M A R C H 1 2 , 2 0 1 4

Robert Ethier V I C E P R E S I D E N T , M A R K E T D E V E L O P M E N T

Capacity Demand CurveISO’s Recommended Curve and Net CONE

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Contents

– Background and Overview – Recap of Demand Curve Objectives– Key Issues Highlighted by Stakeholder Process– Summary of Proposal– Recommended Demand Curve

• Detailed Features• Performance• Performance Sensitivities

– Net CONE– Adjustment to Initial Price Lock-In

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Background and Overview

• On January 24, FERC issued an order requiring that the ISO file a sloped demand curve by April 1:– The ISO must “submit its proposed [sloped] demand curve by April 1,

2014, to allow sufficient time for implementation prior to FCA 9.”– Discussions began with the NEPOOL MC on February 6

• Scope includes a system-wide sloped demand curve, Net CONE, deletion of pool-wide Inadequate Supply/Insufficient Competition rules, and changing the administrative payment rate for zonal IS/IC/Carry Forward rules to Net CONE– Changes incorporated in posted Tariff language

• ISO is also including a change to the length of the initial price lock-in, from 5 to 7 years

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Recap of Demand Curve Objectives• Reliability– Maintain 1-in-10 LOLE target on a long-term average basis– Rarely drop below a “minimum acceptable” reserve margin corresponding to a 1-in-5

LOLE level where ISO-NE might intervene in the market• Efficient Prices– Long-run average price at Net CONE, consistent with a market capable of attracting

sufficient merchant entry to attain reliability objectives at least cost– Short-run prices consistent with current fundamentals, going above Net CONE during

shortage and below Net CONE during surplus– Rationalize prices according to the incremental value of capacity

• Mitigate Price Volatility– Reduce price volatility impact from lumpiness and small movements and uncertainties

in supply, demand, and transmission (no bimodal price distribution)– Few outcomes at the administrative cap, with cap no greater than 2x Net CONE

• Other– Reduce susceptibility to market power– Minimize contentiousness and uncertainty from administrative parameters

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Key Issues Highlighted in Stakeholder Process

• Brattle has noted that there are a range of curves that appear to be reasonable based on objectives and analysis

• ISO agrees with Brattle demand curve objectives

• When selecting its proposed curve and Net CONE, the ISO placed significant weight on three issues:– Cap value, and consequences if an FCA was not competitive

• Limit risk with non-competitive FCA– Intercept of demand curve and Net ICR

• Provide reasonable assurance of meeting 1-day-in-10 target– Consequences of errors in Net CONE

• Reliability degrades quickly when short, while cost of buying more is relatively modest

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Summary of Proposal

• Net CONE uses Combined Cycle technology • $11.08/kW-mo (rounded to $11.1 in presentation)

• Cap at 1.65 x Net CONE • Reliability index of 1-in-7

– $18.27/kW-mo

• Kink at 0.7 x Net CONE• Reliability index of 1-in-16

– $7.70/kW-mo

• Net ICR ≈1.27 x Net CONE • Reliability index of 1-in-10

– $14.07/kW-mo

• ISO is also including a change to the length of the initial price lock-in, from 5 to 7 years

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Recommended Demand Curve• Key Changes from Brattle’s

Initial Candidate– Updated Net CONE value from

$8.32/kW-m to $11.1/kW-mo– Lowered cap from 2×Net CONE

to 1.65×Net CONE• Helps mitigate supplier market

power• Reduces exposure to very high

prices• Closer to PJM and NYISO

curves at 1.5×Net CONE and 1.6×Net CONE, respectively

– Rest of curve slightly right-shifted to maintain resource adequacy

Price at Cap: $18.27

Price at NICR: $14.07

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The Curve’s Features Support the Design Objectives

– Shape: convex • Avoids low-reliability outcomes• Recognizes declining marginal value

– Cap: 1.65 × Net CONE starting at 1-in-7• High enough to attract new entry• Low enough to help mitigate potential

market power & exposure to very high prices

• Minimum at 1x Gross CONE to prevent curve collapse and under-procurement if projected E&AS is high and Net CONE is consequently underestimated

– Kink: 0.7 × Net CONE at 1-in-16• Tuned to meet reliability objectives in

combination with cap point• Produces curve with price at NICR equal

to about 1.25×Net CONE– Toe: $0 price at 1-in-100

• Maintains convex shape

Demand Curve Parameter Values Cap Kink Foot

Prices% of Net CONE 1.65x 0.7x 0.0x$/kW-m (w/ Net CONE = $11.1) $18.3 $7.7 $0.0

Corresponding Quantities in FCA7Reliability Index (1-in-x) 1-in-7 1-in-16 1-in-100Reserve Margin 10.6% 14.5% 21.5%% of NICR -1.4% 2.1% 8.3%MW 32,516 33,648 35,711

Note: Price cap is subject to a minimum price of 1x Gross CONE.

Demand Curve SlopeCap to Kink

(Steep Section)Kink to Foot

(Flat Section)

Change in Price ($/kW-m) $10.5 $7.7Change in Quantity (MW) 1,132 2,063Slope ($/kW-m per 100 MW) $0.93 $0.38

Note: MW quantities based on FCA7; due to supply elasticity, price impacts from a 100 MW shift in supply-demand would be less than the slope suggests.

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PerformanceSimulation Results

AverageStandard Deviation

Frequency at Cap

Average LOLE

Average Reserve Margin

Reserve Margin

Standard Deviation

Frequency Below NICR

Frequency Below

Minimum Acceptable

Average20th

Percentile80th

Percentile

($/kW-m) ($/kW-m) (% of draws) (Events/yr) (%) (%) (% of draws) (% of draws) ($mil) ($mil) ($mil)

ISO Recommended Curve $11.1 $4.7 15.5% 0.10 13.3% 2.5% 32.1% 7.5% $4,404 $2,690 $6,615

Initial Candidate Curve $11.1 $5.3 6.4% 0.10 13.2% 2.5% 32.0% 7.6% $4,395 $2,620 $6,386

Price Reliability Price * Quantity

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Performance SensitivitiesSimulation Results

AverageStandard Deviation

Frequency at Cap

Average LOLE

Average Reserve Margin

Reserve Margin

Standard Deviation

Frequency Below NICR

Frequency Below

Minimum Acceptable

Average20th

Percentile80th

Percentile

($/kW-m) ($/kW-m) (% of draws) (Events/yr) (%) (%) (% of draws) (% of draws) ($mil) ($mil) ($mil)

Base Case

Recommended Curve w/ Base Case Assumptions $11.1 $4.7 15.5% 0.100 13.3% 2.5% 32.1% 7.5% $4,404 $2,690 $6,615

Shock Sensitivities

Shocks 50% Smaller than Base Case $11.1 $3.3 3.0% 0.087 13.3% 1.3% 22.4% 0.1% $4,423 $3,158 $5,725

Shocks 50% Greater than Base Case $11.1 $5.4 23.6% 0.136 13.1% 3.6% 36.0% 16.9% $4,384 $2,349 $6,988

Net CONE Sensitivities

True Net CONE is 33% Less than Administrative Net CONE

$7.3 $3.6 2.3% 0.060 15.5% 2.0% 7.6% 0.6% $2,970 $1,921 $3,764

True Net CONE is 33% Greater than Administrative Net CONE

$14.7 $4.2 42.6% 0.176 11.0% 2.9% 64.0% 28.3% $5,747 $4,109 $7,074

Price Reliability Price * Quantity

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Net CONE

• Technology– The ISO agrees with Brattle that it is appropriate to use Combined

Cycle technology as the basis for Net CONE• Appropriately balances considerations, including lowest cost generation

being actively developed in region

• Net CONE– The ISO supports the final Brattle value of $11.08/kW-mo as the

appropriate value for net CONE• Reflects reasonable assumptions • Reflects stakeholder feedback

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Adjustment to Length of Initial Price Lock-In

• The ISO proposes to change the maximum length of the initial price lock-in available to new resources– Change is a complement to reduction in the cap price

• The ISO is concerned about lack of confidence in the market, and the consequences for competitive entry– New England’s capacity market has history of very low prices and

administrative intervention, which deters investors– Undoing that perception will require multiple auctions with

competitive new entry– Modestly extending the available lock-in period reduces that risk– Need for lock-in will be reevaluated after series of successful auctions

• Proposal to increase from 5 to 7 years

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How Longer Lock-In Helps Compensate for Lowered Cap Price• New entrants/developers are concerned

about market stability and, with the current lock-in, may require a very high price to enter; a low cap threatens to prevent entry

• If this is true, a longer lock-in could compensate for a lower cap. For example:– If Net CONE estimates are accurate but entrants haircut

post-lock-in prices by about 50%, they would enter with a 5-year lock-in if price ≥ 2×Net CONE. Thus they would enter with our initially proposed cap of 2x, but not 1.65x.

– With a 7-year lock-in and the same post-lock-in haircut, the CC would be willing to enter at 1.61×Net CONE (same NPV).

– This is consistent with the final proposed cap of 1.65xNet CONE; would be lower if adjusted for a longer lock-in’s effect on risk and cost of capital.

• This example supports proposal to offer a 7-year lock-in along with the lower price cap.

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