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Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July, 2006

Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

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Page 1: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

Competitive Wholesale Power Market: Capacity Market

By Raj Addepalli, Ph.D., CFA

Presented at

USEA-USAID Executive Business Meeting

Bogota, Colombia

July, 2006

Page 2: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

New York Action Regulatory Restructuring – Flexibility Divesture of utility generation assets to eliminate vertical

market power concerns Creation of the New York ISO Mid 1999 Wholesale and Retail Competition in the State Presently over 40% of customer load is supplied by competitive

suppliers; remaining load is still supplied by host utilities as default service providers

Utilities use a supply portfolio approach - includes certain long-term legacy contracts with divested generators, short-term purchases from generators and wholesale suppliers through bilateral contracts, purchases from the NYISO spot market, and financial derivatives to mitigate risk

Page 3: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

3

New York State: 19,157,532 people

Peak Load Forecast of 33,295 MW

38, 340 MW Native Generation

Over 335 generating units modeledRequired Installed Capacity 39,288 MW

The NYISO Control Area

1700 MW in Demand Response

10,775 miles of High Voltage Transmission

Page 4: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

4

2006 Capacity (MW) by Fuel Type

17%

9%

35%

9%

15%

13%

1%

1%

Gas 6508

Oil 3659

Gas & Oil 13831

Coal 3505

Hydro 5700

Nuclear 5169

Other 341

Wind 245

Page 5: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,
Page 6: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

New York ISONew York ISONew York ISO"Hub of the Northeast"

* = Peak Load in Megawatts

IMO23,857 MW*

HydroQuebec19,410 MW*

ISO -New England25,158 MW*

New York ISO31,983 MW*

PJM54,176 MW*

Area Covered by Northeast

Major Cities coveredwould include:• Montreal• Ottawa• Toronto• Augusta• Portland• Montpelier• Concord• Boston• Providence• Hartford• Albany• Syracuse• Buffalo• New York City• Philadelphia• Harrisburg• Baltimore• Washington, DC

• Serves a combined load onthe order of 155,000 MW

• Involves over 50,000 milesof transmission lines

• Serve a population on theorder of 70,000,000 people

• Includes a combinedcustomer load greater thanthe entire WesternInterconnection

• Includes major worldpolitical, financial andcultural centers

2400 MW

2500

MW1000 M

W1500 M

W

1600

MW

1500 MW

350 MW

- Washington D.C.

- New York City

- Ottawa

Page 7: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

New York Market91% Merchant Generation

Regulated and Merchant Transmission

Regulated Monopoly Distribution

Competitive Retail Sales

Page 8: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

New York Wholesale Markets Energy - Day-Ahead and Real Time Markets Installed Capacity Market Ancillary Services Markets

Market based: Reserves (10 min spinning, 10 min non-spin and 30 minute reserves) Regulation

Cost based: Voltage Support Blackstart Scheduling

Demand Response Virtual Markets Transmission Congestion Contracts

Page 9: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

Bilateral(forward)Contracts

50%

RealTime <5%

NYISODay-Ahead

Market45 – 50%

Bilateral Contracts outside the NYISO 50%NYISO Day-Ahead Market 45 - 50%NYISO Real-Time Market <5%

100%

New York Wholesale Markets- EnergyCentral Dispatch System

Page 10: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

10

Why Capacity Market?

There is a continuing debate regarding whether there is a need for a separate capacity market or competitive markets should rely solely on energy markets to provide sufficient inducement for new entry.

If reliability is not a criterion that needs to be satisfied, or if there is sufficient demand price elasticity, or if there is sufficient tolerance for very high energy prices, then perhaps one could consider reliance solely on energy markets - BUT we are not there yet.

Page 11: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

11

ICAP Market Purpose

Capacity markets were created to insure that a sufficient supply reserve margin would exist to assure the reliability of the electric system.

A combination of bid/price cap energy market mitigation measures and the desired capacity reserve margin result in energy revenues that are insufficient, by themselves, to support new entry.

Capacity market revenues provide the additional revenue stream that is needed to facilitate new entry.

Page 12: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

Installed Capacity Market Reliability criterion of a one day in ten years loss of load expectation is

established by the NERC’s Northeast Power Coordinating Council

(NPCC). To meet the reliability rules, utilities and other load serving entities in New York are required to purchase capacity to meet forecast peak load plus 18% reserve margin

Three Capacity Markets in NY New York City Long Island Rest Of State

Six month strip auctions (summer and winter), monthly auctions and spot auctions are conducted by the NYISO

The six-month and monthly auctions are voluntary Spot auction (deficiency auction) is mandatory If loads do not have sufficient bilateral capacity contracts, they are

assigned the capacity cost based on the spot auction results

Page 13: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

13

Original ICAP Market Design Demand Curve was vertical in nature Loads were required to purchase Minimum Requirement- bilateral

or through NYISO market Deficiencies charged a high penalty Market proved dysfunctional

Erratic ICAP prices When capacity is tight, ICAP prices spike When capacity levels exceed the minimum requirement, however, ICAP prices plunge Loads had no incentive to purchase ICAP above minimum Excess capacity beyond minimum not valued although it may help reliability

Susceptible to market power abuse Suppliers had incentive to withhold to create deficiency

Page 14: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

14

ICAP Demand Curve

Original design used “vertical” demand curve Fixed minimum requirement Fixed deficiency charge

New design uses “sloped” demand curve Price decreases gradually as supply increases Loads buy excess supply cleared in the auction

Market function improved Prices less erratic Prices vary predictably with ICAP supply

Page 15: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

15

Demand Curve

Original ICAP Market Design vs. Sloped Demand Curve

0

5

10

15

20

25

96 98 100 102 104 106 108 110 112

% of Minimum Requirement

$ p

er

kW

-mo

nth

Original market design

Sloped DemandCurve

Page 16: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

16

Demand Curve

$10.88

$6.78

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

$22

80 82 84 86 88 90 92 94 96 98 100 102 104 106 108 110 112 114 116 118

Page 17: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

17

NYS UCAP Prices Under DC

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

Jun-

03

Aug

-03

Oct

-03

Dec

-03

Feb

-04

Apr

-04

Jun-

04

Aug

-04

Oct

-04

Dec

-04

Feb

-05

Apr

-05

Jun-

05

Aug

-05

Oct

-05

Dec

-05

Feb

-06

Apr

-06

Jun-

06

Aug

-06

Oct

-06

$/kW

-mo

nth

Strip

Monthly

Spot

Page 18: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

18

Sloped Demand Curve

The purposes of the sloped demand curve include (compared to a vertical one):

stabilize revenue streams for generators reduce potential market power of generators provide for more predictable prices for sellers and

buyers value capacity beyond the minimum level as having

reliability value

Page 19: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

19

Derivation of the Sloped Demand Curve

The Sloped Demand Curve is specified in the tariff, and approved by FERC. The parameters are updated every three years.

DC is a simple straight line defined by two points. The reference point is (X1,Y1)

X1: The installed capacity requirement: 118% of peak load Y1: The cost of new entry for a peaker less anticipated energy and

ancillary service market revenues X2: The capacity level where its value is zero: 132% of peak; Y2=0 The maximum price is capped at 1.5x the cost of new entry

Page 20: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

20

Reference Point The analysis to help determine the reference point

update last year was performed by a consultant, Levitan Associates, with the help of market participants.

Key Assumptions include: Installed cost of a new peaker- Frame 7FA gas turbine for the ROS

market Equipment (Power Island, Balance of Plant, Spare Parts Construction Owner’s costs (Development, Engineering during construction etc) Startup and Testing

Page 21: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

21

Key Assumptions (contd)

Size, Heat Rate Debt/Equity ratio: 50%/50% Cost of Money: 20 year debt @7.5% interest rate, equity (after tax)

@12.5% Fixed O&M (property taxes, site lease, contract services, staffing,

insurance, general and administrative costs) Depreciation life, Income Tax Rate etc From the above, compute annualized carrying cost of peaker

Page 22: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

22

Key Assumptions (contd)

Expected Energy Revenues Apriori Estimation

Historic Based Expectations

Deterministic Stochastic

OR Post-fact hypothetical peaker based estimate

Expected AS Revenues The annualized reference value is then adjusted for

summer/winter periods

Page 23: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

23

Items Debated Is there a need for introducing a sloped demand curve? Will the change induce new merchant entry - the ability to generate cash

flows to cover cost of new entry over long-term Will it help keep needed existing economicgeneration from retirement? Should there be a forward market (beyond one year) component to the

capacity market? What are the customer impacts - including quantity of ICAP to be

purchased and the new market clearing price? Is there authority for NYISO or regulators to impose such a purchase

obligation on the loads? How does regulatory uncertainty affect investor risk assessment?

Page 24: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

24

Items Debated What should be the frequency for updating parameters? Derivation of each element in the reference price Y1 Levels of X1 and X2: should X1 be exactly at the minimum requirement or

somewhat to the right of it? What should be the price to the left of X1? The slope of the demand curve

stability vs volatility of prices customer impact impact on generator market power

Monopsony power - the ability of large loads to enter into contracts ‘out of market’ with new suppliers to suppress market clearing prices

Page 25: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

25

Resource Planning ISO Reliability Planning Process

Pre restructuring, vertically integrated utilities built (or contracted for) needed resources to ensure reliability of the system

In a restructured market, it is envisioned the market should address resource needs to ensure reliability

Planning process is primarily designed to provide information to the market participants

While market is expected to address resource needs, there could be instances of “market failure” and the market may not satisfy the resource needs

In that case, there is a need for a back-stop solution to procure adequate resources to ensure reliability

Page 26: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

26

Resource Planning

Annual Comprehensive Reliability Plan NYISO does a 5-10 year Reliability Needs Assessment

annually as a first step and identifies reliability based resource needs

It seeks market based responses (transmission, generation, demand response) to meet the needs

In addition, it seeks from the responsible utilities a “backstop regulated solution” in case market solutions do not materialize in a timely fashion; other entities can also offer an “alternate regulated solution”

NYISO certifies projects that would technically meet the identified need without identifying a preferred solution

Cost Allocation based on beneficiaries-pay methodology

Page 27: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

27

Resource Planning

“Economic” Planning process:Primarily intended to address congestionNYISO posts information on a historical basis on

several quantitative metrics of congestion - to assist the market place

Under what conditions should regulatory solutions be considered to alleviate congestion? Work in progress

Page 28: Competitive Wholesale Power Market: Capacity Market By Raj Addepalli, Ph.D., CFA Presented at USEA-USAID Executive Business Meeting Bogota, Colombia July,

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Checklist

Any time we consider changing the market design, we try to address the following: What is the affect on existing wholesale or retail competitive markets? Would it provide sufficient incentives for new generators to enter the market - lead to the entry of

appropriate techonology and size generators? Would it provide sufficient incentives for existing generators to stay in the market, if economically

appopriate? Will it lead to cost minimization to customers? Will it work as intended? Is it simple to implement? Is it a minor change or major change? What are the risks of implementing? Will it have unitended consequences? How are potential market power concerns addressed? Will it be transparent and clear to market participants and accepted by them? Is it easy to police and to ensure there is no abuse by market participants? Would it receive regulatory support?