Trading HubDiscussion

9/17/2015

Nick Parker nparker@spp.org

Ken Rutter - krutter@bepc.com

Folko Mueller - fmueller@bepc.com

Valerie Weigel - vweigel@bepc.com

Agenda

1) Integrated System History and Makeup

2) Makeup of SPP (SPP)

3) Background and Basin Electric

4) History of Existing Hubs (SPP) & Protocol Requirements for New Hubs(SPP)

5) Lack of SPP Trading Hub Liquidity and Brattle Study

6) Trading Hub Survey Results

7) Influences of Hedging & Dodd-Frank

8) Criteria for Successful Trading Hubs

9) Idea Generation

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The Upper Midwest Lacks a Viable Liquid Hub

Primary Objectives of This Meeting

• Is there a hub problem in SPP?

• Does SPP need a new hub that would be more liquid?

• Does SPP need to make any market construct changes to facilitate more activity at existing hubs?

• Does SPP need to redefine existing hubs to increase liquidity?

• Does SPP need to facilitate Dodd-Frank in a different manner to increase liquidity at existing hubs?

• What can market participants do to encourage more liquidity at existing hubs or a new hub?

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INTEGRATED SYSTEM HISTORY

AND MAKE UP

Integrated System Makeup

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The Integrated System (IS) of the Western Area Power Administration (Western), Basin Electric, and Heartland Consumers Power District (Heartland) is the backbone of the high-voltage transmission grid in the upper Great Plains region of eastern Montana, North Dakota and South Dakota.

The IS facilities consist of approximately 9,500 miles of interconnected high-voltage transmission lines (~1,600 miles of line owned by Basin Electric) for delivering power from federal hydroelectric plants and thermal plants owned by the IS participants.

Integrated System History

• This jointly developed transmission system evolved from the 1962 Joint Transmission System (JTS) agreement of the Bureau of Reclamation with Basin Electric and 103 cooperative and municipal preference customers in this region.

• This agreement enabled Basin Electric to lease capacity on the federal transmission system and deliver output from its first power plant to members throughout the region by building only 12 miles of high-voltage transmission line.

• In 1977, the U.S. Congress transferred the power marketing functions of the Bureau to Western (WAPA), and Western assumed the responsibility for the operation of the JTS.

• In response to the Federal Energy Regulatory Commission (FERC) open-access transmission orders 888 and 889, which set forth billing methodologies inconsistent with the JTS methodology, the JTS agreements were terminated.

• The Integrated System (IS) agreement between the Western, Basin Electric, and Heartland replaced the JTS agreements and provides open-access transmission service to customers in the region.

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Background

IS Counterparty Changes

Fewer Counterparties Means Less Efficient Market

MISO’s startup and SPP’s integrated marketplace have

reduced the number of physical delivery counterparties for

WAPA, Basin and the other IS partners.

The New SPP Integrated Marketplace

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1 week till first offers submitted for the 10/1 Go

Live

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MAKEUP OF SPP NICK PARKER

SPP and the Integrated System (IS)

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Make-Up of SPP

• SPP Members

– Transmission Owning

– Transmission Using

• Market Participants

– Asset Owning (58)

– Financial Only (101)

• Transmission Customer

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Make-Up of SPP

• SPP Members

– Cooperatives (18)

– Federal Agencies (1)

– State Agencies (8)

– Independent Power Producers (13)

– Independent Transmission Companies (11)

– Investor-Owned (16)

– Marketers (12)

– Municipals (13)

– SPP Contract Participants (1)

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BACKGROUND& BASIN ELECTRIC

Background• Basin is a buyer/sell depending on the region/time of year/outages, etc. We -try

to get pricing certainty by forward transacting bilaterally in the marketplace to get as much certainty around our projected member rates as we can.

• As we have not seen liquidity at North Hub, we brought an idea last fall to propose another trading hub in SPP. Our goal was to have a hub closer to our generation/load which would correlate more tightly and our other goal was to find/create a hub with more liquidity.

• After the presentation last fall we engaged the Brattle group to come up with new hub proposals which would not only be of benefit to Basin, but to others as well. They came back with suggestions, but what we found is that the new trading hub brought only slightly better correlation for some MP’s. So, we didn’t see significant advantages from the new hubs proposed.

• At this point want to work with other Market Participants to encourage trading at North/South Hub.

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About Basin ElectricDistinctions from WAPA

Basin does not have the Federal Service Exemption & is subject to congestion

We do not have a fuel adjustment clause.

We are buyers and sellers depending on region, time of year, outages etc.

Basin Electric

– Generation and Load on both sides of the DC ties

– Bi-directional rights on two DC ties, uni-directional rights on a third

– Short-term optimization and hedging historically done by two separate WAPA offices (Montrose & Watertown)

– Basin wanted short-term trading in-house to unleash synergies

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Issue Summary

SPP’s integrated marketplace essentially makes the bilateral market a financial market

Entities risk tolerances may require purchases and sales to provide price stability for their customers

To facilitate forward transaction activity, a common, effective transaction point is desired.

Basin desires the ability to transact bilaterally or on an exchange in a low risk manner at a trading hub for:

• Day-ahead buys• Day-ahead sells• Bal-month buys• Bal-month sells• Forward buys• Forward sells

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HISTORY OF EXISTING HUBS

NICK PARKER

History of SPP Trading Hubs

• Marketplace Hubs Task Force established in 2012 to develop Trading Hubs

– Final presentation given at Sept. 7th, 2012 MWG meeting

– Approved at the October 2012 MOPC

– Scope of Charter

Develop of recommend Marketplace Protocols for the establishment of Hubs

Propose the Hub(s) to be implemented at the start of the Integrated Marketplace

Conduct analysis on Hub rules and selection process

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History of SPP Trading Hubs

• Resource Hubs

– Aggregation of only Resource Pnodes

– Primarily used to facilitate slice of system sales in the market

– Not in scope of this meeting

• Trading Hubs

– Aggregation of both Resource and Load Pnodes

– Analysis done by SPP

– Must be approved by MWG and MOPC

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History of SPP Trading Hubs

• Trading Hub Development

– SPP performed Cluster Analysis to find out SPP price clusters.

– SPP performed Best Fit Analysis to determine the most liquid clusters for hub candidates.

– SPP performed Correlation Analysis to verify whether the hub candidates show consistent internal price movements.

– SPP performed Stress Testing to verify external factors have little impact on the hub candidates.

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Cluster Analysis

• Group together Pnodes within the SPP footprint whose hourly LIP were “close” to one another.

• Performed multiple cluster analysis using LIPs from different time frames to mitigate the impacts of anomalies;

(3800 LIPs/hour)* (21,900 hours) ≈ 83 Million LIPs

• The objective is to minimize the Euclidean Price Distance (D)

D=

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t

pnodehub PP 2)(

Cluster Analysis – A Result

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Best Fit Analysis

• Test the liquidity of the potential hubs.

• The hub with lowest price separation and lowest volatility to a load area would be the “best hub” for that load area to hedge on.

• If a hub is the “best hub” for most load areas, it would be the most liquid hub.

– Price Separation=

– Volatility =

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t Loadzonehub PP

t][

1

t

Loadzonehub PPt

2][1

Cluster # of Best Fit Load Areas

1 3

2 19

3 4

4 8

5 0

6 2

7 10

Cluster # of Best Fit Load Areas

1 2

2 33

3 1

4 0

5 0

6 0

7 10

Best Fit Analysis – A Result

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Low Price Separation Low Volatility

•Cluster 2 locates in the south and is the best hub for majority of the SPP load areas to hedge on.•Cluster 7 locates in the north and is the best hub for Nebraska load areas to hedge on.

Correlation Analysis

• The Cluster Analysis and the Best Fit Analysis revealed two hub candidates:

– North Hub

– South Hub

• The Correlation Analysis examines whether all the Pnode prices in these hubs consistently move in the same direction.

• Result:

– All Pnodes prices in the hub candidates move together closely. (correlation coefficient>95%)

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Stress Testing

• Extreme Loads

– Test if pattern exists during high and low load days

– Test if pattern exists during extreme load swings

– Check price correlation among cluster Pnodes during these periods

• Transmission Outages

– Compare cluster correlation and price between non-outage and outage cases

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Analysis Outcome – North Hub and South Hub

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North Hub (496 pnodes)---LES (58), NPPD (191), OPPD (247)South Hub (537 pnodes)---AEP(102), OKGE (309), WFEC (125), GRDA (1)

Old Proposals / Protocol Requirements

• Basin Electric is the only entity to propose a new Trading Hub

• Timeline for a new Trading Hub proposal

– Present proposal to the MWG

– MWG votes to decide for SPP to move forward

– SPP will check to see Tariff/Protocol requirements are met

– SPP takes the proposal back through Stakeholder Process for approval

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Old Proposals / Protocol Requirements

• SPP shall use the following criteria to establish all Market Trading Hubs:

– (1) Each Trading Hub shall contain a sufficient number of PNodesto ensure that a Trading Hub Locational Marginal Price (LMP) can be calculated for that Trading Hub at all times;

– (2) Each Trading Hub shall contain a sufficient number of PNodesto ensure that the unavailability of, or an adjacent line outage to, any one PNode or set of PNodes would have only a minor impact on the Trading Hub LMP;

– (3) Each Trading Hub shall consist of PNodes with a relatively high rate of service availability;

– (4) Each Trading Hub shall consist of PNodes among which Transmission Service is relatively unconstrained; and

– (5) A Trading Hub shall not encompass the combined loads and Resources of a single vertically-integrated utility into a single Settlement Location.

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BASIN’s BRATTLE STUDY FOR POTENTIAL TRADING

HUB MODIFICATIONS

| brattle.com33

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Observations on SPP’s existing Hub Design

Limited Liquidity on the SPP Hubs

Consistently no transaction activity for SPP ICE DA products.

Engaged The Brattle Group

THE Brattle GROUP

•Reviewed Alternative Hubs

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Alternatives for Discussion and Consideration

1.“Stand-alone” UMZ Zone Hub

2.Modified North Hub

3.New North/UMZ Hub (Upper Central Hub) that also keeps North Hub alive

4.“Super Hub” for all SPP that focuses on correlation & consistent spreads of prices

Ultimate findings … New Hub may not be the best answer.

| brattle.com36

Brattle Purpose and Approach

▀ Purpose of Study: Construct a new pricing hub in the Upper Midwest region of the SPP to be used by Basin Electric and other market participants in the region as a liquid trading location for bilateral market transactions.

▀ Approach

– Start with the existing definition of the SPP North Hub, and add load buses for Basin, Sunflower, Westar, KCPL and KACY to construct a new “Upper Midwest Hub” in addition to the existing North Hub

– Compare the following hub definitions:

Existing SPP North Hub, and

New Upper Midwest Hub

– In Approach 1, use the following criteria :

Best Fit to load zone prices in the region: lowest price separation and lowest volatility

Correlation of hub and load zone prices: highest correlation with load zones

Correlation of buses within the Upper Midwest Hub: keep buses with the highest correlation

– In Approach 2, maximize the correlation between the UM Hub and Basin Load subject to attaining at least as good correlation as with North Hub for other load zones.

| brattle.com37

Approach 1

Iterative approach to adjust the definition of Upper Midwest Hub to achieve good fit and correlation to nearby load zones and highly-correlated buses within the hub by using the Promod 2020 run.

▀ Start with including all load buses from the load zones listed below into Upper Midwest Hub definition, then iteratively eliminate dropping buses as follows:

BEST FIT ANALYSISFor each hub and load zone, calculate average and volatility of price separation across hours:

Phub- Pload

CORRELATION ANALYSISFor each UM Hub definition,

calculate correlation coefficients among the buses in that hub

across hours

Upper Midwest Hub

Two iterations to eliminate load buses and North Hub buses that have < 95% correlation with > 10% of the UM Hub buses

Report Best Fit and Correlation results for Upper Midwest Hub vs. North Hub

Load Zones in Best Fit Analysis:BasinNPPDOPPDLESWestarSunflowerKCPLKACY

North Hub

CORRELATION TO LOAD ZONEFor each hub, calculate correlation coefficient to each load zone

| brattle.com38

Round 1 Results – Correlation to Load Zone Prices

With all load buses included in the UM Hub, correlation coefficients to load zone prices in Basin, NPPD, OPPD, and LES are slightly lower compared to the North Hub.

North Hub

Round 1 Upper

Midwest

Round 2 Upper

Midwest

Round 3 Upper

Midwest

Correlation Correlation Correlation Correlation

Basin Load 0.91 0.88

NPPD Load 1.00 0.98

OPPD Load 1.00 0.97

LES Load 1.00 0.97

KCPL Load 0.97 0.97

Westar Load 0.93 0.98

Sunflower Load 0.77 0.88

KACY Load 0.97 0.97

Some loads have better correlation with a new hub and some are worse.

| brattle.com39

Round 2 Results – Correlation to Load Zone Prices

After eliminating some of the load buses with low correlation, the new UM Hub has at least as good correlation as North Hub to load zones.

▀ Note that all load zones except for Sunflower are represented in this UM Hub definition.

North Hub

Round 1 Upper

Midwest

Round 2 Upper

Midwest

Round 3 Upper

Midwest

Correlation Correlation Correlation Correlation

Basin Load 0.91 0.88 0.91

NPPD Load 1.00 0.98 1.00

OPPD Load 1.00 0.97 1.00

LES Load 1.00 0.97 1.00

KCPL Load 0.97 0.97 0.98

Westar Load 0.93 0.98 0.94

Sunflower Load 0.77 0.88 0.78

KACY Load 0.97 0.97 0.98

All loads now have either an equal or better correlation to a new hub.

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Round 2 Correlation Results Under Sensitivities

Upper Midwest Hub prices are highly correlated to load zones prices under market sensitivities, and continues to have at least as good correlation as the North Hub does.

North Hub Correlation Upper Midwest Correlation

Base

Coal

Retirements High Gas High Hydro Low Hydro Base

Coal

Retirements High Gas High Hydro Low Hydro

Basin Load 0.91 0.90 0.93 0.90 0.92 0.91 0.90 0.92 0.89 0.92

NPPD Load 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.99 1.00

OPPD Load 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

LES Load 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

KCPL Load 0.97 0.96 0.97 0.96 0.98 0.98 0.97 0.98 0.97 0.99

Westar Load 0.93 0.90 0.94 0.92 0.94 0.94 0.92 0.96 0.94 0.95

Sunflower Load 0.77 0.71 0.79 0.76 0.77 0.78 0.72 0.80 0.77 0.78

KACY Load 0.97 0.96 0.97 0.96 0.98 0.98 0.97 0.98 0.97 0.99

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Approach 2

By choosing the weights assigned to each load zone, maximize the correlation between Basin Load and Upper Midwest, while keeping the average correlation with other zones as high as their average correlation to North Hub.

The optimized UM Hub has better correlation than North Hub to Basin, Westar and Sunflower load zones.

North Hub Optimized UM HubCorrelation Hub Weight Correlation Hub Weight

Basin Load 0.91 0% 0.94 52%NPPD Load 1.00 45% 0.99 6%OPPD Load 1.00 42% 0.98 6%LES Load 1.00 13% 0.99 0%KCPL Load 0.97 0% 0.97 24%Westar Load 0.93 0% 0.95 4%Sunflower Load 0.77 0% 0.80 5%KACY Load 0.97 0% 0.97 4%

Conclusion

The hub configurations studied bring marginal improvement to other participants.

Review protocol language as it relates to requesting new trading hubs in SPP.

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TRADING HUB SURVEY

Survey

• Survey sent out to MWG exploder list in May

• Open for two weeks

• 30 respondents

• Responses were anonymous

• Held a call open to the MWG - responses were reviewed/discussed

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Survey Categories

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SPP MarketInternal Policies

Transaction Preferences

Other

Sample Questions - SPP Market

• Do you transact forward at the North Hub or the South Hub?

– Most at South Hub

• Are you transacting at the South Hub vs the North Hub due to a lack of liquidity at the North Hub?

– 41% Yes

– 59% No

• From your perspective, do the North Hub and/or the South Hub provide enough liquidity for the transactions you would like to complete? Please explain.

– 100% No

Limited number of participants

SPP Market not mature yet

Not enough volatility to entice traders

Need ICE products to mature

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Sample Questions - SPP Market

• From your perspective why does the North Hub lack liquidity?

– Most are long generation

– No real time ICE product

– Most “players” in the North are utilities which are likely more conservative

– Too much congestion

– Lack of market participants willing to trade financially

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Sample Questions - Internal Policies

• Do you have a forward hedging program?

– Yes 82%

– No 18%

• Do you have a risk management policy?

– Yes 90%

– No 10%

• How far in the future are you authorized to transact?

– 1 year

– 2-5 years

– 50 years

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Sample Questions - Transaction Preferences

• Would you transact at another SPP participant’s generating nodes or load zones?

– Yes 75%

– No 25%

• Do you have authorization to utilize ICE?

– Yes 71%

– No 29%

• Are there any reasons why you wouldn’t trade at either hub?

– South Hub not correlated with load

– Risk policies

– No buyers

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Sample Questions - Other

• Would you be willing to participate in an offsite discussion on longer term trading?

– Yes 62%

– No 38%

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INFLUENCES OF HEDGING & Dodd-

Frank

Hedging Observations

– Hedging = Insurance against Market Uncertainty

– Impact of fuel adjustment clauses on forward hedge activity

– Low price environment impact on forward power hedging

– How much hedging is impacted by poor correlation between loads/asset owners and the existing hubs

– Desire to do only physical forward hedge transactions

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Dodd-Frank Impact

• Many Power and Utility companies originally saw Dodd-Frank chiefly as an issue for the financial services industry, or for swap dealers (SDs) and major swap participants (MSPs).

• Most now realize that the new regulations affect them as well because they use over-the-counter derivatives. Dodd-Frank significantly alters the derivatives market, and every company that transacts in this market is impacted.

• However, the complexities and nuances of the new rules, including those around physical transactions, mean that more time and resources are needed than originally anticipated.

• The rules substantially changed the way data is captured, stored and ultimately retrieved to meet reporting obligations. Key data and reporting issues include:

– New data fields to capture and record the required unique identifiers on a transactional basis

– Connectivity to one or multiple SDRs

– Linking data to provide an audit trail to enable the reconstruction of each swap transaction

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Dodd-Frank Impact?

• Consolidation of banks

• Banks withdrawing from power sector trading

• Lack of willingness for buyers/sellers to execute financial transactions

• Lack of willingness for buyers/sellers to forward trade/hedge

• Uncertainty for physical players requirements due to the complexity of the regulations

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CRITERIA FOR SUCCESSFUL

TRADING HUBS

Criteria for Successful Trading Hubs

Characteristics for a successful hub:

- Location or aggregate location a natural supply/demand balancing point for a particular market.

- Reliable contractual standards for delivery, receipt or settlement of the commodity.

- Transparent pricing at the point. Participants must be confident that transactions are on a level playing field and no single or group of players can manipulate the market price.

- Homogeneous pricing, meaning consistent & uniform (not the same) across the hub.

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Criteria for Successful Trading Hubs contd.

Characteristics for a successful hub contd.:

- Convenient tools to execute transactions such as electronic trading systems, exchanges, etc.

- Critical mass of buyers and sellers

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Criteria for Successful Trading Hubs contd.

What do traders (in particular prop traders) care about?

- Liquidity

- Volatility

What do hedgers care about?

- Basis risk

- Correlation

- Price blow-outs

SPP is lacking both

- Chicken/Egg Problem (how do you attract new market participants that could provide liquidity, when you need liquidity to attract them in the first place)

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INDY Hub vs SPP North Hub Volatility

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Indy Hub DA vs SPP North Hub DA

SPP North Hub

Indy Hub

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Transaction Platforms Such as ICE Can Support Highly Transacted Hubs

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IDEA GENERATION

Primary Objectives of This Meeting

• Is there a hub problem in SPP?

• Does SPP need a new hub that would be more liquid?

• Does SPP need to make any market construct changes to facilitate more activity at existing hubs?

• Does SPP need to redefine existing hubs to increase liquidity?

• Does SPP need to facilitate Dodd-Frank in a different manner to increase liquidity at existing hubs?

• What can market participants do to encourage more liquidity at existing hubs or a new hub?

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Next Steps

1.

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3.

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THANK YOU!