WMS Subgroup – CRR Credit

3. Review of CRR margining methodology for PTP Obligations in Nodal Protocols

4. Potential credit margin alternatives

Cheryl Yager

Overview

3. Review of CRR margining methodology for PTP Obligations in Nodal Protocols

– CRR auction - credit limits– CRR mark to market valuations– Credit review of bilateral trades– Concerns

4. Discuss potential credit margin alternatives

CRR auction - credit limits

Per the Nodal Protocols:

• ERCOT will assign a credit limit that is no more than 90% of the Available Credit Limit prior to the auction (MP may set something tighter)

• The credit constraint for each Counter-Party [in the CRR auction engine] ensures that the following sum for all of the Counter-Party’s CRR Account Holders is less than or equal to the Counter-Party’s CRR Auction credit limit:

(i) all awarded CRR Auction Bids multiplied by the absolute value of the corresponding bid price; plus

(ii) all awarded CRR Auction Offers with negative offer prices multiplied by the absolute value of their corresponding offer price; plus

(iii) the additional credit requirement for all awarded PTP Obligations.

CRR auction - credit limits

• See Beth’s presentation on CRR auction engine capability

CRR mark to market valuations - history

• Nodal Protocols provide for revaluing the forward portion of CRRs– Based on recent historical pricing (within the past 2-5 days)

rather than forward pricing• As the Nodal Protocols were drafted, TNT and CWG considered

various alternatives

– Forward market pricing – couldn’t be sure sufficient price points would be available

– Predictive pricing – ERCOT didn’t have the ability to do predictive pricing based on grid topology and expected changes to that topology

– Recent historical pricing – Not perfect, but available

CRR mark to market valuations - history

– Since mark to market pricing based on historical prices isn’t optimal, minimum collateral requirements were established via the ACPE

• Assumption (based on the real Auction Clearing Price (ACP)):

– If the ACP is high, the CRR is likely to have value – If the ACP is positive but low, the CRR may be at risk for

changing value– If the ACP is negative, the CRR is likely to be at risk

• Minimum collateral established in the ACPE took the above assumptions into consideration

– The minimum collateral requirement doesn’t take into consideration changes (known or unexpected) in the grid topology over the term of the CRR

• Must be caught after the fact through monitoring

CRR mark to market valuations

The Future Credit Exposure (FCE) portion of the Total Potential Exposure (TPE) represents an estimate of the mark to market value of CRRs.

– The FCEOBLo represents an estimate of the mark to market value for PTP Obligations

– FCEOBLo = Max (ACPEOBLo, - FMMOBLo) = Higher of auction clearing price

exposure (as defined) or FMM calculation

CRR mark to market valuations

• FMMOBLo = Forward Mark to Market exposure for all obligations owned where price is determined based on a weighted average of

1) Auction clearing price (actual)

2) Today’s most recent PTP obligation value

3) Most recent five day’s average PTP obligation value

4) Previous month’s PTP obligation value

Note: Weights still need to be determined.

– All values are derived from DAM prices rather than real time (unless DAM prices are not available)

CRR mark to market valuations

• ACPEOBL o (in $)

– Auction Clearing Price Exposure for all PTP Obligations held by the Counter-party as owner o of record at ERCOT for all Operating Days that have not yet occurred and for CRRs that have not settled.

• ACPE h, (j,k) (in $/MW per hour)

– Auction Clearing Price Exposure for PTP Obligations with the source j and the sink k for hour h - Exposure level calculated as follows:

• if the PTP Obligation Auction Clearing Price is greater than $15 per MW, then 150 divided by the PTP Obligation Auction Clearing Price;

• if the PTP Obligation Auction Clearing Price is between $0 and $15 per MW, then $10 per MW; and

• if the PTP Obligation Auction Clearing Price is negative, then $10 per MW, plus the absolute value of the PTP Obligation Auction Price per MW.

Credit review of bilateral trades

Per Nodal Protocols:

A transfer of CRRs through the ERCOT CRR registration system is not effective until the selling CRR Account Holder reports the transaction, the buying CRR Account Holder acknowledges the transaction, and both parties meet ERCOT’s credit requirements to support the transfer. Until all of those occur, the selling CRR Account Holder is considered the CRR Owner for purposes of these Protocols, including financial responsibility.

Concerns

At time of auction• Once the CRR auction is finalized, the CRR risk exists for CRR

obligations• ERCOT can include some level of additional collateral for risk• Will not be “mark to market” • How much to collateralize is TBD

Mark to Market• Values are based on historical pricing

• Captures risk only after it occurs• Doesn’t reflect future known or potential activity• Does DAM pricing capture the risk?

Concerns

• Minimum collateral requirement• Based on the auction clearing price

• Is auction clearing price a good predictor of expected value

• near term?

• longer term (1-2 years out)?

• Is minimum, as currently defined, adequate?• Price cap have gone from $1,000 to $3,000

• What can price volatility be?

• Unknowns– How will the market operate once we go live?– What will Nodal pricing look like?– How will CRRs and CRRAHs behave?

Potential credit margin alternatives

• Need for margin prior to CRR sale• Evaluation of market forwards• Evaluation of outage risk• Other

Need for margin prior to CRR sale

• Protocols allow for additional collateral for all awarded PTP Obligations

• CRR auction engine provides a mechanism for additional collateral at time of auction

• Level of additional collateral during the auction is not defined• ERCOT can include some level of additional collateral for risk• Will not be pure “mark to market” • How much to collateralize is TBD

Evaluation of market forwards

• To utilize forward prices for mark to market, forward prices must – Be consistently available– Be available for most/all hubs/nodes– Be available for most/all terms– Have sufficient trading depth to provide reliable values– Other?

• Are forward markets currently sufficiently developed for the ERCOT Region?

Evaluation of outage risk

• ERCOT to date doesn’t have the ability to do predictive pricing based on grid topology and expected / potential changes to that topology

– Is this an appropriate activity for the ISO? – If so, how would it be accomplished?

Other

• Other possible solutions?

– Short term

– Long term

Questions?

Appendix

CRR auction - credit limits – Nodal Protocol language

16.11.4.6.1 Credit Requirements for CRR Auction Participation

(1) Each Counter-Party participating in any CRR Monthly, Annual or other auction as permitted by Sections 16.11.6.1.4, Repossession of CRRs by ERCOT, and 16.11.6.1.5, Declaration of Forfeit of CRRs, shall communicate to ERCOT the credit limit it would like to establish for the CRR Auction no later than three Business Days prior to the close of the CRR bid submission window.

(2) ERCOT shall assign the credit limit for each Counter-Party participating in any CRR Auction as the lower of 90% of ACL or the Counter-Party’s requested credit limit no later than two Business Days prior to the close of the CRR bid submission window. ERCOT, in its sole discretion, may increase the credit limit until the close of the CRR bid submission window.

(3) ERCOT shall impose a credit limit in awarding bids and offers in the CRR Auction as described in Section 7.5.5.3, Auction Process.

CRR auction - credit limits – Nodal Protocol language

7.5.5.3 Auction Process

(1) The auction must be a single-round, simultaneous auction for selling the CRRs available for all auction products, with the following steps:(a) ERCOT shall enter into the CRR Auction engine model a credit constraint for each Counter-Party. A Counter-Party’s CRR Auction credit limit is equal to the lesser of the credit limit as determined in Section 16.11.4.6.1, Credit Requirements for CRR Auction Participation, or, if provided, the Counter Party’s self-imposed CRR Auction credit limit. The credit constraint for each Counter-Party ensures that the following sum for all of the Counter-Party’s CRR Account Holders is less than or equal to the Counter-Party’s CRR Auction credit limit:

(i) all awarded CRR Auction Bids multiplied by the absolute value of the corresponding bid price; plus

(ii) all awarded CRR Auction Offers with negative offer prices multiplied by the absolute value of their corresponding offer price; plus

(iii) the additional credit requirement for all awarded PTP Obligations.

CRR mark to market valuations – Nodal Protocol language

16.11.4.5 Determination of the Counter-Party Future Credit Exposure

(1) ERCOT shall monitor and calculate the Counter-Party’s Future Credit Exposure (FCE) on Business Days for all CRRs held by the Counter-Party as owner of record at ERCOT, for all Operating Days that have not yet occurred and for CRRs that have not settled, using the formula below.

FCEo = FCEOBLo + FCEOPTo + FCRFGRo

The above variables are defined as follows:

FCEo - Future Credit Exposure - Counter-Party Future Credit Exposure for all CRRs held by the Counter-Party as owner o of record at ERCOT, for all Operating Days that have not yet occurred and for CRRs that have not settled.

FCEOBLo - Future Credit Exposure for PTP Obligations - Counter-Party Future Credit Exposure for all PTP Obligations held by the Counter-Party as owner o of record at ERCOT, for all Operating Days that have not yet occurred and for CRRs that have not settled.

FCEOPTo - Future Credit Exposure for PTP Options - Counter-Party Future Credit Exposure for all PTP Options held by the Counter-Party as owner o of record at ERCOT, for all Operating Days that have not yet occurred and for CRRs that have not settled.

FCEFGRo - Future Credit Exposure for FGRs - Counter-Party Future Credit Exposure for all FGRs held by the Counter-Party as owner o of record at ERCOT, for all Operating Days that have not yet occurred and for CRRs that have not settled.ononeA CRR Owner

CRR mark to market valuations – Nodal Protocol language

(2) The Counter-Party’s Future Credit Exposure for all PTP Obligations (FCEOBL) held by the Counter-Party as owner of record at ERCOT for all Operating Days that have not yet occurred and for CRRs that have not settled is calculated as follows.FCEOBLo = Max (ACPEOBLo, - FMMOBLo

Where:ACPEOBLo = (ACPEh, (j,k)*OBLMWo, h, (j,k))

FMMOBLo = [(W1*ACP h, (j,k) + W2 * TOBLV h, (j,k) + W3 * FDOBLV h, (j,k) + W4 * PMOBLV h, (j,k)) * OBLMWo, h, (j,k)]

If FCEOBLo is negative (a net asset to the Counter-Party), then the FCEOBLo will be recalculated using PTP Obligations registered in the name of the Counter-Party only for (a) the remaining hours of the current month and (b) all hours in the following month;

CRR mark to market valuations – Nodal Protocol language

The above variables are defined as follows:

FCEOBLo - Future Credit Exposure for PTP Obligations - Counter-Party Future Credit Exposure for all PTP Obligations held by the Counter-Party as owner o of record at ERCOT for all Operating Days that have not yet occurred and for CRRs that have not settled.

ACPEOBLo - Auction Clearing Price Exposure for all PTP Obligations held by the Counter-party as owner o of record at ERCOT for all Operating Days that have not yet occurred and for CRRs that have not settled .

ACPE h, (j,k) - Auction Clearing Price Exposure for PTP Obligations with the source j and the sink k for hour h - Exposure level calculated as follows:

– if the PTP Obligation Auction Clearing Price is greater than $15 per MW, then 150 divided by the PTP Obligation Auction Clearing Price;

– if the PTP Obligation Auction Clearing Price is between $0 and $15 per MW, then $10 per MW; and– if the PTP Obligation Auction Clearing Price is negative, then $10 per MW, plus the absolute value of the

PTP Obligation Auction Price per MW.

FMMOBLo - Forward Mark-to-Market for PTP Obligations – Estimate of the forward mark-to-market value of PTP Obligations held by the Counter-Party as owner o of record at ERCOT for all Operating Days that have not yet occurred and for CRRs that have not settled.

ACP h, (j,k) - Auction Clearing Price - The auction clearing price of the PTP Obligation with the source j and the sink k for hour h.

W1 – W4 - Weighting—The weighting associated with the pricing components that sum to 1. The values of these factors must be determined by the Credit Working Group and posted on the MIS Public Area. The weighting factors may be customizable for the month to which a CRR applies.

CRR mark to market valuations – Nodal Protocol language

TOBLV h, (j,k) - Today’s PTP Obligation Value – The difference in current day’s most recent DAM Settlement Point Price between the sink k and the source j of the CRR for the hour h owned. If the DAM is executed but specific DAM Settlement Point Price s are not available, ERCOT may use the appropriate Hub prices instead. If the DAM is not executed for an Operating Day, ERCOT shall use the Real Time Market Settlement Point Prices for that Operating Day.

FDOBLV h, (j,k) - Five-day PTP Obligation Value – Average of the most recent rolling five-day difference in DAM Settlement Point Price between the sink k and the source j of the CRR for the hour h owned. If the DAM is executed but specific DAM Settlement Point Prices are not available, ERCOT may use the appropriate Hub prices instead. If the DAM is not executed for an Operating Day, ERCOT shall use the Real Time Market Settlement Point Prices for that Operating Day.

PMOBLV h, (j,k) - Previous Month’s PTP Obligation Value – Average of the previous month’s daily difference in DAM Settlement Point Price between the sink k and the source j of the CRR for the hour h owned. If the DAM is executed but specific DAM Settlement Point Prices are not available, ERCOT may use the appropriate Hub prices instead. If the DAM is not executed for an Operating Day, ERCOT shall use the Real Time Market Settlement Point Prices for that Operating Day.

OBLMWo, h, (j,k) - PTP Obligation with the source j and the sink k for hour h owned by the Counter-Party as owner o for all Operating Days that have not yet occurred and for CRRs that have not settled.

j - A source Settlement Point

k - A sink Settlement Point

h - An Operating Hour of (i) the remaining hours in the current month and (ii) all hours in the following month.

o - A CRR Owner

Credit review of bilateral trades – Nodal Protocol language

7.8 Bilateral Trades and ERCOT CRR Registration System

(1) Market Participants may sell or trade PTP Options, PTP Obligations and FGRs bilaterally, except PTP Options with Refund and PTP Obligations with Refund.

(2) The characteristics of the CRRs sold or traded bilaterally, including CRR source and CRR sink and time-of-use block, may not be modified from the terms of the original CRR.

(3) ERCOT shall initially populate a database of CRR Owners with the annual and monthly first-buyers of CRRs and first-recipients of PCRRs and MCFRIs.

(4) A transfer of CRRs through the ERCOT CRR registration system is not effective until the selling CRR Account Holder reports the transaction, the buying CRR Account Holder acknowledges the transaction, and both parties meet ERCOT’s credit requirements to support the transfer. Until all of those occur, the selling CRR Account Holder is considered the CRR Owner for purposes of these Protocols, including financial responsibility.

(5) For CRR ownership to be effective in the DAM, the CRR must be registered through the ERCOT CRR registration system prior to the Day-Ahead Market. PTP Obligations acquired in DAM may not change ownership in the ERCOT CRR registration system after DAM execution.