers in RT • Results in little incentive for large, inexpensive providers of Regulation to clear during RCP determination process

8. THE PROBLEM WITH REGULATION (Continued) • Why would a large, inexpensive provider want to clear during RCP determination? • This would result in lower RCPs. • This would not improve their chances of being selected for Regulation in RT • Problem: Regulation market does not incent competitive offers/self-scheduling by large, low-cost Regulation providers prior to RCP setting.

9. THE PROBLEM WITH REGULATION (Continued) • This results in: • Higher RCPs • Large amounts of Regulation self-scheduling in RT • Frequent displacement of units cleared during REGO Optimization • These units are willing to provide Regulation at the RCP but are not selected because of the size of their Regulation range

10. DATA SUGGESTING THE PROBLEM IS REAL • Five of the six most frequent RT Regulation providers showed substantially more RT Regulation provision than selection during RCP process • From mid-June through early December, these five units were committed an average of 764 hours in the RCP determination process • During the same time period, they provided Regulation in RT an average of 2,407 hours • All other significant RT Regulation providers were committed more often during RCP determination than in RT

13. SOLUTION • Appendix A mitigation authority not the right solution: • Calculating costs of Regulation provision is subjective • Some units fail to clear because of Opportunity Costs, yet self-schedule in RT • Underlying Regulation market incentives are the fundamental problem

14. SOLUTION (Continued) • Proposed solution is to eliminate self-scheduling of Regulation after RCP determination • This will incent low-cost providers to clear in the RCP determination process • Reduce the number of units that clear for RCP determination but are not selected in RT • PJM independently proposed same solution to same recognized problem in Regulation market • Other Regulation modifications expected to be part of co-optimized reserves