Overview of Forward Reserve Market

1
Overview of Forward Reserve Market

• Mark Karl
• PSRAWG, Marlborough MA
• April 3, 2003

2
Presentation Objectives

• Review Changes to Proposed Design
• Review Issues From Last Meeting

3
Goals of Design Modifications

• Reduce implementation effort
• Simplify the Design
• Definition of Obligations
• Penalty Processes
• Bare Bones design

4
Summary of Major Design Changes

• No resource specific EFOR or Failure-To-Start
  Rates tracked or used in payments.
• Energy obligation not an ICAP/UCAP obligation
• New penalty structures more sensitive to reserve
  scarcity.
• Forfeit payment
• Additional penalty is a function of market prices
• Failure to Reserve Penalty changed/simplified
• Failure to Activate Reserve Penalty
  changed/simplified

5
Design Summary
6
Total Resources Purchased in Auction

• Procurement is intended to cover total expected
  operational reserve requirement
• Operational requirement is grossed up for
  expected outages and failures to start
• Offers are in unadjusted megawatts of energy
• Delivery requirements are in unadjusted megawatts
  of energy
• No adjustment to payments on basis of EFOR or
  Failure-to-Start rates

7
Obligation of Winning Resources

• Obligation to offer energy above minimum Strike
  Price
• Offer in both Day Ahead and Real Time market
• Deliver reserve energy if dispatched
• Penalties for failure to reserve and for
  failure to activate
• Strike Price is heat rate x fuel price index
• Strike Price set to 2-3 capacity factor
• Adjusted monthly and published by ISO New England

8
Consequences of Failure to Reserve

• Failure to Reserve Consequences
• Forego reservation payment
• Call Option Payoff Penalty Max(zonal LMP
  strike price), 0
• Can be hedged with another resource offered at
  strike price. Encourages replacement with
  physical equivalent product which benefits pool.
• Bidding/hedging strategy locks in LMP strike
  price if alternate resources is offered at strike
  price

9
Consequences of Failure to Activate

• Pay only when reserve is likely to be scarce.
• The greater the scarcity the greater the penalty
• Failure to Activate Reserve Consequences
• Pay megawatts x Zonal LMP

10
Issues From Last Meeting

• Bilateral Market
• Increases implementation effort
• Requires user interface
• Requires extensive safety checks to prevent
  errors
• Desirable as a future enhancement

11
Issues From Last Meeting

• Use of EFOR and Failure-To-Start is confusing
• Agreed that this confuses the obligation, bidding
  and payment
• Eliminated in favor of an energy type of
  obligation
• Total purchase amount is adjusted on a pool wide
  basis.
• Increase purchase amount to allow for
  unavailability
• No effect on offers or settlement

12
Issues From Last Meeting

• Penalties should represent reserve scarcity,
  recognize product is resource specific call
  option on energy
• Failure to Reserve penalty modified to account
  for scarcity
• Penalty for Failure to Activate
• Set to RT Zonal Price
• Represents cost of missing energy

13
Issues From Last Meeting

• Why not longer lead-time in order to minimize
  market power
• Currently in capacity oversupply
• Competition from On-Line Resources provides large
  pool of competition
• Can be extended when RAM is introduced

14
Issues From Last Meeting

• Service Period. Why not coincidence with power
  year and summer/winter seasons? What about
  staggered overlap of service periods to create
  more of a portfolio?
• Included separate summer and winter periods
• Doesnt make sense to create long-term portfolio
  when forward reserve will have to be adjusted
  when co-optimized spot reserve market is
  introduced

15
Issues From Last Meeting

• Do these resources really need to be ICAP
  resources?
• Potential NERC Rules issue
• Design needs Day-Ahead and Real-Time availability
• Allowing delisting would have implications for
  calculations for Objective Capability
• Previous strong objections in FERC filing on
  Forward Reserve

16
Issues From Last Meeting

• What about eventual overlap with future
  co-optimized spot reserve market?
• Could set Failure To Reserve Capacity penalty
  MinDA Spot Reserve Price, Pre-existing Penalty
• Suppliers would clear at the spot market or the
  pre-existing penalty, whichever is more
  profitable for them
• When the Service Period expires new provisions
  take over for the next auction that specify a new
  mechanism tied to co-optimized spot reserve
  markets
• Potentially creates accounting issue and
  confusion
• Goal is to avoid overlap

17
Implementation Timeline

• Full Internal Implementation review not yet
  complete
• Review to date indicates the design is sound but
  a number of loose ends remain. (Impacts on
  MMU, RMR Units, OR Payments)
• Need to complete review to determine full
  organizational impact
• May reveal other market/ Participant issues to be
  dealt with at MC
• Review to date suggests 5-7 month implementation
  effort following completion of final draft design
• Likely earliest implementation as part of SMD 1.1
  release (first half of 2004)