April 10, 2019| Markets committee - PowerPoint Presentation

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April 10, 2019| Markets committee

Andrew Gillespie

413.540.4088 | agillespie@iso-ne.com

Discussion of a market-based solution to improve energy security in the region

ENERGY SECURITY IMPROVEMENTS: MARKET-BASED APPROACHES

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Energy Security Improvements

WMPP ID:125

Proposed Effective Date: 2024In accordance with FERC’s July 2, 2018 orders in EL18-182-000, the ISO must develop improvements to its market design to better address regional fuel security and file by October 15, 2019

Key Projects – Energy-Security Improvements

Discussion paper

2019-04-09 and 2019-04-10 MC A00 ISO Discussion Paper on Energy Security

Improvements

– Version 1

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Scope of Today’s Discussion

This presentation focuses on some of the material in the discussion paper, and is intended to highlight particularly important concepts and insights in the

discussion paper, and facilitate discussionPlease note: ‘Stakeholder questions’ embedded in this presentation and marked this way are a paraphrasing of questions previously asked by two or more stakeholders

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Today’s Presentation Agenda

First, we will briefly review important aspects and components that will be covered in subsequent revisions to the paper and in subsequent presentationsSecond, we will examine

Problem 1 in more depth, including a simple example to demonstrate the problemThird, we will examine the ‘energy on call’ concept for the new ancillary servicesFinally, we will revisit the example to show the application of the ‘energy on call’ concept, and how it is expected to provide the incentives needed

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Overview and context

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Three Conceptual Components

Multi-day ahead market. Expand the current one-day-ahead market into a multi-day ahead market, optimizing energy (including stored fuel energy) over a multi-day timeframe and producing multi-day clearing prices for market participants’ energy

obligationsNew ancillary services in the day-ahead market. Create several new, voluntary ancillary services in the day-ahead market that provide, and compensate for, the flexibility of energy ‘on demand’ to manage uncertainties each operating daySeasonal forward market. Conduct a voluntary, competitive forward auction that provides asset owners with both the incentive, and necessary compensation, to invest in supplemental supply arrangements for the coming winter

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Why the Shift Away from the EIRC Approach

?Below are some

of the challenges we encountered with the Energy Inventory Reserve Constraint (EIRC) input approach:How to choose and precisely define the input ‘product(s)’ needed to ensure electrical energy securityStakeholder questions to the ISO regarding EIRC approach

:

What are the performance characteristics needed? Parameters such as lead-time, minimum

run-time

Where

is the cut-off for those who can and cannot ‘perform?’

Continued on next slide

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Why the Shift Away from the EIRC Approach

?– Continued

How to determine failure-to-deliver, and the consequences for failureStakeholder questions to the ISO regarding EIRC approach:What are the obligations to perform?What precisely is the resource expected to do?What is the quantity to be procured?

Stakeholder

questions to the ISO regarding EIRC approach

:

How would two resources compare/compete to provide performance characteristics? For example, one with 1 MWh for seven days vs. one with 7MWh for one day?

What happens if there is significant under-clearing of demand DA?

Continued on next

slide

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Why the Shift Away from the EIRC Approach?

– Continued

The EIRC design sought to compensate for resource inputs rather than for the actual services (resource outputs) the power system requiresThe challenges above are daunting, not robust to technological change, and miss the primary focus: electrical energy securityHence, the shift to the new ancillary

services,

which

focus

on outputs

(

i.e

., electrical energy capabilities)

to address electrical energy security

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What About the Seasonal Forward Market?

This is a longer term forward concept, intended to facilitate investments in energy supply arrangements well in advance of the Multi-day Ahead Market (M-DAM) market horizon

A successful forward market requires a corresponding spot market for the same good or serviceThe new ancillary services procured in the M-DAM could be, in this context, the ‘spot’ market for this longer term forward marketThis component may entail a substantial re-vamping of the existing Forward Reserve Market, making it the longer term forward market for the suite of new ancillary servicesStakeholder discussions on this topic will be held on a separate track

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Where is the Gap in the Current Products?

Stakeholder question: What is it that the market is not currently providing/procuring? Where is the gap in the current products?

Generally speaking, the market currently assumes there will be something else available (in real-time, something without a day-ahead position) to fill the energy ‘gap’ created if, for example, another unit cannot fulfill its day-ahead obligationsThis may not be a safe assumption as the system becomes increasingly reliant on just-in-time energy supply resourcesContinued on next slide

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Where is the Gap in the Current Products?

– Continued

Stakeholder question: Doesn’t the information about unit supply offers and characteristics (notification time, for example) provide enough information to meet these needs? The current suite of energy market products does not provide adequate financial incentives for resource owners in some cases (see prior question above) to make

energy supply

arrangement investments in advance

Investments that would ensure the resource can provide energy to fill the energy gap when and if needed, and

that

would be cost-effective and benefit the power system

Unit characteristics (

i.e

., flexibility) are not

fully valued

in the current construct

Supply offer information

alone does not provide any incentive to make advanced preparations, nor does it provide any

assurance the

resource

can fill any

energy gap

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Three Interrelated Energy-Security Problems

Incentives and

Compensation. Market participants whose resources face production uncertainty may have inefficiently low incentives to invest in additional energy supply arrangements, even though such arrangements would be cost-effective from society’s standpoint as a means to reduce reliability risksOperational Uncertainty. There may be insufficient energy available to the power system to withstand an unexpected, extended (multi-hour to multi-day) large generation or supply loss, particularly during cold weather conditions

Inefficient Schedules.

The

power system may experience premature (inefficient) depletion of energy inventories for electric generation, absent a mechanism to coordinate and reward efficient preservation of limited-energy supplies over multiple days

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Notes on the M-DAM Component

M-DAM addresses Problem 3 - Inefficient SchedulesThis problem is, to some degree, a consequence of Problem

1Solving Problem 3 helps, but will not completely solve, Problem 1M-DAM should not be confused with the new ancillary services - generally speaking:The M-DAM address how to

schedule

limited supply

resources

efficiently over a longer day-ahead market horizon (resources that are typically ‘in-rate’ day-ahead)

The new ancillary services address how to ensure there is sufficient energy to fill the

energy gap (by resources

that are not typically ‘in-rate’ day-ahead)

Continued on next

slide

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Notes on the M-DAM Component - Continued

Problem 2

- Operational Uncertainties requires a ‘margin’ to deal with uncertainty, which is the role of (and a high-level way to interpret) the new ancillary servicesThe margin provided by the new ancillary services is on top of, and does not take the place of better multi-day resource schedulingThe new ancillary services do not address, by themselves, how to use an ‘in-rate’ limited supply resource most efficiently over a longer market horizon; an M-DAM does

The M-DAM, by itself, does not create

sufficient incentives

to make up-front

supply arrangements

for resources that

are not

typically ‘in-rate’ – the new ancillary services

accomplish that

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Problem 1. A More Detailed look

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Problem 1. Incentives and Compensation

A Closer LookResources that face

production uncertainty may have inefficiently low incentives to invest in additional energy supply arrangements, even though such arrangements would be cost-effective from society’s standpoint, and reduce reliability riskResources that do not regularly clear in the day-ahead market, may be called upon by the ISO to operate in real-time, face production uncertainty (

e.g

.,

the higher

heat rate

units and units with low

capacity

factors)

These resources may

not be able to operate unless they have made costly supplemental fuel/energy supply arrangements in

advance

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A Case of Misaligned Incentives

Making supplemental fuel/stored energy arrangements in advance requires and investment (a cost is incurred)

The value that society places on making the supplemental arrangements is based on the high price it avoids with the investmentThe value the generator places on the same arrangement is based on the lower price it receives in the energy market (with the investment)

Misaligned

incentives

:

This value difference results in a divergence between the social and private benefit of the investment in supplemental fuel/stored energy arrangements

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Production Uncertainty:

Catch-22The

very act of investing in a costly supplemental fuel/stored energy arrangement that reduces the risk of shortages can simultaneously prevent high market prices that, at present, are the only means by which a competitive generation owner would receive a return on such an investment

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Example

This

section will walk-through a simple numerical example showing the misaligned incentives problem (Problem 1)

This example is simplified as much as possible to focus on the essentials20

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Example 1. Setting and Assumptions

This example is a case where the fixed cost of arranging fuel is lower than society’s expected cost

savings, but the fixed cost exceeds the generator’s expected profitAs a result, the competitive generator’s rational decision is to not make advance fuel/supply arrangementsBut the system would be better off (more efficient) if it didThis example considers a single generator with 1 MW of capacity, for a single hour,

without a day-ahead market

award

A note on units of measurement:

In this presentation we denote costs in dollars ($) and prices as rates ($/MWh)

Because the example is based on a 1 MW generator for one hour (i.e., 1 MWh) we can add/subtract these terms

Continued

on next

slide

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Example 1. Setting and Assumptions

- ContinuedThe generator must decide

in advance whether or not to incur the cost of supplemental fuel/supply arrangements, knowing that it is uncertain whether the generator will actually be called upon to operate (in real-time)‘In advance’ meaning however far in advance as is necessary (a day, a week, a month, or a season)Note: The use of the term ‘fuel’ in the remainder of the presentation is used for brevity, and should be interpreted as the neutral

‘fuel/energy supply’

term

Continued on next slide

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Example 1. Setting and Assumptions

- Continued

If the generator makes supplemental fuel arrangements in advance, an up-front fixed cost of $40 is incurredThis cost will be incurred regardless of whether or not the unit operatesThis up-front fixed cost is in addition to the unit’s marginal cost of $70/MWh, which is only incurred if the generator operates

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Example 1. Possible Market Outcomes

With advanced fuel arrangements the unit may operate

If demand is high (20% probability) the real-time LMP is $120/MWh, and the unit operatesIf demand is low (80% probability) the real-time LMP is $50/MWh, and the unit does not operateWithout advanced fuel arrangements the unit will not (cannot) operate if demand is high (same 20% probability) the real-time LMP is instead $400/MWhIf demand is low (same 80% probability) the real-time LMP is

still

$50/MWh

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Cost and Price Assumptions

(from ISO Discussion Paper on Energy Security Improvements – Version 1)

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Example 1. The Generator’s Decision

With advanced fuel arrangements the unit may

operate; the cost of advanced fuel arrangements is $40, whether or not the unit operatesIf demand is high (20% probability) the real-time LMP is $120/MWh, and the unit operatesIf demand is low (80% probability) the real-time LMP is $50/MWh, and the unit does not operateThe generator’s expected

profit, if it arranges fuel in

advance

is a

$30 loss

Without

advanced supplemental fuel/energy supply arrangements the unit will not (cannot) operate

The generator’s expected profit, if it does not arrange

for fuel

is

$

0

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Expected Net Revenue

(from ISO Discussion Paper on Energy Security Improvements – Version 1)

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Example 1. The Generator’s Decision

TakeawaysAccounting for uncertainty, the generator’s expected net revenue is a

loss for the up-front $40 investment in fuel arrangementsThere is only a 20% chance of earning a gross margin to cover the up-front cost Arranging fuel in advance is not financially prudent for the generator

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Example 1. Society’s Preferred Outcome

High DemandHigh demand is expected to occur 20% of the time

When it does, having fuel arrangements made in advance means incurring a marginal cost of $70/MWh instead of $400/MWhIn this example the expected cost savings to the system is $66/MWh

20% x ($400/MWh - $70/MWh) = $66/MWh

From society’s perspective, incurring

the $40 cost of the supplemental arrangements is

beneficial:

$

66/MWh - $

40 =

$26/MWh

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Example 1. Modify the Assumption

Reserve DeficiencySlightly modify the assumptions:

With advanced fuel arrangements the unit may operate If demand is high (20% probability) the real-time LMP is $120/MWh, and the unit operatesIf demand is low (80% probability) the real-time LMP is $50/MWh, and the unit does not operate Without advanced fuel arrangements the unit will not (cannot) operate

if demand is high (same 20% probability) the real-time LMP is

instead

$1,400/MWh

(

high demand

and

reserve deficiency)

If demand is low (same 80% probability) the real-time LMP is

still

$

50/MWh

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Example 1. Society’s Preferred Outcome

Reserve Deficiency

Having fuel arrangements made in advance means incurring a marginal cost of $70/MWh instead of $1,400/MWhIn this variant the expected cost savings to the system is $266/MWh 20% x ($1,400/MWh - $70/MWh) = $266/MWh

From society’s perspective, incurring

the $40 cost of the supplemental arrangements is

even more worthwhile

$266/MWh

- $

40 =

$

226/MWh

However

, things are the same from the generator’s

standpoint!

It

is never paid the high LMP in the scenario where it doesn’t

operate

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Example 1. Society’s Preferred Outcome

TakeawaysThe problem of misaligned

incentives not only has adverse efficiency consequences, it can also have adverse reliability consequencesThe divergence between society’s and the generator’s incentives gets worse (high demand → reserve deficiency)In both cases society would be better off, and the system’s reliability risk lower, if the generator makes advanced fuel arrangementsHowever, in both cases arranging fuel in advance is not financially prudent for the generator

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Example 1. Takeaways

The market price for energy is impacted by the supplier’s investment in advanced fuel arrangements

Investments in energy supply arrangements lowers the system’s expected total cost to achieve equally (or more) reliable outcomesHowever, under the current market design making such fuel supply arrangements is not in the generator’s commercial interest – misaligned incentives!This misalignment problem will not solve

itself –

the

current

energy market cannot produce efficient market outcomes

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What about Pay-for-Performance?

Pay-for-Performance helps, but it does not fully solve Problem 1To illustrate why we extend the example, but with only a 1% chance of high demand (

i.e., a 1% chance of a Capacity Scarcity Condition), absent the advance fuel arrangementsAdditional Pay-for-Performance assumptions:The generator has a Capacity Supply Obligation of 1 MW The balancing ratio (BR) is 0.8The performance payment rate (PPR) is $

3,500/MWh

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Example 1. Pay-for-Performance

The Generator’s SituationWith advanced

fuel arrangements the unit may operate If demand is high (1% probability) the real-time LMP is $120/MWh, and the unit operates If demand is low (99% probability) the real-time LMP is $50/MWh, and the unit does not operateWithout advanced fuel arrangements the unit will not (cannot) operate

if demand is high (

1% probability

) the real-time LMP is $

1,400/MWh,

and the generator will

incur a non-performance charge

If demand is low (

99% probability

) the real-time LMP is $50/MWh

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Example 1. Pay-for-Performance

The Generator’s DecisionThe generator’s most prudent financial decision is

the loss-minimizing oneArranging fuel involves an expected net loss of $39.50Not arranging fuel involves an expected net loss of $28.00The prudent course of action is to not incur the up-front cost of fuel arrangements

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Expected Net Revenue with Pay-for-Performance

(from ISO Discussion Paper on Energy Security Improvements – Version 1)

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Example 1. Pay-for-Performance

TakeawaysPay-for-Performance does not fully solve Problem 1

Society faces a lower reliability risk (as before) if the generator arranges fuel in advance of the operating day, but those arrangements are not consistent with the generator’s commercial interest As this example illustrates, when the risks of a reserve shortage are low, the performance incentive is significantly reduced, perhaps to the point that the generator is not induced to incur the up-front investment in fuel arrangementsEven though the investment would be efficient (cost effective for the system overall)

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Root causes

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Problem 1. Root Causes

Example 1 should be viewed as a broader

problem with the current energy market construct, with three root causes:Uncertainty over whether the generating unit will be in demandFixed costs of making arrangements for fuel, which must be incurred in advance of learning whether or not the generator will be in demand (asked to operate)

Energy supply arrangements that matter,

in the

sense

that if the generator does not make arrangements for fuel in advance, then with some probability

the

real-time price for energy will be higher, or reliability will be worse, than if it

did

Continued on next

slide

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Problem 1 - Root Causes

- ContinuedIn

the past, if a unit wasn’t able to operate (for fuel or any other reason) there was (assumed to be) some other unit to dispatch up in its placeThis assumption may not be valid in an increasingly energy-limited system, especially during cold winter conditionsThe decision to make advanced fuel arrangements could dramatically impact the energy price, especially if demand turns out to be high (or cause a deficiency)

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Problem 1 - Takeaways

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Problem 1. Incentives and Compensation Takeaways

Resources that face production uncertainty may have inefficiently low incentives to invest in additional energy supply arrangements, even though such arrangements would be cost-effective from society’s standpoint and would tend to reduce reliability risk

Misaligned incentives: The value difference between what society avoids and what generators are paid (with the investment in advanced fuel arrangements) results in a divergence between the social and private benefit of the investmentEnergy supply arrangements matter:

If the generator does not make arrangements for fuel in advance, then with some probability the real-time price for energy will be higher, or reliability will be worse, than if the generator did make advance fuel/supply arrangements

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Key Concepts and Properties of New Ancillary Services

This section provides an overview of the key concepts and properties that are similar between the various new day-ahead ancillary services

This overview is intended to facilitate stakeholder understanding of these common fundamentals prior to discussing the different detailed design elements of each new ancillary service (in a subsequent presentation)

44

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Categories of New Ancillary Services

A

multiple-day ahead market for energy, co-optimized with three new ancillary service products:Replacement Energy Reserves (RER) – New product in the day-ahead markets, not in real-timeA ‘call on energy’ product from on-line or off-line gen

1+ hour ramp-up/start-up capability

Generation

Contingency Reserves (GCR)

– Forward form of existing TMSR, TMNSR, and TMOR

products

Energy

Imbalance

Reserves (EIR)

–

New

product in day-ahead markets

A ‘call on energy’ product to cover the load forecast in excess of day-ahead cleared load (net virtual bids/offers

)

Combined, these provide the ‘margin for uncertainty’ in an increasingly energy-limited system

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Design Objectives for a Market-Based Solution

Risk Reduction. Minimize the heightened risk of unserved electricity demand during New England’s cold winter conditions by solving Problems 1,

2, and 3Cost Effectiveness. Efficiently use the region’s existing assets and infrastructure to achieve this risk reduction in the most cost-effective way possible Innovation. Provide clear incentives for all capable

resources

, including new resources and technologies that can reduce this risk effectively over the long term

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Design Principles for a Market-Based Solution

Product

definitions should be specific, simple, and uniform. The same well-defined product or service should be rewarded, regardless of the technology used to deliver itTransparently price the desired service. A resource providing an essential reliability service (for instance, a call on its energy on short notice) should be compensated at a transparent price for that

service

Reward outputs, not inputs.

Paying for obligations to deliver the output that a reliable system requires

creates

a level playing field for competitors that deliver energy reliably through cold-weather

conditions

Sound

forward markets require sound spot markets.

Forward-market procurements work well when they settle against a transparent spot price for delivering the same

underlying

service

Compensate

all resources that provide the desired

service

similarly.

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Common Parameters of

New Ancillary Services (Energy Options)

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Goals

Two broad goals in creating a market product to solve the misalignment problem (and Problem 2)

Compensate the supplier such that it will be willing to incur the fixed costs of arranging energy supplies in advance when that would be cost-effective from the system’s standpointThis first sub-section covers the construct generally (product definition concept,

quantities, etc.)

Tie compensation to consequences,

so that the suppler will be induced to incur the fixed costs of arranging energy

supplies whenever efficient (for the

system

)

The

second

sub-section covers the settlement rules, which show the consequences of not covering the

call option

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New Ancillary ServicesProduct

Definitions: ConceptAt a high level, a day-ahead seller of these ancillary services is providing the ISO with a

call option on its resource’s energy during the operating day Different time-related parameters (e.g., generator ramp or startup times) will be relevant to the awards of different ancillary service productsThe resource capabilities necessary to provide (i.e., be awarded) each day-ahead ancillary service will differ by product (GCR, RER, and EIR

)

The clearing process would be designed to select the most valuable assignment of offers to awards

For a given MWh the obligation

may be for energy, or GCT,

etc.

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New Ancillary Services

Participation and Quantities Procured

Participation:Offers to provide these ancillary services will be voluntaryQuantities Procured:Current thinking: Quantities procured for each day-ahead ancillary service product would be based (at a minimum) on the procedures currently applied by the ISO in developing a reliable next-day operating plan

Required

quantities are not

static; they

are inherently

dynamic

and will

vary

day-to-day based on:

The demand forecast

The generation cleared for energy in the day-ahead market

The system’s largest anticipated potential single-source energy loss

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New Ancillary Services

Product Substitution Structure Conceptually, there is some

overlap between the different ancillary service products and the capabilities of resources to supply eachThe details can be quite technical, and will be addressed as the design of each of these ancillary services products is further developed

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New Ancillary Services

Pricing and CompensationThe market clearing optimization would compensate both energy and ancillary service awards at uniform, transparent, product-specific market prices

The clearing prices of these day-ahead ancillary services would vary over time (i.e., as we envision it presently, each hour day-ahead), as supply and demand dictate Importantly, the clearing prices of each day-ahead product would account for the inter-product opportunity cost

Clearing

prices

would

reflect both the marginal offer price

and

the

suppliers’

opportunity

costs

of not providing energy or any other

ancillary service

product for the same delivery hour

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New Ancillary Services

Day-ahead Co-Optimized ClearingProcurement of these ancillary services

would be co-optimized (i.e., simultaneously cleared) with all participants’ energy supply and demand awards in the multi-day ahead marketThis ensures that the clearing prices for energy and each ancillary service incorporate the (respective marginal) suppliers’ opportunity costs of not receiving an award for a different day-ahead productIt also means that, whenever these inter-product opportunity costs are non-zero (as determined in the clearing process), the day-ahead LMPs for energy will incorporate the clearing prices for the ancillary

services

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New Ancillary Services

Real-Time Remains Least-Cost DispatchSuppliers have the ability to update (“reoffer”) their energy offer prices during the operating

day (i.e., after the day-ahead market for the operating day has closed)Consequently, the least-cost solution to the system’s total real-time energy and reserve requirements may be different than the day-ahead solutionReal-time dispatch of the system would continue to perform co-optimization of energy and operating reserves only, as is the case today

Commitment and dispatch in real-time

will continue to be

based

on

supply reoffers

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Day-ahead ancillary services:

Energy Option Settlements and Examples

In today’s day-ahead energy market, all forward energy sales and purchases are financially-settled based on the energy produced in

real-time and the real-time energy price The new ancillary services will also be financially-settled, however, the treatment is slightly different

56

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Energy Option Settlements: Components

A call option involves three elements: The option price (V)

The strike price (K) This is a pre-defined value, set by the ISO before sellers specify their offer pricesThe price of the underlying productIn this context it is the real-time LMP during the delivery hour

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58

Energy Option Settlements: Mechanics

Like day-ahead energy, a call option would involve both a day-ahead and a real-time settlement

The day-ahead settlement is a payment to the seller at the option clearing price (V) for each MWh of the option soldThe real-time settlement is based on what the seller delivers in real-time, and has two parts. The first part is a charge for each MWh of the option sold, equal to the real-time LMP minus

the strike price

(

K),

if that difference is positive

=

(– max{0,

RT LMP – K

})

The second part is a

credit

at the real-time

LMP

for the energy the resource actually produces

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Where:

V is the new ancillary service clearing price ($/MWh)

QDA option is the new ancillary service quantity (MWh)K is the strike price ($/MWh)

RT RCP is the real-time reserve clearing price ($/MWh)QRT reserves is the real-time reserve designation (MWh)Summary of Settlement Rules

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Settlement Rules: Formulas

Energy settlement (no change)

= (DA LMP × QDA energy) - (RT LMP x QDA energy

) + (RT LMP × QRT energy)Which can be re-written:= (DA LMP × QDA energy) + RT LMP x (Q

RT energy

- Q

DA energy

)

 

New ancillary services settlement

(new,

with no

day-ahead energy position

)

= (V × Q

DA option

) - (max {0, RT LMP – K} x Q

DA option

) + (RT LMP × Q

RT energy

)

 

Combining

these

(new ancillary services

with

a

day-ahead energy position)

= (DA LMP × Q

DA energy

) - (RT LMP x Q

DA energy

)

+ (V × Q

DA option

) - (max {0, RT LMP – K} x Q

DA option

)

+ (RT LMP × Q

RT energy

)

60

a.k.a. “deviations”

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Different settlement cases

In this section we will review a series of simple cases to see the net settlement implications

61

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62

Different Settlement Cases

A series of simple cases:

3 cases where the resource produces in real-time2 cases where the resource does not produce in real-time2 cases to show that the outcomes (cases) above do not require a change to the existing real-time incentives to reoffer and follow dispatchThese cases demonstrate why resources providing these day-ahead ancillary services will have an incentive to be capable of covering their positions (

i.e.,

provide energy if and when dispatched in real-time during the operating day)

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Different Settlement CasesAssumptions

In each case, assume:

A resource sells 1 MWh of a day-ahead ancillary serviceThe option clearing price (V) is $5/MWhThe total premium paid to the resource is $5 (1 MWh x $5/MWh)The strike price (K) is $50/MWhThe resource has no day-ahead energy positionThis simplifies the settlement calculation

= (DA LMP × Q

DA energy

) - (RT LMP x

Q

DA energy

)

+ (

V × Q

DA option

) - (max

{0

, RT LMP – K} x Q

DA option

)

+ (

RT LMP × Q

RT energy

)

Both terms are = $0

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64

Settlement Cases Summary

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65

Settlement Cases

Resource Produces 1 MWh in Real-Time

Case (a) The real-time LMP is $60/MWh The real-time price is > KThe net settlement simplifies to V + K, $55Case (b) The real-time

LMP is $40/MWh

The real-time price is <

K

T

he

net settlement simplifies to

V

+ RT LMP,

$45

Case (c)

The

real-time

LMP is $60/MWh

The resource produces

2

MWh

One

MWh

‘

covered’ the

day-ahead

option

(

Case (a)) and the other is an (additional) energy

sale

The

net settlement is $55 + $60 =

$115

In general, a seller of a call option is ‘giving up’ its potential gain from selling in the real-time market if/when the real-time price is higher than the strike price

and

the energy is delivered

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66

Settlement Cases

Resource Does Not Produce in Real-TimeCase

(d) The real-time LMP is $60/MWhThe real-time price is > KThe net settlement simplifies to V – (RT LMP – K), -$5 (a charge)

The

resource is ‘paying’ for the (replacement) energy that the seller did not produce, to the extent the cost is greater than the strike price

Case (e)

The

real-time

LMP is $40/MWh

The real-time price is <

K

The

net settlement simplifies to V

,

$5

We expect this

will change

a seller’s

incentives as

the resource may be required to ‘cover’ at the prevailing real-time market price, if it exceeds the strike price

– an incentive to be

capable

of delivering energy

Slide67

67

Settlement Cases

Real-Time Reserve DesignationThe next two cases show that the day-ahead ancillary services market outcomes do not change the real-time market incentives to re-offer supply and follow real-time dispatch

Case (f) The real-time LMP is $60/MWhThe resource provides 1 MWh of reserves in real time in lieu of energyAssume the resource’s offer cost is $45/MWh, and the real-time reserve clearing price (RT RCP) is $20/MWhThe net settlement simplifies to V – (RT LMP – K) + RT RCP,

$15

This is a sensible outcome because the real-time reserve price ($20) exceeds the resource’s potential energy margin ($60 - $45 = $15)

Despite selling the day-ahead ancillary service (which settles as an option on

energy

), in real-time the resource is better off providing

real-time reserves

than producing energy, given the real-time prices

Slide68

68

Settlement Cases Following

Real-Time DispatchCase (g)

The real-time LMP is $60/MWhAssume the resource’s reoffer cost is $75/MWh - the resource produces 0 MWh of energySimilar to Case (d), the net settlement simplifies to V – (RT LMP – K),

-$

5

(a

charge)

In

this case the ‘buy-out’ cost is less than the resource’s cost if it produced energy

($

60 - $75 =

-$15

)

Despite selling the day-ahead ancillary service (which settles as an option on

energy

), in real-time the resource is better off following the assigned real-time dispatch and

buying out

its day-ahead ancillary service obligation

Slide69

69

Key Concepts and Properties of New Ancillary Services: Takeaways

Energy Options – Product Definitions

While precise product definition will be specific to the particular category of new ancillary service, we reviewed how this approach satisfies the following core design principlesProduct definitions should be specific, simple, and uniform. Reward

outputs, do not specify

inputs.

Sound

forward markets require sound spot

markets.

The day-ahead

(“short forward”)

sales of ancillary services have a delivery-dependent real-time market settlement

This combination ultimately helps achieve all three broad design

objectives (see slide 46)

Continued on next

slide

Slide70

70

Key Concepts and Properties of New Ancillary Services: Takeaways

- Continued

Energy Options - Pricing and CompensationWe reviewed how the market clearing optimization would compensate both energy and ancillary service awards at uniform, transparent, product-specific market prices and how this approach satisfied the remaining design principlesTransparently price the desired service.

Compensate

all resources that provide the desired service

similarly.

This

approach incorporates the clearing price of these new A/S products in the

day-ahead

LMP for energy

Continued on next

slide

Slide71

71

Key Concepts and Properties of New Ancillary Services: Takeaways

- Continued

Energy Options – SettlementsWe reviewed how these new ancillary services would be settled, noting how the this day-ahead settlement is expected to change behavior (i.e., induce suppliers to make fuel arrangements in advance

)

We reviewed how

this

day-ahead does

not impact supply re-offers or real-time dispatch

Slide72

Example 1. Revisited: Solving Problem 1

In this section

we revisit Example 1 and show that introducing a call option on energy can incent generators to invest in energy supply arrangements that benefit the system (i.e., how to align the incentives)

72

Slide73

73

Example 1. Recap

The main point of Example 1 was to show the misalignment problemThe example showed that the energy market, in its current

form, does not provide sufficient incentives for resource owners to invest proactively in energy supply arrangements even when such investments would be cost-effective (i.e., efficient) and yield expected net benefits to the system

Slide74

74

Example 1. Day-Ahead Ancillary Service

AwardSetup

We need to make some additional assumptions about the day-ahead ancillary service product prices:Option clearing price (premium, V) is $50The option strike price (K) is equal to $120/MWhFor selling the ancillary service day-ahead the unit receives $50, whether or not the unit operates

Slide75

75

Example 1. Possible Market Outcomes

With advanced fuel arrangements the unit may operate

If demand is high (20% probability) the real-time LMP is $120/MWh, and the unit operatesIf demand is low (80% probability) the real-time LMP is $50/MWh, and the unit does not operateThe generator’s expected profit for arranging fuel in advance

is

$

20

Without advanced

fuel

arrangements the unit will not (cannot) operate

if demand is high

(20

% probability) the real-time LMP is

$

400/MWh

If demand is low

(80

% probability) the real-time LMP is

$50/MWh

The

generator’s expected

profit

if it does not arrange for

fuel

is

a

$

6

loss

Slide76

76

Expected Net Revenue with Option Award

(from ISO Discussion Paper on Energy Security Improvements – Version 1)

Slide77

77

Solving Problem 1.Takeaways

Real options change behavior – in this case, the generator’s willingness to undertake a costly investment in arranging

fuel in advance, even if it may not be usedThis option construct works because:The option premium (paid to the generator) makes it profitable on an expected basis for the generator to make advanced fuel arrangements, andThe option premium (i.e., the clearing price of the option) is based not only on the LMP the generator expects to receive when it has fuel, but also on the LMP society expects to avoid if it makes the investment in advanced fuel arrangements

Incentives are now

aligned

!

Slide78

Today’s Discussion Takeaways

78

Slide79

Takeaways from Today’s Discussion

The trouble with advanced supplemental fuel/stored energy

arrangements:The value that society places on making the supplemental arrangements is based on the high price it avoids with the investment

The value the generator places on the same arrangement is based on the lower price it receives in the energy market (with the investment)The problem (Problem 1) is a case of misaligned incentivesThe value difference above results in a divergence between the social and private benefit of the investment in supplemental fuel/stored energy arrangements

Continued on next

slide

79

Slide80

Takeaways from Today’s Discussion

The problem of misaligned incentives

is a growing concern because energy supply arrangements matter as the system becomes increasingly reliant on just-in-time energy supply resources

If the generator does not make arrangements for fuel in advance, then with some probability the real-time price for energy will be higher, or reliability will be worse, than if the generator did make advance fuel/supply arrangementsThe new ancillary service call option construct solves this problemThe option premium (paid to the generator) makes it profitable on an expected basis for the generator to make advanced fuel arrangements, andThe option premium (

i.e

., the clearing price of the option) is based not only on the LMP the generator expects to receive when it has fuel, but also on the LMP society expects to avoid if it makes the investment in advanced fuel

arrangements

Incentives are aligned!

80

Slide81

81

Conceptual Design Elements Summary

Slide82

Next steps

82

Slide83

Stakeholder Schedule*

83

Stakeholder

Committee and DateScheduled Project Milestone

Markets Committee

March 5-6, 2019

Update on ISO conceptual design considerations, stakeholder proposals

Markets

Committee

April 9-10, 2019

Initial review of discussion paper;

Continued discussion of the problem(s) being solved

Markets Committee

April 23, 2019

Continued

discussion of stakeholder proposals

Markets

Committee

May - June, 2019

Continued discussion of ISO and stakeholder

proposals; Updates of discussion paper as warranted

Markets

Committee

July 9-10, 2019

Initial review of impact analysis’ results;

Initial

discussion of seasonal forward component

Markets

Committee

August 13-15, 2019

Draft ISO Tariff language and draft ISO impact analysis report;

Continued discussion of

the ISO proposal

Markets

Committee

Septemb

er

18-19, 2019

Final review of proposed

Tariff language (ISO proposal and proposed stakeholder amendment(s));

Vote on ISO

proposed Tariff language and submitted stakeholder amendments

Participants

Committee

October 4, 2019

Vote on ISO proposed

Tariff language

and submitted stakeholder

amendments

*Additional MC meetings may need to be established over the May – September period