Alternative Proposal for the Capacity Cost Component of Schedule 2 Payments for Reactive Support

1. Alternative Proposal for the Capacity Cost Component of Schedule 2 Payments for Reactive Support Maine PUC Staff Presentation to the Transmission Committee April 25, 2006

2. Summary • At the start of the Forward Capacity Market (FCM), in 2010, the CC component should be set to zero. • During the transition period, any capacity payments that cover part or all of VAR capacity costs should be deducted from the CC component. • Any calculations of the CC component based on the AEP methodology should correct a flaw in that methodology.

3. At the start of the FCM the CC component should be set to zero. • Generators will be fully compensated for their capacity costs through a competitive market system. • A 1995 FERC staff white paper on reactive power supports this approach.

4. During the transition period, any capacity payments that cover part or all of VAR capacity costs should be deducted from the CC component. • Capacity payments that generators receive should compensate them for most, if not all, of their VAR capacity costs. • To not make a deduction for this would constitute double recovery of some costs.

5. Correction of the AEP Methodology • The Working Group’s blended rate uses a cost of $4.20/kVAR-yr for new units based on calculations performed in PJM using the AEP methodology. • One component of that methodology is the reactive allocator.

6. The Reactive Allocator in the AEP Methodology • With the AEP methodology, part of the costs for equipment such as generators, exciters, and step up transformers are allocated to VAR support. • The AEP methodology does this with the standard power triangle formula: MW2 + MVAR2 = MVA2 • The resulting allocator is: Reactive allocator = MVAR2 / MVA2 = 1 - pf2

7. The Problem with the Reactive Allocator in the AEP Methodolgy • It is a fully allocated approach. • Costs for added capacity for producing VARS should be considered incremental to the costs for producing real power. • To avoid double counting, a generator compensated for VAR support using the AEP methodology would have to be paid a lower rate for its real power production than a generator producing only real power.

8. The Correct Reactive Allocator • It can be shown mathematically that the incremental reactive allocator is: Reactive Allocator = 1 - pf • Material and electromagnetic physics shows that this linear approach to incremental costs is conservative (high). • Empirical evidence also supports this approach.

9. Reactive Allocator Calculation MVA*(1-pf2) MVA*(1-pf) MW MVA MVAR MW

10. Impact of the Correction • Dividing the equation for reactive allocator used in the AEP methodology by the incremental formula described here shows the overstatement of costs to be: Overstatement of Costs = 1 + pf • Thus, at an 85% power factor, the overstatement is 1.85

11. Impact of the Correction • At an 85% power factor: • New unit costs allocated to reactive support should be reduced from $4.20/ kVAR-yr to $2.27/kVAR-yr. • The blended rate proposed by the working Group should be reduced from $2.32/kVAR-yr to $1.68/kVAR-yr.