Initial Observations on LMP in Other Jurisdictions

1
Initial Observations on LMP in Other
Jurisdictions
- Market Evolution Program - Day-Ahead Market
Working Group
Andrew Pietrewicz October 30, 2003 DRAFT -
For Discussion Purposes Only
2
Purpose and Overview

• Share initial research and observations on the
  experiences of other jurisdictions with LMP
• Extract observations made in other markets
  regarding LMP
• Why go to LMP?
• How was stakeholder risk addressed?
• What is (and is not) the role of LMP?
• Briefly profile the LMP systems of ISO-NE, NYISO,
  and PJM
• Context for implementing LMP
• LMP trends
• FTRs and ARRs
• how they are allocated/auctioned,
• FTR and ARR results/trends

3
Observations

• 1. Why go to LMP?
• PJM
• 1997- Uniform pricing system without
  constrained-off payments
• Generators were self-scheduling to avoid dispatch
  instructions
• Command and control orders were on the rise
• Counter-intuitive prices were becoming more
  frequent
• Confidence in the market waned
• PJM approached FERC with the support of most PJM
  Transmitters and State Commissions, requesting
  adoption of LMP to remedy uniform pricing
  problems
• NYPOOL
• Generators were self-scheduling to avoid Split
  Savings arrangement
• ISO-NE
• Initial ISO-NE market design was conditionally
  approved as interim it was based on uniform
  pricing

4
Observations

• CAISO
• Current congestion management model only
  considers inter-zonal congestion (rather than
  both inter- and intra-zonal congestion)
• As a result, CAISO accepts forward schedules that
  cause intra-zonal congestion, which CAISO
  subsequently has to manage in real time
• CAISOs Congestion Management System (CMS) not
  only supports DEC-type gaming (i.e. is not the
  sole cause of), but also has been known to
  inspire such schemes
• CAISO concludes that their CMS is unwieldy,
  burdensome, costly to consumers, and subject to
  manipulation. It is problematic from both an
  operational and a financial perspective and
  results in unjust and unreasonable prices being
  borne by California consumers.
• FERC directed CAISO to file a new congestion
  management proposal

ISO-NE, PJM, and CAISO initially used
uniform/zonal pricing systems these pricing
systems proved to pose a number of problems. LMP
was subsequently adopted to address and remedy
those problems, as well as others. LMP was
recognized as a significant improvement on flawed
legacy congestion management or pricing systems.
5
Observations

• 2. Managing the transition to LMP
• A variety of mechanisms were /will be/ employed
  in parallel with LMP to moderate potential price
  impacts
• a) Impact studies and market trials were
  performed.
• e.g., ISO-NE and CAISO
• - produced white papers
• - published indicative LMPs,
• - published analyses of regional congestion
  patterns,
• - performed /will perform/ market trials,
• - maintained extensive stakeholdering and
  information sharing

Jurisdictions adopting LMP recognized and
addressed the importance of sharing accurate
information with stakeholders and establishing
realistic expectations as early and as frequently
as possible
6
Observations

• 2. Managing the transition to LMP (continued)
• b) Load-weighted average zonal settlement for
  load (a.k.a. load aggregation)
• ISO-NE settles load at 8 different zones
• NYISO settles load at 11 different zones
• CAISO will settle load at 3 different zones
• Aggregating load into zones moderates price
  impacts on
• consumers in congested areas.
• As pointed out by CAISO, this is particularly
  important since such impacts would
• be the result of constraints in transmission
  systems designed and constructed
• under regimes that did not employ competitive
  generation markets or nodal
• pricing.

7
Observations

• 2. Managing the transition to LMP (continued)
• c) Allocation of FTRs or ARRs to load (via
  Transmission Owners or LSEs)
• ISO-NE allocates most ARRs to Load via LSEs
• NYISO allocates ARRs to load via Transmission
  Owners
• PJM allocates ARRs to load via Transmission
  Owners (initially allocated FTRs also)
• CAISO proposes to allocate FTRs to load via LSEs
• Allocating FTRs or ARRs to load assists load to
  recover the costs of
• congestion.

8
Observations

• 3. Role of LMP
• LMP is seen as a complementary part of a larger
  suite or portfolio of
• mutually reinforcing tools (both market and
  regulatory), that
• acting together, improve the reliability and
  efficiency of a market or
• power system. LMP has both inherent/stand-alone
  value and enabling
• value.
• For instance, LMP
• a) Supports reliability and commercial advantages
  of Day-Ahead market
• - ISO-NE, NYISO, PJM, and CAISO (as proposed in
  MD02) utilize a Day-Ahead market (DAM) the
  merits of DAM are recognized
• - Jurisdictions utilizing a Day-Ahead market do
  so in conjunction with LMP LMP enables DAMs

9
Observations

• 3. Role of LMP (continued)
• b) Enhances the informational basis available for
  investment decisions
• - identifies congested areas
• - produces transparent prices which assist
  investment analysis
• - helps account for the value of upgrades to the
  system
• - assists in comparing value of competing
  investment options
• c) Supports efficient regional planning
• - enhances available information, for same
  reasons as listed above
• - PJM LMPs are used to help identify desirable
  expansions from both a reliability and
• efficiency point of view
• - PJM analyzes LMPs to determine whether
  congestion at a given location is

10
Observations

• 3. Role of LMP (continued)
• LMP alone does not solve all investment problems
  - barriers to investment persist for a number of
  reasons
• Siting considerations and restrictions, lack of
  appropriate cost allocation arrangements, lack of
  financing, undeveloped long-term FTR markets,
  etc.
• LMP jurisdictions do not over-sell the logic that
  signals necessarily lead to investment prices
  are not only about LMP/LMP is not only about
  prices
• LMP is realistically seen in other jurisdictions
  as a necessary but not sufficient system feature
• Notwithstanding, the desirability of LMP as a
  prudent congestion pricing policy is not negated
  by persistent and widespread investment barriers
  - there are numerous good reasons to adopt LMP
• LMP is seen to have inherent value (i.e.
  information) as well as enabling value (i.e.
  complements, supports, enhances other power
  system/market aspects)
• The sense is that LMP is forward thinking,
  responsible public policy
• A uniform pricing system with constraint
  side-payments does not have the same stand alone
  or enabling value as LMP

11
ISO-NE Background

• June 1997 ISO-NE conditionally commenced
  operation under an interim market design
  featuring uniform pricing and a single settlement
  system
• In 2000, further to its conditional approval of
  the ISO-NE interim market design, FERC directed
  that a proposal be filed for the development of a
  New England Congestion Management and Multiple
  Settlement System (CMS/MSS)
• In its 2000 directive, FERC expressed concern
  over the prevalence of ill-sited new generation
  developments under the interim uniform pricing
  system, and expressed a desire to remedy this for
  an oncoming surge of new generation developments
• July 2001 NEPOOL and ISO-NE jointly proposed to
  replace interim ISO-NE market with a New England
  Standard Market Design (NE-SMD), featuring
  provisions for LMP and a Day-Ahead Market
• September 2002 FERC issued an order accepting
  NE-SMD
• March 2003 NE-SMD implemented.

12
ISO-NE LMPs

• Prices have declined since implementation of
  NE-SMD, though it is too early to make profound
  price-related conclusions
• Caveat FTR and ARR payments lower the price paid
  by loads. Looking at nodal prices alone without
  considering the net effects of FTRs/ARR can be
  misleading. Further, comparing LMPs against
  legacy uniform prices can be misleading all
  prices offered in this presentation are for
  reference purposes only, and have not been
  normalized.

13
ISO-NE LMPs

• So far, simple average LMPs are highest where
  constraints are the greatest unlike during the
  interim market, prices are now reflecting
  locational constraints

14
Definitions FTRs and ARRs

• A Financial Transmission Right (FTR) is defined
  by a specific MW value in one direction between a
  source point and a sink point.
• Congestion revenues arise because the sum of load
  payments exceeds the sum of generator receipts
  when there is congestion. The difference between
  these two sums is the congestion rent or
  settlement surplus, and is used to fund FTRs.
• FTR holders are entitled to receive congestion
  revenues (or to pay congestion charges, depending
  on the type of FTR) up to an amount equal to the
  MW value of the FTR times the difference in the
  Locational Marginal Prices for the points defined
  in the FTR.
• FTRs may typically be obtained by allocation,
  through a centralized FTR auction, or through
  Secondary Markets.
• Auction Revenue Right (ARRs) represent shares of
  the revenues generated by the sale of FTRs in a
  specific auction. Like, FTRs, they are expressed
  in terms of MW quantity, source point, and sink
  point.

15
ISO-NE FTRs and ARRs

• ISO-NE currently holds periodic auctions for
  monthly FTRs.
• Auctions for 3-month FTRs will commence sometime
  this October, while 6-month and annual FTR
  auctions will likely begin in 2004.
• ISO-NE FTRs are currently offered on an
  Obligation basis, though Option FTRs are
  contemplated for the future.
• FTR auction revenues (ARRs) are allocated to
• A) Entities paying for transmission upgrades
  that increase transfer capability on the NEPOOL
  transmission system
• B) Loads via LSEs

16
ISO-NE FTRs and ARRs

• The total monthly amount of FTR auction revenue
  distributed in New England since the
  implementation of NE-SMD has increased from
  approximately 1 million in March to about 6.6
  million in August
• Bid volumes for FTRs have also increased within
  the same time period.
• These trends suggest that the merit of FTRs as a
  hedging instrument is increasingly being
  recognized and valued in New England. In
  conjunction, as auction revenues increase, so too
  does the amount available to be refunded to loads
  et al. as ARRs

17
ISO-NE FTRs and ARRs

• 99 of ARRs have been allocated to load so far
  ARRs are assisting load to recover the costs of
  congestion
• The greatest share of ARRs has been allocated to
  those zones paying the highest congestion costs
  NEMA/Boston, Connecticut, and SEMASS
• Qualified Upgrade Awards represent 1 of the
  total 15 million in ARRs allocated between March
  and August. QUAs are provided to those who
  have paid to upgrade the Transmission System

18
ISO-NE Investment

• ISO-NE has had much generation investment
  recently (by 2005, new generation will have
  increased New Englands capacity by 40 since
  1999) LMP was introduced, in part, to
  facilitate better generation siting decisions
  going forward
• Transmission Investments are now being proposed
  in higher LMP Zones (Southwest Connecticut
  Phase 1 of 700 million upgrade approved
  Northwest Vermont Siting review underway for
  150 million upgrade NEMA/Boston Two major
  transmission projects soon to be proposed for
  fast track development SEMA/Rhode Island
  Transmission studies underway) Constraints and
  costs highlighted by LMPs are being recognized
  and addressed

19
NYISO Background

• NYISO assumed responsibility for the operation of
  New York States electric power system on
  December 01, 1999.
• New Yorks electric wholesale markets and LMP
  congestion pricing system were initiated
  coincident with the establishment on the NYISO

20
NYISO LMPs

• New Yorks unweighted average annual LMP has
  declined between 2000 and 2002
• Monthly average LMPs have fluctuated in
  correlation with fuel prices and transmission
  congestion costs
• Recent congestion cost fluctuations (i.e. 2001 -
  2002) were largely driven by changes in load
  pocket modeling to better reflect some grid
  constraints.
• Improved modeling and pricing of congestion
  resulted in reduced uplift payments associated
  with out-of-merit generation dispatch

21
NYISO FTRs (TCCs) and ARRs

• NYISO is currently in the midst of an interim
  FTR market design
• Grandfathered rights (physical, Point To Point,
  use it or lose it),
• Grandfathered rights converted into FTRs,
• FTRs offered to Transmission Owners.
• FTRs can be sold directly or offered into
  auction
• Auctions are held for single-round monthly
  reconfiguration FTRs as well as for multi-round
  6-month, 1-year, 2-year, and 5-year FTRs
  (Obligations).
• Auction revenues are allocated to Transmission
  Owners and applied to embedded costs of
  transmission system (to reduce the Transmission
  Service Charge paid by loads)

22
NYISO Investment

• New York recently experienced a boom in
  generation investment (2,500 - 3,500MW).
• However, NYISO notes that some of the new supply
  is being offset by retirements of existing
  facilities, and that barriers to optimal siting
  persist onerous siting restrictions, lack of
  an effective regional planning process, paucity
  of investment financing.
• Transmission investment is less forthcoming,
  though interest is apparent (i.e Cross-Sound
  Cable, Neptune)
• NYISO cites the lack of appropriate cost
  allocation formulas and cost recovery mechanisms
  and lack of a regional transmission expansion
  plan as major barriers to transmission
  investment.

23
PJM Background

• Became the first FERC-approved ISO in the USA in
  late 1997
• Implemented market rates in early 1998, based on
  uniform pricing
• Replaced uniform pricing with an LMP congestion
  pricing and management system in April 1998
• Introduction of LMP driven primarily by threat of
  loss of dispatch control as a result of
  incentives to self-schedule - driven by use of
  uniform pricing without constrained-off payments

24
PJM LMPs

• The 2002 unweighted PJM average LMP was 12.6
  lower than in 2001 and was approximately equal to
  the unweighted average LMPs of 1999 and 2000
  Average annual PJM LMPs have been relatively
  stable since 1999

25
PJM LMPs

• Temporary fluctuations in monthly average LMPs
  have been correlated with fluctuations in fuel
  prices and temporary congestion costs
• Increased congestion costs were said to be due
  in significant part to
• The addition of PJM-West facilities in 2002 and
• Forced transmission outages, outages for planned
  transmission maintenance, and outages to enable
  construction of new transmission facilities in
  the Delmarva Peninsula Zone (beginning around the
  year 2000).
• LMPs in Delmarva Zone were noted to re-converge
  with Western Hub following the completion of
  initial Delmarva facility upgrades (beginning
  around 2002)

26
PJM FTRs

• Initially, all FTRs were allocated to load (i.e.
  without an auction mechanism)
• Later, PJM auctioned unallocated FTRs as
  Obligations
• Currently, PJM auctions all FTRs on a monthly and
  multi-round annual basis
• Annual FTRs and FTR Options were introduced in
  2003
• ARRs are allocated to load via Transmission
  Owners, assisting load to rebate congestion costs
• Where applicable, ARRs are reassigned as load
  switches among LSEs

27
PJM FTR Revenues and ARRs

• Average monthly auction revenues have been on the
  increase since 1999
• Since 1999, bid volume for FTRs has exceeded
  offer volume by a ratio of 101

28
PJM Investment

• 6,750MW of new generation has been placed in
  service since 1999
• Since 1999, PJM has received 380 requests for
  new connection of generation (totaling
  approximately 120,000MW of proposed capacity).
• As of January 2003, projects representing
  27,500MW of new capacity remained in PJMs
  interconnection queues
• Demand response programs have grown to currently
  represent 1,383 MW of reducible load or
  approximately 2 of the all-time peak of PJM.
• Siting investment in the most appropriate
  locations remains a challenge for reasons similar
  to those cited in the NYISO context

29
Summary of Observations

• New England, PJM, and California started out with
  uniform pricing, though later opted for LMP no
  one is looking to return to a uniform price
  system
• LMP has been acknowledged as a significant
  improvement on legacy congestion pricing and
  management systems
• Other mechanisms have been employed in parallel
  to moderate potential price impacts upon
  introduction of LMP
• Prices are now reflecting locational constraints
• FTRs and ARRs are increasingly helping to hedge
  congestion costs

30
Summary of Observations

• LMP is seen as complementary, supportive,
  enabling, and enhancing of reliable and efficient
  power systems and markets LMP has inherent/stand
  alone value as well as enabling value
• LMP alone does not account for price or
  investment trends
• Barriers to investment persist LMP is necessary
  but not sufficient
• Overall, LMP is seen as forward thinking,
  responsible public policy

31
THANK YOU
- Market Evolution Program - Day-Ahead Market
Working Group
Andrew Pietrewicz andrew.pietrewicz_at_theimo.com