May 14-15, 2013 | Westborough, ma

MAY 14-15, 2013 | WESTBOROUGH, MA

Matthew WhiteSENIOR ECONOMIST

MARKET DEVELOPMENT

A Strategic Planning Initiative

FCM Performance Incentives

Ron Coutu MANAGER,

BUS. TECH. & SOLUTIONS

Andrew GillespiePRINCIPAL ANALYST

MARKET DEVELOPMENT

Presentation Topics

• Overview

• Balancing Ratio & Application to Zones

• Maximum Loss Limit (or Stop-Loss)

• Impact Analysis Update

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OVERVIEW

FCM Performance Incentives - Overview

• Capacity resources with uncertain performance present a risk to system reliability if too many resources cannot ‘perform’ when needed most – during a capacity deficiency

• In this context, ‘perform’ means delivery of either energy or reserves during a capacity deficiency

• The current FCM construct provides insufficient incentives for resources to make investments to improve performance

• FCM Performance Incentives provides market signals and investment incentives for resources to improve performance i.e., deliver energy or reserves during a capacity deficiency

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Future Topics (approximate dates)

• Elaboration on the details of this proposal will be the topic of future presentations to the Markets Committee, including but not limited to:– Balancing ratio & application to zones ~ May– Maximum Loss Limit (or stop loss) ~ May– Financial Assurance impacts (w/B&F committee) ~

June– Establishing the Performance Payment Rate ~ June– Bilateral trading ~ July– Reliability rejection of de-list bids ~ July

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BALANCING RATIOFor the system and zones

Balancing Ratio?

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• As part of the Pay-for-Performance proposal the ISO introduced a need for a Balancing Ratio

• The following slides intend to focus on that Balancing Ratio to explain the need for it and the mechanism for calculating the Balancing Ratio

• Explain the application of the Balancing Ration to System deficiency events

• Explain the application of the Balancing Ratio to Reserve Zone deficiency events

When do we need a Balancing Ratio?

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Deficiency Conditions?

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• There are 3 basic Deficiency Conditions:

• DEFCON #1 – System Shortage of Total Operating Reserves

• DEFCON #2 – System Shortage of Total 10 Minute Reserves (but not short of Total Operating Reserves)

• DEFCON #3 – Shortage of Reserve Zone Requirements

Deficiency Conditions #1

• During this type of shortage all Resources will be measured towards meeting the system requirements of Load + Total Operating Reserves– This measurement will be calculated every 5-minutes

– Load + Total Operating Reserves is the “requirement” the ISO is trying to meet for that timeframe

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DEFCON #1 – System Shortage of Total Operating Reserves

Balancing Ratio

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• Goal of the Balancing Ratio:• Define a capacity resource’s financial obligation as a pro-rata share of

the system’s needs (load + reserve requirements) whenever these needs are not satisfied.

• This implementation has the (intended) effect that ‘under-performers’ are charged total payments that are sufficient to cover the credits paid to ‘over-performers’.

• The use of this Balancing Ratio means an individual resource’s financial obligation is less than its CSO during deficiencies, because the ISO does not need all capacity resources to perform to their full CSO if system’s total needs (load + reserves) are less than that during the deficiency.

Balancing Ratio

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• Balancing Ratio will be calculated for each 5-minute interval where a shortage of load plus reserves occurs (DEFCON)

Balancing Ratio = (Load* + Total Reserve Requirement)

Total CSO

*Load = (Gen + Net imports + DR provided)

Balancing Ratio – Load vs. Total Supply

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DEFCON #1 - SYSTEM SHORTAGE OF TOTAL OPERATING RESERVES

Balancing Ratio – Details – DEFCON #1

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• System Balancing Ratio denominator component:• Total CSO = Equal the sum of CSO of all resources

• This is close to but not necessarily equal to ICR

• Due to “lumpy” offers causing the FCA to clear CSO > ICR

• Due to Intermittent Resources having different monthly CSO

• Due to ICR changing downwards from FCA

• Total CSO is what load is getting to get charge for procuring


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• System Balancing Ratio numerator components (each 5-minute interval):• Generation (as measured by 5-minute RQM)

• Demand Response provided (as measured by Baseline Calculations or measured estimates for unmetered assets like passive)

• Net Imports per Participant (for the 5-minute interval)

• Total Reserve Requirement (Requirement that was violated )

• Total Reserve Requirement (TMSR + TMNSR + TMOR)

• Does not include Supplemental Reserve Requirement (when active)

• Will be indicated by TMOR RCPF (currently $500) activation

Balancing Ratio - Details

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Balancing Ratio

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Balancing Ratio = (Load + Total Reserve Requirement)Total CSO

Example:Load (translates to Gen + Net imports + DR provided) = 21,757 MWTotal Reserve Requirement = 2,078 MWTotal CSO = 33,322 MWBalancing Ratio = (21,757 + 2078) / 33,322 = 0.715

Date Load Reserve Requirement

Total CSO Avg. Balancing Ratio

5/22/10 14,690 2,000 37,963 0.440

8/31/10 27,378 2,057 32,704 0.900

9/14/11 21,757 2,078 33,322 0.715

Impact of the Balancing Ratio

CSO Resource No CSO

Off Under Perform Over

CSO 1 1 1 1 0

Actual (Load + 10 and 30 Reserve Designated )

0.0 0.35 0.7 1.0 1.0

Balancing Ratio 0.7 0.7 0.7 0.7 0.7

Score -0.7 -0.35 0 0.3 1.0

Score = Actual – (Balancing Ratio x CSO)

Consider the following five different 1 MW resources, each at different output levels during the same period (i.e., the same balancing ratio)

Additional Points to Consider

• Since the amount of CSO should always be expected to be greater than any potential load + reserve requirement this ratio should always be less than 1

• The ratio leads to a slight over-collection from under-performers, equal to the Performance Payment Rate times the reserve deficiency, since the reserve requirements are used in the numerator– This over-collection will fund the stop-loss reserve, which will be

described further in the Stop Loss portion of the presentation

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DEFCON #2 - SYSTEM SHORTAGE OF TOTAL 10 MINUTE RESERVES


• During this shortage all Resources will be measured toward meeting the system requirements of Load + Total 10 Minute Reserves

• Note: During this Deficiency Condition 30 Minute Reserve Requirement is being met, so no incentive applies for 30 minute Reserves

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DEFCON #2 – System Shortage of Total 10 Minute Reserves


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Impact of the DEFCON # 2 Balancing Ratio

Score = Actual – (Balancing Ratio x CSO)

Consider the following five different 1 MW resources, each at different output levels during the same period (i.e., the same balancing ratio). The Balancing Ratio has changed from DEFCON #1 because the Numerator has changed.

DEFCON #3 – RESERVE ZONE SHORTAGE OF RESERVES


• During this shortage Reserve Zone Resources will be measured towards meeting the Reserve Zone specific requirements of Load + Reserve Zone Operating Reserves

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DEFCON #3 – Reserve Zone Shortage of Operating Reserves


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• Reserve Zone Balancing Ratio numerator components (each 5-minute interval):• Reserve Zone Generation (as measured by 5-minute RQM)

• Reserve Zone Demand Response Provided (as measured by Baseline Calculations or estimates for passive)

• Net Imports per Participant (for the 5-minutes interval for external interfaces that only connect to that Reserve Zone)

• Net Reserve Zone Requirement (Reserve Requirement that was violated for the interval)

• Note: The numerator will depend on the need for Reserve Zone resources to provide energy & reserves due to limitations of the transmission interface into the Reserve Zone


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• Net Reserve Zone Requirement equals:• Reserve Reserve Requirement (TMOR) minus Reserve

Support from Outside the Zone through unloaded capacity on the transmission interface into the Reserve Zone

For example, if the Reserve Zone Requirement was 500 MW and the interface into the Reserve Zone was unloaded by 300 MW then 300 MW of that 500 MW requirement are being met from outside. So only 200 MW is needed from inside the zone, the 200 MW would be the reserve MW number used in the numerator.


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• System Balancing Ratio denominator component:• Total Reserve Zone CSO = Equal the sum of CSO of

all Resources within the Reserve Zone

Balancing Ratio – DEFCON #3

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Balancing Ratio = (RZ Supply* + RZ Reserve Reqt – Ext. Resv)Total Reserve Zone CSO

*Reserve Zone (RZ) Supply = (Reserve Zone Gen + Net Reserve Zone specific imports + Reserve Zone DR provided)

What about the energy and reserves coming into the Reserve Zone across the transmission interface ? DEFCON #3• Although some of the Reserve Zone energy and reserve

requirements are being met with energy and reserves from outside the area, if another MW of energy or reserves outside the area would not help the Reserve Zone area, it has no marginal value in solving DEFCON #3– If the Reserve Zone requirement being violated does not impact LMPs

or Reserve Market Clearing Prices (RMCPs) in the other areas of the system, no PFP is calculated for those other areas

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BALANCING RATIOWrap-Up

Wrap Up – points to take away

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STOP-LOSS PROVISIONSConceptual Design and Main Elements

Liability Limits: Purpose and Rationale

• Issue. It is not economically reasonable for suppliers to face ‘unlimited’ risk of loss in commercial relationships

– Markets commonly employ liquidated damages (‘LD’) provisionsto address losses from non-performance

– Concern occurs when a Participant cannot ‘trade out’ of its CSO

• Solution direction. Provide a liability limit on a capacity supplier’s financial loss exposure for non-performance during the commitment period

– A ‘stop-loss’ system

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Conceptual Framework

• The stop-loss is a mutual insurance system among capacity suppliers:– Suppliers’ performance payments contribute to a Reserve Fund– Provides each supplier with some financial protection

(capped maximum losses for non-performance)

• What makes it ‘mutual’?

– Costs are borne by capacity suppliers’ contributions– Potential beneficiaries are the pool of capacity suppliers– Actual beneficiaries are the capacity supplier(s) with non-

performance charges that exceed the stop-loss amount

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Objectives and Principles

• Transparency. System should be transparent, succinct, and easy to specify in the tariff

• Maintain performance incentives. A good stop-loss design should minimally distort: – Incentives to perform during DEFCON events– Incentives to trade-out or replace a non-performing CSO resource

• Insure against extreme loss scenarios for a resource owner.– Suppliers still face some net-loss exposure for non-performance on

FCM obligations (how insurance works generally)

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Mechanics: Three Major Components

1. At the Resource-Level: How the stop-loss works

2. At the Pool-Level: How the money flows

– Reserve Fund accruals and disbursements

3. The Stop-Loss amount

– Current ISO thinking and considerations

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1. Resource-Level: Main Features

• Annual cap on total loss exposure for FCM obligations

– Limits apply monthly during commitment period

• Cap applies to sum of Base and Performance payments

– Intent: Limit total financial consequences from FCM participation

• Cap is per CSO MW (not per-participant)

• Design features maintain (some) performance incentives even if a resource reaches the stop-loss limit

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Examples: The Basics

For simplicity, in the following example the numbers have been scaled down to demonstrate the concept

•Use a PPR = $1/MWhResource has a 1MW Capacity Supply Obligation

•A stop-loss amount of $10 is used for demonstration purposes only

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Resource-Level: Simple Example

For entire commitment period:

Base payments total = $8Performance payments total = ($21)Net financial position = ($13)

Effect of stop-loss is to limit net financial position:(using a stop-loss of minus $10, for example)

Pre stop-loss net financial position = $8Stop-loss limit = ($10)Post stop-loss net financial position = ($10)

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Resource-Level: Examples

Example 1 – shows the same simple example, but over discrete periods over the entire commitment period– ‘Severe’ event occurs during last period

Example 2 – shows the same simple example as in Example 1, but in reverse– The ‘severe’ event occurs during the first period

Example 3 – is nearly the same as Example 2, but the event is not as severe– The first period is ‘stopped-out’– But the net financial position at the end of the entire commitment

period is not stopped out

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Example 1 – Stop-Loss

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Pre Stop-Loss Post Stop-Loss

Period Base Performance Payment

Monthly Net

Cumulative Net

Cumulative Net

Monthly Net

1 $2 $1 $3 $3 $3 $3

2 $2 ($2) $0 $3 $3 $0

3 $2 $0 $2 $5 $5 $2

4 $2 ($20) ($18) ($13) ($10) ($15)

Total $8 ($21) ($13) ($13) ($10) ($10)

For demonstration purposes only, a $10 Stop-Loss amount is used


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Monthly Net

Cumulative Net

Cumulative Net

Monthly Net

1 $2 ($20) ($18) ($18) ($10) ($10)

2 $2 $0 $2 ($16) ($10) $0

3 $2 ($2) $0 ($16) ($10) $0

4 $2 $1 $3 ($13) ($10) $0

Total $8 ($21) ($13) ($13) ($10) ($10)


1. Here, the cumulative pre-stop-loss calculation will continue, and the stop-loss limits monthly payments

2. The same annual performance (as in Example 1) leaves the resource with the same annual net financial outcome


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Monthly Net

Cumulative Net

Cumulative Net

Monthly Net

1 $2 ($13) ($11) ($11) ($10) ($10)

2 $2 $0 $2 ($9) ($9) $1

3 $2 ($2) $0 ($9) ($9) $0

4 $2 $1 $3 ($6) ($6) $3

Total $8 ($14) ($6) ($6) ($6) ($6)


1. Similar to Example 2, the pre-stop-loss cumulative net will continue to be calculated, and evaluated against the stopped amount ($10)

2. The resource’s cumulative net by Period 2 is the same pre- and post-stop-loss3. Here, the second period Monthly Net has been reduced to ‘repay’ the stop-loss

reserve fund

2. Pool-Level Settlements

• How does the money flow to cover a stop-loss limit?

• Issue: – ISO uses money from under-performers to pay the over-performers – If an under-performer reaches its loss-limit, where does the money

come from to pay the over-performers?

• Solution direction:– There is a ‘natural’ ISO revenue surplus that can cover some of this

– If necessary, capacity suppliers would then have performance payments adjusted (downward), so settlements balance

– This is the mutual insurance aspect of the stop-loss design

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The ‘Natural’ Revenue Surplus under PFP

• During any DEFCON, more resources are under-performing than are over-performing– That is why the system is deficient– The reserve deficiency (in MW) equals the difference between total

under- and over-performance

• At the pool level: This means suppliers’ total performance debits exceed total credits in PFP settlement

• The difference is a net revenue surplus in ISO Settlement

• Detailed Example: FCM PI White Paper, Example 5 (p. 17)

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Pool-Level Stop-Loss Effects: Example

• Assume:– A one-hour DEFCON #1 (system-level total-30 deficiency)– Reserve deficiency magnitude is 200 MW (average over event)– PPR = $5,000 / MWh

• If no one’s stop-loss limit is reached, there’s a net surplus of:

$5,000 / MWh x 200 MW x 1 hour = $10 million

• But: If a supplier has reached its stop-loss limit, and under-performs by (say) 80 MW, the net surplus would be less:

$5,000 / MWh x (200 – 80) MW x 1 hour = $6 million

The ISO does not collect $4 million from the stop-loss underperformer

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Implications

• Stop-Loss Reserve Fund. ISO proposes to accrue the ‘natural’ PFP revenue surplus in a stop-loss reserve fund

• Purpose. The reserve fund would be used to cover payments to over-performers (to maximum extent possible) when an under-performer has reached its stop-loss limit

• Reserve fund balance would accumulate (potentially) each DEFCON event during the commitment year

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Two Issues

• What if the Reserve Fund reaches zero?

– Capacity suppliers payments would have to be adjusted (downward), to ensure it does not go negative (i.e., ISO settlements balance)

• Disbursement of ‘excess’ Reserve Fund balance (if any)?

– Beneficiaries

– Timing

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3. The Stop-Loss Value

Three competing considerations to be balanced:

A. Incentive problems if stop-loss is set too low:

– The value should be high enough to create an incentive to cover the obligation, rather than ‘stop-out’ and not cover

– A resource that is ‘stopped-out’ has some incentive to perform, but it is attenuated

– If many resources hit the stop-loss, it burdens the remaining capacity suppliers with short-pay risk

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Stop-Loss Considerations (Cont’d)

B. Economic argument against setting the stop-loss too high:

– We may interpret the FCA starting price as ISO’s value (or willingness-to-pay) for capacity

• Used in both the FCA and Reconfiguration Auctions– Sensible that the stop-loss should not exceed this value

• A supplier should not be expected to cover its obligation at a cost that exceeds the ISO’s value for it

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Stop-Loss Considerations (Cont’d)

C. Stop-Loss value should be consistent with loss exposure for other capacity reduction events

Example: If a resource suffered a significant decrease before the third annual reconfiguration auction, the ISO would submit a bid on behalf of the resource at the FCA starting price (III.13.4.2.1.3(b))

In this situation:

Max loss exposure = FCA Starting Price – FCA Capacity Clearing Price

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Stop-Loss Value – Alternatives in Consideration

Several indexes under evaluation for stop-loss value:

• FCA Capacity Clearing Price (a multiple thereof)

• FCA Starting Price

• Combinations of these two:

Example: Stop-Loss = FCA Capacity Clearing Price – FCA Starting Price

– In this example: A resource would reach the stop loss limit if its cumulative net performance charges exceed the starting price

– In effect, this stop-loss accepts that a resource does not need to cover itself if the price to do so exceeds $15/kw-mo, less net performance charges to date

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Perspective: How many DEFCON hours is that?

• What would the number of DEFCON hours have to be for a zero performing capacity resource to hit a stop-loss limit of:

FCA clearing price – FCA starting price?

– Assume: $5/kw-mo FCA clearing priceAverage balancing ratio of 0.75 Performance Payment Rate of $5,000/MWh

– Answer: 48 hours

• Interpretation: The average resource expects to receive $5/kw-mo in FCM, but could lose up to $10/kw-mo if:

• It has zero performance during all deficiency events;• It does not cover its obligation during any events• There are 48 or more hours of DEFCON events

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IMPACT ANALYSIS UPDATE

Impact Analysis

• Impact Analysis of ISO’s proposal: June/July– See April Markets Committee presentation for scope & assumptions

background (link: A17C Analysis Group Presentation 04-10-13)

• Stakeholder alternative(s) to ISO’s proposal– ISO may be able to evaluate the impact of alternatives that are well-

developed and detailed enough to model– The sooner a stakeholder proves a well-developed alternative, the

more likely the ISO would be able to evaluate it in a timely fashion• Markets Committee vote in October; detailed alternative proposals

submitted by June would allow for analysis (potentially) by August

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http://www.iso-ne.com/committees/comm_wkgrps/mrkts_comm/mrkts/mtrls/2013/apr9102013/a17c_analysis_group_presentation_04_10_13.ppt

LOGISTICS & TIMING

Logistics & Timing

• ISO Direction: ISO White Paper (October 2012) onFCM Performance Incentives

Also at: http://www.iso-ne.com/spi > Materials

• Timeframes:– Mar-Sep 2013: Markets Committee– Fall 2013: MC & PC votes– Q4 2013: FERC Filing

• Implement: For FCA 9 (FCA held 2015, CCP of 2018/19)

• A major initiative: Impact analysis with MC Q2-Q3 2013

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http://www.iso-ne.com/committees/comm_wkgrps/strategic_planning_discussion/materials/fcm_performance_white_paper.pdf

http://www.iso-ne.com/spi

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Andrew Gillespie [email protected]

Ron Coutu [email protected]

Matthew White [email protected]

mailto:[email protected]



May 14-15, 2013 | Westborough, ma

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