Exhibit 99.445
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A REPORT TO THE CALIFORNIA POWER
EXCHANGE: THE BENEFITS OF A
SIMULTANEOUS VERSUS SEQUENTIAL PX
MARKET FOR ENERGY AND ANCILLARY
SERVICES
December 7, 1998
Dr. Peter H. Griffes
Analysis Group Economics
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A REPORT TO THE CALIFORNIA POWER EXCHANGE:
THE BENEFITS OF A SIMULTANEOUS VERSUS
SEQUENTIAL PX MARKET FOR ENERGY
AND ANCILLARY SERVICES
I. EXECUTIVE SUMMARY........................................................................................ 4
II. PURPOSE OF THE STUDY..................................................................................... 4
III. AN OVERVIEW OF THE CURRENT ANCILLARY SERVICES MARKET..................................................... 6
A. BIDDING AND BID EVALUATION............................................................................ 6
B. SELF-PROVISION OF ANCILLARY SERVICES.................................................................. 8
C. THE PX AND SELF-PROVISION............................................................................. 8
D. REAL-TIME DISPATCH OF ANCILLARY SERVICES AND SUPPLEMENTAL ENERGY...................................... 9
E. SUPPLY REMUNERATION FOR ANCILLARY SERVICES............................................................ 10
F. DEMAND CHARGES........................................................................................ 11
IV. PERFORMANCE OF THE ANCILLARY SERVICES MARKET TO DATE..................................................... 11
A. COST-BASED PRICE CAPS HAVE CREATED THIN MARKETS AND PRICE VOLATILITY.................................. 12
B. THE ISO'S DEMAND FOR ANCILLARY SERVICE IS HIGH........................................................ 12
C. THE CASCADING AUCTION FORMAT INSPIRES INVERTED PRICES ACROSS ANCILLARY SERVICE MARKETS................ 12
V. PROPOSED IMPROVEMENTS TO THE ISO MARKET.................................................................. 13
A. LINEAR PROGRAMMING OPTIMIZATION APPROACH.............................................................. 13
B. SMART BUYER APPROACH.................................................................................. 13
C. COMPARISON OF THE THREE APPROACHES.................................................................... 14
VI. THE RELATION BETWEEN PROVISION OF ENERGY AND ANCILLARY SERVICES.......................................... 15
A. POLICY OBJECTIVE IS TO GAIN EFFICIENCY WHILE RETAINING UNBUNDLED NATURE OF SERVICES................... 15
B. RELATION OF THE ENERGY AND ANCILLARY SERVICES PROVISION............................................... 15
1. The temporal aspect of these markets............................................................... 16
2. The substitutability of these services in production............................................... 16
3. Application of these concepts to California institutions........................................... 17
VII. METHODOLOGY FOR ADDRESSING THE EFFICIENCY GAINS FROM A SIMULTANEOUS MARKET............................ 19
A. EMPIRICAL ANALYSIS OF HISTORIC BIDS WILL NOT BE USEFUL................................................ 19
B. SIMULATION ANALYSIS CAN BE ENLIGHTENING............................................................... 19
C. DESIGN AND EXECUTION OF THE ANALYSIS................................................................. 20
VIII. A MODEL FOR PX PROCUREMENT OF ENERGY AND ANCILLARY SERVICES........................................... 20
A. DESCRIPTION OF THE PROPOSED MARKET.................................................................... 21
B. BIDDING INTO THE PX MARKET............................................................................ 22
C. BID TYPE.............................................................................................. 22
1. Demand side........................................................................................ 22
2. Supply Side........................................................................................ 23
D. PX EVALUATION OF BIDS................................................................................. 24
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1. Sequential evaluation methodology.................................................................. 24
2. Simultaneous evaluation methodology................................................................ 25
E. NOTIFICATION OF SELECTED BIDS......................................................................... 25
F. PRICING OF ENERGY AND ANCILLARY SERVICES.............................................................. 26
1. FERC Requirements for Pricing...................................................................... 26
2. Separate prices for AS and Energy.................................................................. 27
3. Pricing in the ISO AS market....................................................................... 27
G. SUPPLY REMUNERATION AND DEMAND PAYMENTS............................................................... 28
IX. THEORETICAL IMPACTS FROM A JOINT ENERGY ANCILLARY SERVICE MARKET......................................... 28
A. POTENTIAL FOR LOWER COSTS............................................................................. 28
B. POTENTIAL FOR HIGHER PRICES........................................................................... 29
X. NUMERICAL COMPARISON OF THE EFFECTS OF SIMULTANEOUS AND SEQUENTIAL MARKET AUCTIONS....................... 31
A. DESCRIPTION OF THE SPREADSHEETS....................................................................... 31
1. Model inputs....................................................................................... 32
2. Model outputs...................................................................................... 33
B. MODEL RESULTS......................................................................................... 34
XI. ASSESSMENT OF SIMULTANEOUS AND SEQUENTIAL MARKETS........................................................ 36
A. SEQUENTIAL EVALUATION OF ENERGY AND ANCILLARY SERVICES AUCTION.............ERROR! BOOKMARK NOT DEFINED.
B. SIMULTANEOUS EVALUATION OF ENERGY AND ANCILLARY SERVICE AUCTION.............ERROR! BOOKMARK NOT DEFINED.
XII. CHANGES REQUIRED TO IMPLEMENT THE PX MARKET........................................................... 38
A. ISO OPERATIONS........................................................................................ 38
B. PX OPERATIONS......................................................................................... 38
XIII. CONCLUSIONS AND RECOMMENDATIONS....................................................................... 38
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THE BENEFITS OF A SIMULTANEOUS VERSUS
SEQUENTIAL PX MARKET FOR ENERGY AND ANCILLARY SERVICES
I. EXECUTIVE SUMMARY
II. PURPOSE OF THE STUDY
In its filing to the Federal Energy Regulatory Commission (FERC) in March 1997,
the PX proposed to implement its own ancillary services auction that would
enable the PX to self provide all or a portion of its ancillary service
obligations to the ISO.(1) In October of 1997, the FERC conditionally authorized
the operation of ISO and the PX. The October 30th order supported the
development of both an ISO and PX ancillary services market.(2)
Although the FERC granted the PX the authority to implement an interim
sequential market of its own, Commissioners questioned whether greater
efficiencies would be achieved if the PX implemented a simultaneous market for
ancillary services. To address this concern, the FERC ordered the PX to file a
study that analyzes the merits of developing a simultaneous auction for both
energy and ancillary services. Specifically, the FERC noted:
Whether sequential or simultaneous auctions are more efficient is an
unresolved empirical question. Accordingly, we will approve the
proposal for sequential auctions on an interim basis in order to gather
experience with which to evaluate the proposal more fully at a later
date. To assist us in that evaluation and to address the concerns
articulated above, we will require the PX to conduct further studies,
and to file a report on their results by January 1, 1999, at which time
we may revisit the issue. The studies should analyze and compare
sequential and simultaneous auctions in terms of their abilities to
develop an efficient, least-cost dispatch(3)
This report responds to the FERC request for a study of the merits of sequential
and simultaneous auction models.
While FERC clearly states the analysis should compare simultaneous and
sequential auctions, it is unclear what delineates a sequential auction from a
simultaneous one. There are two ways to interpret this. First, there could be
simultaneous bidding where the bids for the energy market are also used for
ancillary services; however, the evaluation of the bids would take place in a
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(1) PX March 31, 1997 FERC filing, Section 3.3.4. NEED FORMAL CITE.
(2) Docket Number EC96-19-001 et al.
(3) October 30th order, p. 194-195.
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sequential fashion. Second, there could be simultaneous bidding and evaluation
of bids for energy and ancillary services where the same bids are used for both
markets and are considered together at the same time to meet the needs in all
markets.
Since the opening of the market in April, significant problems have arisen in
the ancillary services markets. Price caps had been imposed, lifted and
re-imposed. As a result of the summer price spikes in these markets, FERC
required a report(4) from the Market Surveillance Committee of the California
ISO (MSC). On top of the MSC's list of recommendations, was for the ISO to adopt
practices that allowed it to "substitute cheaper superior services for more
expensive inferior services in its procurement of ancillary services.(5)" The
discussion in the MSC report makes it clear that consistency between the bids
for the various services would contribute significantly to attenuating the
instability in these markets.(6)
The introduction of simultaneous bidding for energy and ancillary services
imposes this same restriction of consistency between bids for different markets.
With a simultaneous bidding framework, regardless of whether there is sequential
or simultaneous evaluation, the capacity bid could be used for either energy or
ancillary services. The framework requires that the willingness to sell capacity
for energy is the same as the willingness to sell capacity for ancillary
services. Thus, it requires that the bids for the same capacity are identical
regardless of the market, energy, regulation, spin, non-spin or replacement.
This is a bit more restrictive than the bid consistency rules suggested by the
MSC where bids for inferior services could be no higher than bids for superior
services.
Because of the desirability of bid consistency, this report posits a
simultaneous bidding framework. It then examines the question of whether there
are efficiency gains from the simultaneous evaluation of energy and ancillary
services markets in relation to the sequential evaluation of the markets.
The analysis addresses three different ways to evaluate these markets. The first
is `fully simultaneous', where all markets, energy and ancillary services
markets, are considered simultaneously. The second is `sequential, simultaneous'
where the energy market is evaluated before the ancillary services markets which
are evaluated simultaneously. The third is `fully sequential' where the markets
are evaluated in the following sequence: energy, regulation, spin, non-spin, and
replacement. The prior expectation is that `fully simultaneous' will produce the
lowest costs, followed by `sequential simultaneous,' and `sequential,
sequential' will have the highest costs.
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(4) Preliminary Report On the Operation of the Ancillary Services Markets of
the California Independent System Operator (ISO), Prepared by the Market
Surveillance Committee of the California ISO, August 19, 1998. (MSC Report)
hereafter.
(5) MSC Report, p. 37.
(6) MSC Report, p. 38-41.
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To summarize the results, they are somewhat surprising. The level of costs
depends significantly on perspective. As with most markets, the costs incurred
by producers are not the same as the costs incurred by consumers. The major
difference between them is commonly known as the producer's surplus and depends
considerably on how prices are set in the market. In this analysis, the results
vary by whether the producers or consumers perspective is adopted.
The efficiency of the dispatch (or cost to producers) does follow expectations
using the bids as a representation of costs. Namely, `fully simultaneous'
produces the most efficient dispatch. The dispatch under `Sequential
simultaneous' is lower in cost than `fully sequential.' As quoted above, the
FERC's concern lies with the efficient dispatch of the generators in the market.
However, costs to consumers (or revenues to producers) are a different matter.
THE REMAINDER OF THIS REPORT IS LAID OUT AS FOLLOWS . . .CONTINUE WITH THE
DESCRIPTION ONCE THE OUTLINE HAS BEEN SETTLED.
III. AN OVERVIEW OF THE CURRENT ANCILLARY SERVICES MARKET
The ISO is responsible for ensuring that adequate ancillary services exist to
support the dispatch and consumption of power on the grid. Currently, the ISO
operates a day-ahead and hour-ahead competitive market to supply four ancillary
services -- regulation, spin, non-spin and replacement power.(7) The ISO
determines the quantities of each ancillary service that will be required based
on WSCC and NERC requirements and ISO estimates of day-ahead forecast load.
A. BIDDING AND BID EVALUATION
Via their Scheduling Coordinators (SCs), generating units, curtailable demand
and external import/export resources may bid to supply ancillary services into
the ISO auction.(8) Suppliers submit two-part bids (capacity and energy) to the
ISO for each of the four auctions that they seek to bid into. For each ancillary
service being offered, SCs must include a bid price for energy in the form of a
staircase function composed of up to eleven ordered pairs of quantity-price
information.(9) Dispatchable load may also bid into the non-spin and replacement
power. Bids must contain information that allows the ISO to validate that the
generation or load offered into the auctions meets the technical requirements
for the particular service.
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(7) Black-start capability and voltage control are procured by the ISO on an
annual basis under contract. Currently, these requirements are met by
Reliability Must Run (RMR) units.
(8) Tariff, section 23, "Temporary Changes to the Real-Time Market for
Imbalance Energy, p. 285.
(9) ISO Tariff, p. 285.
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The ISO ancillary service market is run as a sequential auction. The ISO
receives bids for all four auctions in the day-ahead and hour-ahead markets and
evaluates and selects "winning" bids in the following order: regulation;
spinning reserve; non-spinning reserve; and replacement reserve.
Each SC may specify which markets it wants to bid ancillary service capacity
into. With the exception of down regulation, capacity selected by the ISO in one
of the markets is subtracted out of the total capacity offered into the market
by a bidder. If designated by the bidder, any capacity that is not selected in
the preceding market may be passed on into the next auction for consideration.
Different capacity prices may be specified for the same capacity in each of the
markets.(10)
The ISO evaluates bids based on the capacity price in selecting the entities
that are designated to provide ancillary services. For the day-ahead auction,
the capacity prices paid for each ancillary service are posted on the ISO
website by 3 p.m. on the day before the operating day.
B. SELF-PROVISION OF ANCILLARY SERVICES
The ISO's ancillary service requirements may be self provided by SCs.(11) Load
choosing to self provide may either contract directly with a generator or a
broker to insure adequate ancillary services are supplier. SCs then submit a
self-provision schedule for each ancillary service, designating the unit, load
or system resource that will be called upon to provide the ancillary services in
real time.
Partial self-provision of ancillary services is permitted with any not
self-provided being procured in the ISO's market. For the portion of load that
is self-provided, the SC must submit a proxy energy bid, representing price at
which the designated resource may be dispatched in real time. As with bid-in
resources, self-provided resources must be certified by the ISO that they
comport with the ISO's technical requirements for providing the ancillary
service.
C. THE PX AND SELF-PROVISION
As a SC, the PX has a right to self-provide ancillary services.(12) Self
provision would require the PX to operate its own separate auction for ancillary
services and forward to the ISO information about winning resources selected by
the PX to cover ISO-enforced ancillary service obligations. In addition, the
FERC has acknowledged that PX participants should be allowed to contract
bilaterally with generation resources to meet any of their own ancillary
services obligations without utilizing either a PX or ISO auction.
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(10) ISO tariff, p. 79
(11) Voltage Support and Black Start may not be self provided under the ISO
Tariff and will be procured by the ISO.
(12) See December 1997 FERC decision, p. 23 and October 30 decision, p. 16.
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Currently, the PX neither operates ancillary service markets nor self-provides
ancillary services, but procures them from the ISO market. Any PX resource
meeting the technical requirements for supplying ancillary services may bid into
the ISO auction. After clearing its day-ahead energy market, the PX acts as an
intermediary by accepting the bids from its participants and passes them on to
the ISO but otherwise has no role in the ISO auction. Similarly, in the
hour-ahead market, ancillary bids are submitted to the PX no later than two
hours prior to the dispatch hour.(13)
D. REAL-TIME DISPATCH OF ANCILLARY SERVICES AND SUPPLEMENTAL ENERGY
The ISO dispatches capacity providing ancillary services and supplemental energy
in real-time to insure that reliability standards mandated by the WSCC and NERC
are met. The ISO calls on resources to supply incremental energy to keep the
system in balance. It also requires generators to decrement generation resources
to correct oversupply.
Additional energy in real-time is supplied from five possible sources -- the
winning bids submitted in the four ancillary service markets and from
supplemental energy bids.(14) The ISO assembles the energy bids from ancillary
service providers and supplemental incremental energy bids into a single
merit-order stack of system-side resources.(15) Any incremental energy needed in
real-time is drawn from this stack when there is under-supply. Similarly, the
ISO assembles a decremental merit-order stack, consisting of scheduled
generation that willing to be decremented in real time. The decremental stack is
used when there is oversupply.
Thus, while ancillary service resources are selected to stand ready to provide
real-time energy on the basis of their capacity bids, these resources are only
dispatched if they are the least-cost alternative available to the ISO in
real-time. If a supplemental energy bid is less costly, the ISO will draw on
this resource first to provide real-time energy.
E. SUPPLY REMUNERATION FOR ANCILLARY SERVICES
Resources providing ancillary services are paid a capacity payment and an energy
payment if called in real-time. For each ancillary service, the marginal unit
sets the capacity payment. That is, the last bidder whose capacity is accepted
in the day-ahead or hour-ahead market by
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(13) Report on Market Issues in the California Power Exchange Energy Markets,
The Market Monitoring Committee of the California Power Exchange, August
17, 1998, p. 6. (MMC Report).
(14) Supplemental incremental energy is bid into the ISO by generators that have
uncommitted capacity. They can be submitted anytime after the day-ahead
market but cannot be withdrawn within 45 minutes prior to start of
real-time hour.
(15) The energy bids for spin, non-spin, and replacement reserves are added to
the stack.
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the ISO to stand ready sets the market-clearing price for each ancillary
service.(16) Whether or not the resource is actually called to provide ancillary
services in real-time, resources are remunerated for capacity if selected to
stand ready. Suppliers of regulation also receive a Regulation Energy Payment
Adjustment (REPA).(17)
Currently, cost-based caps limit the capacity remuneration of some ancillary
service suppliers. Since market inception, all utility-owned generation has been
under a cost-based cap for all ancillary services. They range from between $4.47
to $9.55, depending on the service. Southern California Edison, for example, is
capped at $4.47/MW for replacement reserve bids.
Energy remuneration for ancillary services is based on real-time dispatch.
Instructed deviations are paid the 10-minute price for energy relevant for the
time in which the ISO instructs the generator or load to supply ancillary
services.(18) Because the ISO may need to either constrain on or constrain off a
resource, effectively, there are two prices for each interval, the incremental
10-minute price (for resources called on) and the 10-minute decremental price
(for resources constrained off). Each is set at the price of the last or
marginal unit for generation (or load) that is called to adjust its schedule
over a 10-minute period.
F. DEMAND CHARGES
The ISO charges all SCs for their share of the total costs of providing the four
ancillaries services that it buys from competitive markets. In its daily
settlement process, the ISO determines the hourly user rates charged for each
service for each settlement period for both the day-ahead and hour-ahead
markets. For each ancillary service procured in the ISO auction, the ISO
calculates charges based on the ratio between the SC's forecast hourly demand
(less any ancillary services self-provided) and the total demand scheduled by
all SC in that hour for each zone.(19)
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(16) If congestion exists, the ISO establishes zonal market-clearing prices in
each ancillary service market. The details of these payments can be found
in the ISO tariff, section 2.5.
(17) Under Amendment 8, filed with the FERC on May 19, 1998 the REPA is equal to
the energy potentially available in the regulation bid (R(up) + R(down))
multiplied by the greater of $20/MWh or the hourly ex-post price. Effective
November 23, 1998, REPA payments were set to zero.
(18) The ISO's automated software system, Balancing Energy and Ex-Post Pricing
(BEEP), prices real-time energy. In the original market design, BEEP was
designed to determine the dispatch instruction required to keep the system
in balance on the basis of a five-minute interval. Due to system
limitations, a five-minute interval is not feasible, and thus BEEP
calculates prices on a 10-minute interval.
(19) Prior to mid-August, the ISO procured ancillary services based on scheduled
load, as per the ISO's April tariff, Section 2.5.20.1. Because some SCs
were deliberately under-scheduling load in the day-ahead market to avoid
ancillary service charges, the ISO received approval from the ISO Board of
Governors to adopt forecast SC loads to calculated ancillary service
charges.
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IV. PERFORMANCE OF THE ANCILLARY SERVICES MARKET TO DATE
A number of problems have been observed in the ISO ancillary services market
since inception, the most publicized of which was large price spikes in the
replacement power market in mid-July. Replacement reserves reached $5,000/MWh on
the trading day of July 8 for power delivered on the 9th. On July 12, prices for
replacement power delivered on July 13 spiked to $9,999/MWh for the hours
between 2 and 6 p.m.(20)
The existence of cost-based caps -- concomitant with market-based rates for a
limited number of owners -- has been attributed to causing significant price
spikes in the ancillary services market in July. Because of price volatility,
the FERC authorized on July xx the imposition of a market-based cap of $250/MW
for ancillary services. Thus, utilities and IPP continue to be regulated under a
cost-based cap and are paid a maximum of their capped rate for providing
service. Suppliers authorized for market rates can receive no more than $250/MW.
In July, the FERC directed the ISO Market Surveillance Committee and the
California Power Exchange (PX) Market Monitoring Committee to conduct
independent studies regarding the performance of the competitive energy and
ancillary service markets in California. The reports highlighted several areas
in which the current market structure has lead to inefficiencies. These issues
are reviewed below.
A. COST-BASED PRICE CAPS HAVE CREATED THIN MARKETS AND PRICE VOLATILITY
The ISO's Market Surveillance Report (MSR) concluded that because investor-owned
utility (IOU) generation has been under price caps for ancillary services since
the start of the market, incentives for utility's to bid into the ancillary
service market have been dampened.(21) Even after divestiture of fossil assets,
IOUs are presently the largest source of ancillary services, and their low
participation has provided opportunities for new owners of plant to withhold
capacity to drive up the market price for ancillary services.(22)
B. THE ISO'S DEMAND FOR ANCILLARY SERVICE IS HIGH
The MSR found that the ISO is procuring about twice as much regulation, spin and
non-spin as was provided prior to competition. Most of the over-procurement
relative to pre-market practices takes place in the regulation and is a function
of problems with market design. Because the system is self-dispatched, operators
have less control over the actions of generators
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(20) In contrast, average prices for replacement power in the months of April,
May and June north of Path 15 were: $8.02, $7.93, and $4.28 per MW,
respectively.
(21) This is particularly true because utility generation designated as RMR
could earn more under these contracts than through the ancillary service
market.
(22) In addition, the FERC rules (cite) that replacement reserves are not an
ancillary service governed by the FERC. This ruling effectively removing
any price cap for this service.
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and the impact on reliability. Further, there are built in incentives to
deviate. Because the energy market clears without reference to generator ramp
rates, awarded schedules may be difficult to meet given generator ramping
constraints. Under the portfolio bidding structure, bidders are responsible for
this minimizing these effects. Also, paying instructed and uninstructed
deviations different amounts produces incentives for uninstructed deviations in
the early parts of ramping hours.
C. THE CASCADING AUCTION FORMAT INSPIRES INVERTED PRICES ACROSS ANCILLARY
SERVICE MARKETS
Because the ISO procures services in a cascading, sequential basis, it is often
the case that the least economically valuable ancillary service (e.g.,
replacement) is more highly priced than regulation, which is the most valuable
ancillary resource.(23) Less rigid rules of procurement might relieve some of
the pressure on the auctions, the report indicated.
V. PROPOSED IMPROVEMENTS TO THE ISO MARKET(24)
The ISO has begun efforts to evaluate and improve the operation of its ancillary
services market. As described above, the sequential nature of its auctions and
evaluations has lead to inconsistent prices across the markets. While the
discussions on revising these markets are ongoing at this point, there are two
different concepts under consideration. Despite the fact that the particular
details of implementing each concept has yet to be worked out, it is helpful to
examine the types of improvements under consideration. They can be labeled the
linear programming optimization approach and the Smart buyer approach. Each will
be discussed briefly in turn.
A. LINEAR PROGRAMMING OPTIMIZATION APPROACH
Under this approach, the ISO would evaluate the bids for ancillary services in a
simultaneous fashion. Namely, it would collect the bids for each of the reserves
markets and find the combination of bids that produced the least cost for the
provision of the full quantities needed. Because the same capacity can be bid in
each of the reserve markets, the approach allows for a better allocation of
capacity to its highest value across reserve markets. For example, a low bid for
regulation may not be taken in favor of a higher regulation bid because taking
the corresponding capacity for spin displaces a much higher cost spin bid. The
high differential in the spin bids justifies taking the higher cost regulation
bid because the differential is not as great as in the spin market. In order to
implement this type of approach, it would be necessary
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(23) Quality assertions are made on the basis of how quickly the ancillary
service must be made available. Regulation must be instantaneously
available to the system, whereas replacement reserves must be on line
within two hours of being called.
(24) This section is based on a conversation with Ziad Allowan who works for the
ISO.
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to set up a linear programming optimization problem. An example of this approach
will be given below.
B. SMART BUYER APPROACH
Under this approach, the ISO would still evaluate the markets in a sequential
fashion. However, it would not discard any unsuccessful bids from prior markets
in the evaluation of subsequent markets. Namely, the nearer-term markets, e.g.
regulation, are more valuable than the further-out markets, e.g. replacement
reserves. Because the operating requirements on the further-out markets are less
stringent, any unawarded capacity in the nearer-term markets could easily
fulfill the operating requirements in the further-out markets. Thus, the ISO, as
a smart buyer, would roll over any unsuccessful bids in nearer-term markets to
further-out markets. It would then essentially replace any higher cost bids in
subsequent markets with the unsuccessful lower cost bids for the same capacity
in earlier markets.
For example, a generator's $20/MW bid was not successful in the regulation
market and it bid $30/MW for the same capacity in the spin market. As a smart
buyer in the spin market, the ISO would replace the $30/MW bid in the spin
market with the $20/MW bid for the same capacity that was revealed in the
regulation market. From another viewpoint, the ISO is buying more regulation
capacity (because its cheap) and less spin capacity (because its expensive) and
substituting regulation for spinning reserve in meeting its reserve
requirements. Again a simple example of this will be given below.
C. COMPARISON OF THE THREE APPROACHES
A simple comparison will highlight the differences between these approaches. For
simplicity, assume there are only two reserve markets, spin and replacement
reserves. Further assume there are only two scheduling coordinators bidding into
these markets. Their bids and ISO requirements are spelled out in the following
table. In the bid columns, the first number is the quantity and the number in
parenthesis is the capacity bid price.
Total Capacity Bids Into Each Market
------------------------------
Available Spin Replacement
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SC1 100MW 100MW($1/MW) 100MW($6/MW)
SC2 100MW 100MW($5/MW) 100MW($100/MW)
ISO Requirement 100MW 100MW
Under the current sequential approach, the ISO first clears the spin market
before evaluating the replacement market. All unsuccessful bids in the previous
markets are discarded. Under this approach, the ISO awards 100MW to SC1 for
spin. and 100MW to SC2 for replacement.
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The cost of this is $10,100 to the ISO ($1/MW x 100MW + $100/MW x 100MW). SC1
takes home $100 while SC2 receives $10,000.
Under the optimization approach, the ISO considers the markets together to
minimize the total cost of spin and replacement subject to available capacity.
By jointly evaluating the markets, the ISO realizes tat by accepting an
additional cost of $4/MW in the spin market it can achieve savings of $94/MW in
the replacement market. Consequently, it awards 100MW of spin to SC2 and 100MW
of replacement to SC1. This costs the ISO $1,100 ($5/MW x 100MW + $6/MW x
100MW). SC1 gets $600 while SC2 is paid $500.
Under the smart buyer approach, the ISO considers the markets in sequence, first
clearing the spin market. In the spin market the ISO awards SC1 100MW. The ISO
then proceeds to the replacement market; however, the losing bids from the spin
market are not discarded. They are carried over into the spin market and
compared on a SC by SC basis. Because SC1 was awarded 100 MW in the spin market,
it has no capacity left for the replacement market. The ISO, however, compares
SC2's bids between the markets. Because SC2 was willing to sell 100MW of spin at
$5/MW and that capacity is still available, the ISO replaces SC2's $100/MW bid
for replacement with SC2's $5/MW bid for spin. It then awards SC2 with 100MW in
the replacement market at a price of $5/MW. The cost to the ISO is $600 ($1/MW x
100MW + $5/MW x 100MW). SC1 gets $100 while SC2 is paid $500.
An alternative way to view the smart buyer approach is that the ISO decides to
buy 200 MW of spin and 0 MW of replacement. It still is meeting its reserve
requirements because the operating requirements for spinning capacity are more
stringent than for replacement reserves. In this case, the cost to the ISO is
$1000 ($5/MW x 200MW + 0/MW x 0MW). Both SCs get $500.
It is clear from this example that the lack of a requirement for consistency
between bid values across the reserve markets can contribute significantly to
high costs for reserves.
VI. THE RELATION BETWEEN PROVISION OF ENERGY AND ANCILLARY SERVICES
A. POLICY OBJECTIVE IS TO GAIN EFFICIENCY WHILE RETAINING UNBUNDLED NATURE
OF SERVICES
There are two policy goals of procuring energy and ancillary services. The first
is to do so in the cheapest way possible. Namely, it is the desire that the
cheapest resources available provide the energy and ancillary service
requirements for the system. This least cost provision saves society's
resources.
The second objective is to unbundle the consumption of energy and ancillary
services into separate products. This unbundling of services means that only
those consuming each service
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pay for the particular service they consume. To
achieve effectively this separation, it is necessary to price the separate
products, energy and each of the ancillary services, on an individual basis.
Thus, it requires both sides of the market, supply and demand, respond to the
incentives to produce or consume each of the market separately.
Unbundling allows consumers to choose how these services will be provided for
them. While it is not possible for consumers to affect appreciably the AS they
consume, they do have the choice of paying different prices for the services
from different providers. Consequently, it is necessary to price each service
individually. Similarly, producers will also respond to prices when deciding on
their allocation of capacity to each market. The relation between these markets
will be discussed in greater detail below.
B. RELATION OF THE ENERGY AND ANCILLARY SERVICES PROVISION
As mentioned above, the policy objective of providing producers and consumers
the choice is the result of unbundling. In order to unbundle effectively, both
supplier and demanders of these services must respond to market forces. While
this should not be of great concern on the demand side of the market, suppliers
will watch each market closely. This section will briefly describe two aspects
of these markets that hinder the complete separation of these markets.
1. THE TEMPORAL ASPECT OF THESE MARKETS
There is a timing difference between the provision of energy and the provision
of ancillary services. This timing difference may be highlighted by the
structure and timing of the markets for energy and ancillary services.
As described above, ancillary services are capacity markets. Namely, the service
being provided is unloaded generating capacity in the real time dispatch of the
electrical system. This unloaded generating capacity is available to be used to
generate in the event of an unanticipated change in supply and/or demand
conditions. Having this capacity available significantly reduces the possibility
of a real time failure of the system.
Consequently, ancillary services markets keep generating capacity available but
unloaded, for use in real time. Because the services are procured in advance of
needed generation, they are forward markets for generating capacity. In
contrast, an energy market has no such requirement for being a forward market.
Energy markets could be forward or spot markets.
This difference highlights how these two services could be compensated. Because
of the forward nature of the ancillary service markets, it is necessary to pay
the owner for holding capacity idle. It may also be necessary to pay for any
energy that the capacity may produce in real time. A two-part payment scheme has
arisen for compensating providers of ancillary services. First, there is a
payment for holding the capacity idle; second there is payment for energy if and
when produced. It is not necessary to pay for ancillary services in this way. If
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the up-front payment is high enough, then it could additionally cover the cost
of providing the energy in real time. This is important because energy payments
are simpler being only a payment for a forward sale or one for a spot sale.
In California, the institutions providing these services have been well
established. The PX operates forward energy markets. The ISO operates a real
time spot energy market as well. In procuring ancillary services, the ISO uses a
two-part payment. It makes both a forward payment for holding capacity idle and
a real time payment for any energy produced.
As will be discussed in greater detail below, the nature of the supply for
these services and how they are compensated dictates how the markets will be
related to each other.
2. THE SUBSTITUTABILITY OF THESE SERVICES IN PRODUCTION
The provision of ancillary services and energy can be made from the same
sources. A generator producing energy could just as easily retain some capacity
to be able to provide spinning, non-spinning or replacement reserves. In most
cases, generators do provide both energy and ancillary services simultaneously
since they have minimum levels of output. Further, generators can switch from
providing one to the other quite simply and almost costlessly. In many cases,
there is a perfect substitution between the production of spinning and
non-spinning reserves and energy. There is less of a perfect relationship
between energy and replacement reserves. This is because a generator does not
have to be on line to provide replacement reserves. The only exceptions to this
are demand-side resources that can only provide non-spin and replacement
reserves. However, their role in these markets has been (and are likely to
continue to be) limited.
This ability to substitute easily allows generators to get the most for their
generating capacity. Namely, they have the ability to sell capacity in either
the energy markets or in the ancillary services markets. Unbundling of the two
markets may or may not lead to prices for energy that are determined using a
different methodology than for prices in the ancillary services markets.
However, the profit maximizing motives of generators leads to arbitrage between
the markets. Namely, generators will provide capacity to whichever market they
believe will provide them with the greatest return. Thus, arbitrage on the
supply side of these markets will produce compensation for generators that, in
equilibrium, will be the same whether the generator sells into the energy or
ancillary services markets. As will be discuss in greater detail below, this has
particular consequences for the introduction of an ancillary services market run
by the PX.
Consumers do not have the same opportunities for arbitrage between the markets.
This is because the consumption of energy does not provide the same benefits to
consumers as the consumption of ancillary services. The consumption of ancillary
services enhances the consumption of energy because it reduces the likelihood of
an interruption in service and, thus, adds to the quality of the energy
consumed. If consumers also had the ability to arbitrage in the same way
suppliers can, then arbitrage on both sides of the market would lead to
different market results. In this case, there would be countervailing forces
working on both markets.
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With supply-side arbitrage only, only generators move from one market to others
seeking higher compensation when the difference between markets is significant.
With arbitrage incentives on both sides of the market, consumers will move
between the markets to pay the lowest costs they can. With incentives on both
sides, differentials can be made up of either of supply or demand side
movements.
3. APPLICATION OF THESE CONCEPTS TO CALIFORNIA INSTITUTIONS
The existing structure of the California energy and ancillary services markets
has a significant impact on how much more efficiency and arbitrage can be
squeezed from these markets. There are currently three separate markets here,
the ISO's forward ancillary services market, the PX's forward energy markets,
and the ISO's real-time energy market. If the PX were to self-provide its
ancillary services, it would also introduce a day-ahead ancillary services
market.
Currently there are arbitrage opportunities between the existing markets. The
ISO's ancillary service market is a forward market, but its energy market is
only a real time market. Producers cannot arbitrage between the ISO's ancillary
services and its energy markets. They can arbitrage the temporally different
PX's and ISO's energy markets. This is a two-sided arbitrage since both
suppliers and consumers can do it.
More importantly, producers can arbitrage between the PX's energy market and the
ISO's ancillary services markets. However, it's difficult to call the current
arrangement arbitrage because suppliers do not have to make an exact allocation
of capacity to each market. With portfolio bidding in the PX's energy market,
generators have a tremendous amount of influence not only on the quantities bid
into each market, but also the prices that they will receive for ancillary
services. This is because they know the energy price before making their
allocation of capacity between generators. Of course, the allocation among
generators influences how much capacity is available for each ancillary service
market. Whatever is not scheduled in the energy market could then be bid into
the ancillary services market. Further, energy prices are known when the bids to
the ancillary services market are made. Thus, it is possible to gauge the level
of bids by the level of demand for ancillary services and the energy price.
Suppliers only have competition from other suppliers in limiting their bids from
high levels. Demand uncertainty and revenue from energy production do not play a
role in limiting the bids for ancillary service capacity. The introduction of
uncertainty from these sources should reduce the bids for ancillary services
because bidders are less able to assess whether their capacity will be chosen at
the higher bid prices.
In whatever ancillary services market the PX develops, it will attempt to take
advantage of the efficiency afforded from being operated in conjunction with the
energy market. There is the further challenge of addressing the potential
arbitrage between the PX ancillary services market and the ISO's ancillary
services market. In whatever structure is adopted, it will be difficult to keep
suppliers from participating in both markets. This means the structure and
compensation in the ISO's market will dictate whether anyone will participate in
the PX's market. Unless the compensation is at least as much as that afforded in
the ISO's ancillary services market, the PX
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ancillary services market may not attract any sellers. This arbitrage reality
makes it difficult to design a PX market that attempts to exploit the
efficiencies of joint energy/ancillary services market and produces a lower
price for ancillary services than the ISO's market. Consequently, the two-part
nature of the ISO's market may have to be altered in order for the efficiencies
of a joint market to be realized. From a public policy view, it is not clear
whether the costs of designing a PX market and altering the ISO's market to
reduce arbitrage opportunities will be offset by the efficiency gain from a
joint energy/ancillary services market at the PX.
As described above, the ISO's ancillary services market has two parts, a
capacity bid to stand ready to be dispatched and an energy bid that is the
minimum the bidder is willing to accept for energy production if dispatched in
real time. Only the capacity bid is evaluated when determining which generators
will provide ancillary services. The payment for energy will only be made if
dispatched in real time. Because the PX's market will have to compete with the
ISO's market for suppliers, the payment structure must be similar if there is to
be a benefit from the PX having an ancillary services market. Thus the PX
ancillary service market must make a capacity payment for standing ready as well
as an energy payment when dispatched.
Simply imitating the structure of the ISO's AS market provides no avenue for
efficiency gains. Efficiency gains means reallocating the mix of generation so
that the total energy and AS requirements are met at significantly lower costs
(as revealed through bids). One way to do this would be to introduce a
simultaneous energy/AS market at the PX. The task at hand is to design a
combination energy ancillary services market for the PX market that introduces
efficiencies in relation to the separate PX energy and ISO ancillary services
market. The challenge is further complicated by the requirement that it must
compete with the ISO ancillary service market. The rest of this report will
discuss this design and it potential for producing efficiency gains over the
current structure.
VII. METHODOLOGY FOR ADDRESSING THE EFFICIENCY GAINS FROM A SIMULTANEOUS
MARKET
The purpose of this report is to address the added benefit from a simultaneous
ancillary services and energy market. This section discusses the proposed
methodology to estimate such benefits. There are a number of different options
to do this estimation. These include, among others, an empirical analysis of
actual bids into these markets and simulation of the different market designs.
A. EMPIRICAL ANALYSIS OF HISTORIC BIDS WILL NOT BE USEFUL
Although the energy and ancillary services markets have been in operation for a
number of months, it is not wise to rely on an analysis of actual market data.
There are a number of reasons for this. First, the markets are new markets.
Participants have been learning how to operate in these markets and best take
advantages of their opportunities. Their bidding behaviors have changed over
time as they have learned more about the market rules.
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Second, there have been significant changes in the markets over this period,
particularly with the ancillary services markets. Initially, all ancillary
services bids were capped. Then some bidders had their caps removed. An overall
price cap was introduced as well as a supplemental payment for regulation.
Currently, the ISO is examining how it might better operate its ancillary
services markets. On the energy side, an hour-ahead market was introduced.
Besides these changes in the markets, historic and current bids are formulated
under the rules that exist for the market at that time. A change in the market
rules should elicit a change in bidding behavior. Similarly, the rules and
formulation of bids in a joint energy and ancillary services market would elicit
different bidding strategies. Thus, using current bids is not helpful in
answering question.
B. SIMULATION ANALYSIS CAN BE ENLIGHTENING
It may be helpful to set up hypothetical markets with the bidding structure to
examine how large of a difference the simultaneous structure makes in procuring
ancillary services. Simulations can easily illustrate the potential savings from
different markets incorporating degrees of simultaneity. Simulations could also
be used to study the behavior of market participants if hypothetical markets are
actually set up and the participants are allowed to bid in them to establish
equilibria. These experimental simulations could prove fairly accurate estimates
of the differences in the markets. However, the depth needed to establish highly
accurate experimental results is beyond the scope of this analysis. The
following sections undertake the more modest goal of providing examples of how
much more efficient different levels of simultaneous markets than others.
C. DESIGN AND EXECUTION OF THE ANALYSIS
The rest of this report describes a model for procuring energy and ancillary
services that can be applied with different degrees of simultaneity. The
analytical approach isolates the efficiency differences between approaches by
keeping all the other information identical in the treatments. Three market
evaluation treatments will be analyzed. They are: fully sequential evaluation
(fully sequential); a partially sequential, partially simultaneous evaluation
(sequential-simultaneous); and a fully simultaneous evaluation (fully
simultaneous). The fully sequential approach evaluates in the sequential
following order energy, regulation, spin, non-spin, replacement reserves. The
sequential-simultaneous approach evaluates the energy market before evaluating
the reserve markets simultaneously. The fully simultaneous approach evaluates
energy and all reserve markets together.
In order to isolate the degree of simultaneity, the level of energy and
ancillary service demand remains identical between the treatments. Similarly the
bid prices and quantities also stays unchanged. The resulting differences in
costs of provision will indicate the magnitude of the benefits from a particular
level of simultaneity. The differences in efficiency will be calculated
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for a number of different levels of demand in order to illustrate how efficiency
varies over different demand levels. Again it should be highlighted that this
research approach does not capture differences in bidding behavior that will
result from the different market rules.
The measure of efficiency is usually the level of costs incurred for the given
level of provision of services. In this case, the perspective of whom is
incurring the cost matters. The pricing rules adopted will impact the
out-of-pocket costs for consumers and the revenue streams to producers.
Different rules produce varying impacts on consumers and producers. In many
cases, these are simply wealth transfers between parties and have no impact on
the overall resource cost to society. Efficiency measures taking the societal
perspective are most appropriate. However, the distribution of costs and
benefits is also of concern. As will be discussed in greater depth below, it
could well be the case that simultaneous markets lead to overall lower costs to
society, but higher costs to consumers (and higher revenues to producers)
because of the particular pricing rules. Thus, the analysis will focus not only
on the efficiency of the market (as measured by the minimization of costs as
revealed by bidders), but also the costs and revenues to participants. Despite
the possibility of incentives to bid above costs, the analysis below assumes
there is sufficient competition that the bids represent bidder's true costs.
The next section specifies a common model described is an improvement over the
existing structure in that it requires consistency between the bids offered for
energy and each of the ancillary services.
VIII. A MODEL FOR PX PROCUREMENT OF ENERGY AND ANCILLARY SERVICES
This section develops a framework for the PX introducing an ancillary service
market that complements its day-ahead energy market. The model is based on one
very significant change from the way the energy and ancillary services markets
currently function. Under the current structure, bidders do not have to reveal
their willingness to provide ancillary services until after they know the
results of the energy auction. This framework assumes that, by bidding in a
combined energy/ancillary services market, producers are revealing their
willingness to provide generating capacity the following day, whether it produce
energy or ancillary services by standing ready to produce energy. Consequently,
bidders make only one bid for both energy and ancillary services.
A. DESCRIPTION OF THE PROPOSED MARKET
Under the proposed mechanism, the bidding by suppliers will be the same
regardless of evaluation treatment. There will be differences in the PX's
determination of capacity awards under the three mechanisms. There may also be
differences in the way the PX determines the market clearing prices for each of
the reserve and energy markets.
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To begin, suppliers will still bid for energy in the way they currently do.
However, bidders will also indicate ramp rates for each section of each of the
portfolios. The PX will examine the demand bids and project ancillary service
requirements. This forecast of ancillary service requirements will be discussed
more fully below.
Under the fully sequential market, the PX will create a market supply curve from
the bids and clear the market for energy in the same way it does today. The PX
then take adjusts the bid curves for the energy awards and regulation ramping
constraints before clearing the regulation market. Similar, adjustments and
clearing takes place for each of the remaining reserve markets.
Under the sequential-simultaneous approach, the PX creates a market supply curve
from the bids and clears the market for energy in the same way it does today.
The PX will then take the remaining supply curve and adjust it for the ramp
rates as indicated by the bidders. Using the adjusted supply curve and its
estimated reserve requirements, the PX will then clear the reserve markets using
a single optimization that minimizes the costs of meeting all reserve
requirements, including the ramping constraint provided by the bidders.
Under the fully simultaneous approach, the PX will set up an optimization
problem to minimize the cost of providing the needed level of energy and
estimated reserve requirements. This optimization problem will take into account
the prices and quantities offered as well as the ramp rates and capacity of each
portfolio segment. The result of the optimization problem will be assignments of
capacity to the energy and reserve markets.
Under each method, the PX will determine the market price for energy and each
reserve service once the capacity has been assigned to the energy and reserve
markets. At that point the PX will inform the supply bidders of their awarded
energy and ancillary services quantities as well as the prices for each. The
bidders would then be responsible for submitting generator specific schedules to
meet the awards. Suppliers would be allowed to submit any unallocated capacity
into the ISO's ancillary service auctions as they do today. Various details of
the market will be discussed below in the rest of this section.
B. BIDDING INTO THE PX MARKET
This framework requires a consistency among bids that does not currently hold in
the existing markets. Namely, in existing markets, supplier's ancillary services
bids need not have any relation to their willingness to sell energy. They can
bid whatever capacity prices and quantities they desire. This leads to
inconsistency in the bids and willingness to provide. For example, more capacity
can be offered for up-regulation, than is offered for spin. Similarly, the
prices offered for regulation could be higher or lower than those offered for
spin from same generator. The mechanism described below requires consistency in
the willingness to sell in these markets.
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As described above, the objective of the proposed structure is to promote
consistency between bids for energy and ancillary services while facilitating
lower cost provision of these services through joint procurement. The structure
allows for portfolio bids to be offered for both energy and reserve capacity. It
also allows suppliers the option to participate in the energy market only or to
whatever extent they wish in the PX's ancillary services market. This is
accomplished by indicating a ramp rate for each reserve market for each bid
segment. An indication of no ramping capability indicates the supplier does not
want to offer capacity in that particular reserve market.
C. BID TYPE
1. DEMAND SIDE
Demand side bids will operate in the same way they do currently. The only change
in the demand side bidding is that for each segment, bidders would indicate how
much of each reserve requirement they desire to have self-provided for them
through the PX market. If bidders do not wish to participate in the PX's
self-provision then the PX will purchase their reserve requirements from the ISO
in its auction. In this way, the demand side can also influence the arbitrage
between the PX's and ISO's reserve markets. This adds another level of data
information and cost to the PX since it must keep track of transactions in
separate markets for each of its demand bidders.
Once the PX gets the demand bids and indications of how much AS demanders wish
to be self-provided, there is still uncertainty about its quantity
responsibility at the ISO. This is because reserve requirements are not simply a
set percentage of load. Although they are often indicated as such, reserve
requirements will vary depending on the sources of power. For example, WSCC
requires different amounts of reserves for hydro generation than fossil
generation. Similarly, imports into the system are treated differently in the
calculation of reserve requirements.
In this PX market, the PX will not know the sources of the energy being
provided. This is because the PX still will be accepting portfolio bids that are
not required to specify the generation source. Thus, it is impossible for the PX
to know exactly what its reserve requirements will be at the ISO and how much to
buy in its market to self-provide. Nonetheless, this simply gives the PX a
degree of discretion in deciding how many reserves it wants to schedule as
self-provided. Anytime its estimate is too high and it agrees to purchase more
reserves from its suppliers than it needs in for self-provision, the PX can bid
these resources into the ISO's ancillary services market. Similarly, anytime the
PX it fails to purchase enough reserves to meet its self-provision requirement,
it can purchase these from the ISO's market. Discretion at the PX in its
estimation of need also acts as a mechanism to keep the prices for reserves in
line between the two markets.
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2. SUPPLY SIDE
The form of the PX bids on the supply side retains its same structure. Namely,
each bidder puts in a 16 piecewise linear, monotonically increasing bid for each
portfolio it wishes to have the PX consider.
Under this new market, the bidder also submits ramp rates for each reserve
market for each segment in its bid. For example, a bidder offers a portfolio
with three segments. For each of the three segments, the bidder must specify how
quickly capacity in that segment can be ramped up to meet each of the reserve
requirements, namely, up-regulation, spin, non-spin, and replacement reserves.
If capacity represented in that segment has AGC capability, then the ramp rate
bid indicates how much capacity is available in that segment for up-regulation.
Similarly, ramp rates for spin indicates how much capacity in that segment is
available for providing spinning reserve.
As is clear from the description, it is possible for the bidder to opt out of a
particular reserve market by setting a ramp rate for a particular segment to
zero. Under this circumstance, the PX would not consider that segment of the
portfolio available for the particular market. However, it would consider the
segment for the energy market and other reserve markets as indicated by the ramp
rates for the particular reserve service.
The bid prices associated with a segment indicate the bidder's willingness to
assign capacity from that segment for whatever service that might be assigned to
it. For example, an incremental price of $2/MW associated with a particular
segment means the bidder is willing to sell capacity for any of the markets at
that price. Namely, the price bid for capacity to produce energy, up-regulation,
spin, non-spin and replacement reserves are all the same, in this case, $2/MW.
Of course, the ramp rates and time horizons for each service limit the amount of
capacity that can be offered from that segment to each of the markets.
By requiring the bids for energy and reserves to take this form, there is a
built in consistency between the bids for energy and those for reserves. While
the bidders can control the quantity offered for each service from an ex ante
perspective, they cannot alter the prices, selling essentially the same capacity
at different prices depending on the particular market. Under the current
structure of the ISO's ancillary services market, bidders do have flexibility on
both price and quantity.
Notice that portfolio bidding would still be available to bidders. Thus, there
could be no check on whether the ramp rates were reasonable for each section of
the bid curves. Bidders would take this risk on themselves. Namely, bidders
would be required to provide the capacity from generators that would meet the
requirements that it was assigned in the auctions. This requirement and risk
puts a greater burden on bidders to bid in ways that would facilitate compliance
with the awards from the market. In portfolios with multiple generators
represented, this is a formidable problem. However, the problem becomes
significantly easier if fewer generators are represented in a single portfolio.
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D. PX EVALUATION OF BIDS
As described briefly above, evaluation will differ for the three different
approaches. The main difference between the methodologies under consideration
has to do with how the energy and reserve markets are evaluated. In the fully
sequential treatment, each market is evaluated separately in sequence. As
described above, the ISO evaluates each of the reserve markets sequentially
after the PX has evaluated the energy market. This methodology differs
significantly from today's practice because bids are required to be consistent
with each other. In the other two approaches, the ancillary services markets are
evaluated simultaneously with one another. This is a significant departure from
the manner in which the ISO currently evaluates its ancillary services markets.
In the sequential-simultaneous approach, the energy market is cleared before
consideration of the ancillary services markets. In the fully simultaneous
approach, energy is evaluated at the same time as the ancillary services.
The proposed methodology for simultaneous evaluation is very similar to that
described above under the ISO's consideration of LP optimization. Namely, it
evaluates the bids using an optimization approach. The objective is to minimize
the combined costs of the provision of the services, given the bids, ramp rates
and quantity being purchased in each market. The particulars of evaluation under
each methodology(25) will be discussed in turn.
1. FULLY SEQUENTIAL EVALUATION METHODOLOGY
The fully sequential approach means the bids are used to meet the requirements
of each service in order. First, the PX will create a market supply curve from
the bids and clear the market for energy in the same way it does today. The PX
will then take the remaining supply curve and adjust it for the awarded energy
quantities and regulation ramp rates indicated by the bidders. Using this
adjusted supply curve and its estimated regulation requirements, the PX will
then clear the regulation market. Next, the PX will adjust the remaining supply
curve for energy and regulation awards and the ramp rates indicated for spinning
reserve. The spinning reserve market will then be cleared using this adjusted
supply curve and estimated needs for spinning reserve. Similar, adjustments and
clearing takes place for each of the remaining reserve markets in order.
This approach most closely matches the manner in which energy and ancillary
service awards are evaluated today, by the combination of the PX and ISO.
However, there is one very important distinction. The suggested methodology
requires bid consistency between the ancillary services. Because the PX works
off the capacity bids used in the energy market, it can impose consistency by
requiring any capacity unused in the energy market to bid exactly
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(25) The discussion in the rest of this report abstracts away from the
consideration of demand bidding on the problem. In what follows, the
discussion focuses on cost minimization given a level of demand. The
results and applications described will also be applicable to an analogous
surplus optimization where demand bidding is explicitly taken into account.
Such an abstraction is warranted given the limited bidding activity on the
demand side of the market and the clarity of exposition of the cost
minimization framework.
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the same price for all the reserve markets for which it might be eligible. In
this regard, the approach is also close to the ISO's proposed smart-buyer
methodology that attempts to impose this consistency on bids through
administrative rules.
2. SEQUENTIAL-SIMULTANEOUS EVALUATION METHODOLOGY
Sequential-simultaneous procurement means the bid curves are first used to meet
energy requirements in an optimal fashion. Namely, the PX would minimize the
costs of meeting the required level of demand. Once an allocation of energy to
portfolio bids has taken place, then the quantities in the portfolios are
adjusted for awarded capacity and ramp rates for each segment. The entire set of
reserve markets is then procured minimizing the costs of meeting the ancillary
service requirements subject to the ramping constraints. Under this methodology,
the PX is able to substitute higher cost suppliers for lower cost suppliers in
one market, say spin, if such a substitution allows the PX to save costs in
another market. This substitutability does not apply to the energy market, but
only extends to the other ancillary services markets.
This approach is very similar to the combination of the PX's current energy
market and the ISO's proposed LP optimization with one very important exception.
Again, the ISO does not require consistency between the bids made for the
various services offered. Although it has been discussed, this requirement on
the market has not been imposed on the current market.
3. SIMULTANEOUS EVALUATION METHODOLOGY
Fully simultaneous procurement means the bid curves and accompanying ramp rates
are used to meet energy and ancillary service requirements using a single
optimization problem. The objective function of the minimization problem is the
sum of the energy and ancillary service costs. Because the energy market is
included in consideration with the ancillary services markets, it is possible to
reduce total overall costs by substituting relatively low cost capacity that
would be used for energy for much higher cost capacity that would be used for
reserves. As will be discussed in greater detail below, this is the primary
theoretical advantage of a simultaneous approach.
Because of the trade-off between the energy and reserves markets, this type of
an approach cannot be replicated by the ISO. The ISO cannot set up the
conditions that would allow such a substitution because energy schedules are
fixed by the time the ISO receives the bids for the ancillary services markets.
E. NOTIFICATION OF SELECTED BIDS
Under each of the three methodologies, the PX will determine which portfolios
have been selected through its processes to provide energy and each of the
ancillary services. Notification
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will take place in much the same way it does now. Namely, the PX will post
energy and ancillary services prices and tell each participant its allocation in
each of the markets. The suppliers will then be required to turn these awarded
capacities into generating unit schedules. The PX will have to check that the
schedules submitted for these services meet the technical requirements for such
services. The PX must also identify these resources as self provision resources
to the ISO. After it receives the generator schedules it should be able to
calculate its required provision for each ancillary service. Any excess capacity
can be bid into the ISO's ancillary services market. Any shortfalls will simply
show up that the PX is only partially self-providing.
There are two options for how the PX could interact with the ISO's market when
it has over-purchased ancillary services. It could act as a price taking bidder
or a normal bidder into the ISO's market.
If the PX followed price taking behavior in the ISO's ancillary services market,
it would bid its excess capacity at a low price. This would insure that the ISO
scheduled the capacity and that the PX would receive something for it. As
discussed below, the PX would still be responsible for paying its winning
capacity its market clearing prices for ancillary services. Any shortfalls or
excesses due to price differences between the ISO and PX would flow through to
the consumers in the PX's ancillary services market.
Under the second option, the PX would bid in any excess ancillary service that
it may have purchased at the PX's market clearing price. If accepted, then it
will be assured that the price it will be paid by the ISO for the capacity will
cover the cost it has agreed to pay for it. If rejected in the ISO auction, the
PX would have to pay all of its suppliers and charge the excess costs to
demanders. Or it may be able to adjust its awarded quantities (and price)
downward so there is no excess self-provision. The particulars of this type of
mechanism have not been explored.
F. PRICING OF ENERGY AND ANCILLARY SERVICES
In this discussion so far, little has been said about how the PX will set its
prices for ancillary services. There are a number of ways to set prices for
these markets. Economic theory suggests a correct way to price these
services.(26) However, there are also considerations of existing institutions
and fairness that influence the pricing rule to be adopted. All of these factors
will be taken into account in discussing a pricing rule.
- --------
(26) The theoretically correct pricing methodology would pay the providers of AS
the difference between the highest cost bid and providing that service and
the energy price. This pricing methodology came up in discussions on the
original market design. The delegation of the energy market to SCs and AS
markets to the ISO makes implementation of this methodology by the ISO
difficult.
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1. FERC REQUIREMENTS FOR PRICING
In response to California Public Utility Commission concerns that joint market
would lead to inefficiencies (because generators are paid for spin whether or
not it is actually provided), the FERC in its December 18 order wrote, "We note
that Order No. 888 requires that all ancillary services be unbundled.(27)" Thus,
the FERC is intent on having the energy market unbundled from the ancillary
services markets. The FERC has also indicated that it will not permit a joint
energy and ancillary service market in which winning supply bids are paid an
energy price that incorporates reserve requirements into the energy price. FERC:
"The energy price paid to winning bidders should not roll in the price of
spinning requirements." CITE
2. SEPARATE PRICES FOR AS AND ENERGY
As described above and as FERC points out, one of the points of unbundling is to
provide separate prices for energy and each of the ancillary services.
Consequently, separate prices for energy and each ancillary service are
required. The question is how to set the prices for each. There two similar ways
to set prices in a market clearing fashion. The first is to set price at the bid
of the source that would provide another unit of output if needed. This is
setting price at the bid of the marginal supplier. The second methodology would
be to set price at the bid of the highest cost source providing the service.
This is may sound exactly like setting price at the bid of the marginal
supplier, but, in cases of joint production, it is not always the same. Although
in many instances the two methodologies produce the same prices, there are
important cases where the pricing rules will diverge.
This is particularly the case when there is joint production of the services
being provided. In both the simultaneous evaluation methodologies, it is
possible to accept higher cost bids for some services because in the overall
scheme it produces lower total costs. In some cases, it is possible to hit the
maximum of such a source and then go to a lower cost source. In these cases, the
marginal source will be the lower cost source, but full output will have been
accepted from a higher cost source. It is in these cases that the pricing rules
diverge.
For example, in evaluating spin, it may be optimal to choose a $4 source before
a $2 source because it allows a lower payment for replacement. If the entire $4
source is used up, then some of the $2 source may be needed. Assume it is, and
the $2 source is the bid of the marginal source. Under the first pricing rule,
the price for spin is $2. Under the second rule, it is $4. Thus, in such joint
production scenarios, it is possible to set a price (based on marginal source)
below the highest cost accepted. Compensating based on the marginal source could
lead to producers not being assured that the prices paid will be at least as
great as their bids. To avoid this possibility, prices should be set by the bid
of the highest bid used in providing the service rather than on the bid of the
marginal source.
- --------
(27) FERC December 18 Decision, p. 22.
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3. PRICING IN THE ISO AS MARKET
In setting up the pricing in the PX, one consideration is how the ISO
remunerates capacity providing ancillary services. As described above the ISO
takes a two-part bid for providing reserves, capacity and energy components.
However, the ISO only uses the capacity bid in choosing which resource will
provide capacity. The prices in these markets have been as high as, if not
higher than, the energy prices. If the PX were to pay something significantly
less than what the ISO pays, suppliers would simply move to the ISO's market and
not participate. Even with the reforms under consideration, it does not appear
the ISO will change the structure of its market mechanisms for ancillary
services. Also, the point of introducing PX self-provision is to lower the cost
of ancillary services in the market. Thus, the PX's pricing rule must be
comparable to the ISO's.
G. SUPPLY REMUNERATION AND DEMAND PAYMENTS
Under this framework, payments to suppliers and charges to consumers are
relatively straight forward and work as in a standard market. The main
difference is that the PX will have to track and settle with buyers and sellers
who opt to participate in the ISO's market rather than its own. There is the
further complication of pricing and paying for any reserve requirements that are
sold or purchased through the ISO's market. Each of these aspects will be
discussed briefly.
It is clear that the PX should pass on the ISO's prices to suppliers and
demanders who have opted out of the PX's self-provision market for ancillary
services. The PX prices may be higher or lower than the ISO's prices. By
requesting participation in the ISO market, suppliers and demander will receive
those prices.
It is less clear how the PX will deal with sellers and purchasers in its own
markets, particularly since there is the risk that the PX may purchase too much
or too little in its own market. The PX itself must remain revenue neutral with
respect to transactions in the ISO's markets. Any costs or benefits that accrue
due to differences in AS market prices and over or under selling should be borne
by the demanders who have opted for the PX market. On the one hand, the PX will
pay winning generators the PX price it has determined for each service,
regardless if it needs to sell that output into the ISO market or not.
On the other hand, demanders will pay a blended rate for their services. This
blend may include the cost of ISO-provided services if the PX has purchased too
little in its own auction. The blend may also include a credit if the PX has
over purchased and sold its excess into the ISO's market at a price higher than
its own. Similarly the blended rate could include costs if the PX has over
purchased and sold its excess into the ISO's market at a price lower than its
own. This latter case provides an incentive for demanders to opt out of the PX's
market for the ISO's market since the PX's price is higher and gets an adder for
over self-provision.
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IX. THEORETICAL IMPACTS FROM A JOINT ENERGY ANCILLARY SERVICE MARKET
In the discussion so far, there has been some general recognition that joint
provision of energy and ancillary services can lower the total costs of
producing each. This section explicitly discusses the impacts of a joint market.
There is the possibility of lower costs to society; however, it is likely that
these cost saving will result in higher prices for electricity and lower prices
for reserves in comparison to a similarly constructed sequential market. Each
will be discussed in turn.
A. POTENTIAL FOR LOWER COSTS
There are efficiency gains that can be achieved from a joint energy and
ancillary services market in relation to a similarly designed sequential market
as described above. These efficiencies result from having a wider scope of
choices between uses of capacity.
In a sequential energy and ancillary services market, it is possible to miss
efficiencies from joint procurement. This is because joint procurement allows
capacity to substitute for each other across all markets, reserve and energy. In
fully sequential market, the energy market is cleared before consideration of
any of the reserve markets, and the regulation market before consideration of
the other reserve markets, as so on. This means capacity allocated to energy (or
an earlier reserves market) cannot be considered for substituting for capacity
in the later reserve markets. This missed opportunity for substitution is a
missed opportunity to lower costs. A fully simultaneous market does not miss
this opportunity. The sequential-simultaneous approach only misses the
opportunity for energy to substitute for reserves.
For example, in a sequential market, the procurement of energy ignores the ramp
rates for suppliers. However, they are an important component of the procurement
of ancillary services. Because the ancillary service market follows the energy
market, it is possible to award energy production to capacity that has fast
ramping capability. This means only slower ramping capacity is available in the
reserves market. The joint cost of producing energy and reserves may be higher
because the lower-cost, fast ramping capacity cannot substitute for the
higher-cost, slower ramping capacity. In a fully simultaneous market, it is
possible for this substitution to take place. This substitution will reduce the
overall cost of energy and ancillary services.
B. POTENTIAL FOR HIGHER PRICES
The simultaneous provision will also have an impact on the pricing of energy and
each of the ancillary services. As discussed above, one of the purposes of
unbundling is providing separate prices for each of the services being provided.
Thus, the objective includes pricing services as well as minimizing costs.
Depending on the pricing rule adopted, there is also a difference in energy and
reserve prices between procuring them under each evaluation approach.
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As discussed above, the most appropriate way to price these services is the cost
of the highest bid providing the service. In a fully sequential market, the
energy market is cleared before the reserves markets are considered in order.
Thus, the highest bid from capacity providing energy will be at least as low as
the highest bid providing any of the reserves. This means the energy price will
be no higher than the lowest price for reserves.
However, allowing the substitution of capacity between the energy and reserve
markets allows lower cost capacity to be used for ancillary services. When this
substitution takes place, it necessarily means higher cost capacity is used for
energy than would be used under a sequential approach. By setting the price at
the highest bid providing the service, this means the energy price is higher
than in a sequential procurement. It will also mean that the highest bid for the
most expensive reserve service will be lower than in a sequential procurement.
The end result are cases where the energy price is higher (and reserve prices
are lower) under a simultaneous procurement than under a sequential procurement.
This is in conjunction with lower overall costs of provision under a
simultaneous approach than a sequential approach.
This result can be illustrated graphically. In order to aid in illustration of
the results, these graphs incorporated two simplifying assumptions that do not
change the results in general. First, demand is assumed to be inelastic. Second,
it is assumed that the ramp rate constraints for capacity do not bind in
constructing the market supply curve.
The first graph illustrates a fully sequential market. Equilibrium in the energy
market is established first. Prices are set for the other services in order as
described above. Each price is higher than the last since the lowest bids are
accepted first for each market.
[LINE GRAPH]
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The second graph illustrates a sequential-simultaneous market. Equilibrium in
the energy market is established first. This sets the energy price at P(E).
After this price is set, the market supply curve is used to procure ancillary
services. Through the joint optimization of these resources, prices are set for
each of the ancillary services depending on the cost of the highest bid
providing the service.
[LINE GRAPH]
The third graph illustrates a simultaneous market for energy and ancillary
services. There is a joint optimization including ancillary services and energy.
Notice that there is no clear delineation between low cost capacity that is
providing energy and higher cost capacity that is providing ancillary services.
The optimization problem spreads capacity to wherever it may be most effective
in reducing the joint costs of energy and ancillary services. The pricing rule
then comes into play. Again setting prices at the cost of the highest bid
providing the service. It is clear from the picture that higher cost capacity is
being used for energy, thus increasing the energy price while lower cost
capacity is being used for ancillary services, thus decreasing their prices. The
end result is that it is possible for the simultaneous auction to produce higher
energy prices than the sequential auction.
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[LINE GRAPH]
X. NUMERICAL COMPARISON OF THE EFFECTS OF SIMULTANEOUS AND SEQUENTIAL
MARKET AUCTIONS
This section describes three simple spreadsheet models(28) that were built for
the purpose of examining the difference between the three evaluation approaches.
The models have been used to compare the cost and pricing results under exactly
the same inputs with the only variation being in how the markets are cleared.
The results of this analysis will be presented.
In brief, the numerical models illustrate the same conclusions discussed in the
previous section. Namely, for the same inputs, a simultaneous clearing of the
markets can produce lower total costs than a sequential approach. However,
energy costs are higher (and ancillary services costs lower) under simultaneous
approaches than under the sequential approach. Further, the comparison shows
that the simultaneous approach can yield lower overall costs and higher revenues
to generators than the sequential approach.
A. DESCRIPTION OF THE SPREADSHEETS
As discussed above, the spreadsheets take inputs from hypothetical bidders and
the PX and uses optimization methodology to allocate capacity awards for energy
and reserves. The methodologies are both cost minimization problems where costs
are represented by the supplier's bids. The fully simultaneous model minimizes
the costs of energy and reserves in a
- --------
(28) The fully sequential, sequential-simultaneous and fully simultaneous
spreadsheets have been included as files named `example2v5.xls'
`example3v5.xls' and `example4v5.xls' respectively.
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single optimization. The sequential-simultaneous model first minimizes the cost
of energy before solving a subsequent cost minimization problem for the rest of
the reserves markets. The fully sequential model solves them in order. In all
cases, the demand side of the market is significantly simplified as being
represented by an inelastic level of demand to be met. Because all of the
impacts to be investigated are on the supply-side of the market, this
representation does not reduce generality. The rest of this section will
describe each of the inputs and outputs from the models.
It should be highlighted that the numbers used for the bids in this analysis are
completely hypothetical. While they do represent consistency with rational
bidding behavior, they do not represent or are they intended to represent
specific bids in the market. Their purpose is wholly for illustrating the
difference between a sequential and simultaneous representation of these
markets.
1. MODEL INPUTS
PX inputs are primarily on the demand side of the model. They include the level
of energy demand to be met and how many reserves the PX wants to purchase. The
desired reserve requirements are specified as percentages of energy demand and
vary by ancillary service. For example, in the analysis presented below, the PX
was assumed to be purchasing 1% of load as up-regulation, 3.5% of load for each
of spinning and non-spinning reserves, and 5% of load for replacement reserves.
The analysis was undertaken by varying the level of demand to be met and
comparing the results across the two models.
Bidder inputs are a bit more complex. The model assumed there were three
supplier bidders, each with its own portfolio bid. Each portfolio has four
parts. In order to facilitate computation, each portfolio uses a step function.
This is in contrast to the piece-wise linear specification described above.
Besides bidding the price level and quantity of each step on the function,
bidders also provided ramp rates for each step for each reserve market. The ramp
rates specify the percentage increase each step could contribute to providing
the reserve. As described above, these ramp rates allow the suppliers to
indicate how much they would like to bid in the PX's reserve markets. The table
shows supply side bids used in the analysis.
SUPPLY BIDS
Quantity (MW) Maximum Ramp Rates (%)
--------------------- ------------------------------------------------------
Bid Price Maximum Minimum Regulation Spin Non-Spin Replacement
--------- ------- ------- ---------- ---- -------- -----------
Portfolio 1 2.00 1200 0 0 1 2 10
2.30 500 0 0.5 2 2 10
2.59 100 0 0.5 2 2 10
2.96 600 0 0.5 2 2 10
Portfolio 2 1.70 400 0 0 1 2 10
2.49 500 0 0.5 2 8 10
2.68 700 0 0.5 1 2 10
2.90 700 0 0.5 1 2 10
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Portfolio 3 2.10 600 0 0 1 2 10
2.50 500 0 0.1 2 8 10
2.60 200 0 0.5 1.5 2 10
3.20 900 0 0.5 1 2 10
2. MODEL OUTPUTS
Each of the models solves its respective cost minimization problems to allocate
capacity. This is a standard cost-minimization allocation problem where the
suppliers bids represent their willingness to provide capacity in each market.
For the models using simultaneous approaches. The ramping percentages are used
to establish constraints in the cost minimization problem. The table below
represents the model's quantity outputs for a particular level of demand (2650)
and evaluation technique (sequential-simultaneous).
SUPPLY
Awarded Quantities
------------------------------------------------------------------------------------
Energy Regulation Spin Non-Spin Replacement Total
------ ---------- ---- -------- ----------- -----
1200 0 0 0 0 1200
450 2 0 0 48 500
0 0 0 0 0 0
0 0 0 0 0 0
400 0 0 0 0 400
0 25 93 93 84 295
0 0 0 0 0 0
0 0 0 0 0 0
600 0 0 0 0 600
0 0 0 0 0 0
0 0 0 0 0 0
0 0 0 0 0 0
All models calculate prices based on the methodology described above. Namely,
each model determines which step has the highest bids of all those awarded for
each service. This highest cost sets the price for each service. These prices
are illustrated in the table below. Again the table report the values for 2650MW
and the sequential-simultaneous technique.
MARKET CLEARING PRICES
($/MWH)
Highest Cost Resource
Energy 2.30
Regulation 2.49
Spin 2.49
Non-Spin 2.49
Replacement 2.49
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Replacement 2.49
Using these prices, the models also calculate the revenues to each portfolio.
These revenues are also the costs to consumers for each ancillary service. These
revenues are represented in the table below. This table corresponds to the
quantities dispatched and prices in the tables above.
PORTFOLIO REVENUE
Revenue from Each Market
- ----------------------------------------------------------------------------------------------------------------
Energy Regulation Spin Non-Spin Replacement Total Total
------ ---------- ---- -------- ----------- ----- -----
2760 0 0 0 0 2760
1035 4 0 0 121 1159
0 0 0 0 0 0
0 0 0 0 0 0
3795 0 0 0 121 3919
920 0 0 0 0 920
0 62 231 231 209 733
0 0 0 0 0 0
0 0 0 0 0 0
920 62 231 231 209 1653
1380 0 0 0 0 1380
0 0 0 0 5
0 0 0 0 0 0
0 0 0 0 0 0
1380 0 0 0 0 1380
Totals
66 231 231 330 6953
6095 858 6953
B. MODEL RESULTS
1. DESCRIPTION OF RESULTS
The spreadsheet models were designed to inform the intuition about these markets
and the differences in outcomes from the two market evaluation techniques. The
importance here is to isolate the impacts of the market evaluation techniques
from one another. This end is best achieved by using identical inputs into each
model. The results calculated by each will highlight how the awards and prices
will vary under each methodology using exactly the same inputs. The easiest
comparison is to vary level of demand for each model.
This methodology was used for three different levels of demand. The table below
summarizes the results for each model. Demand is the level of demand on the
system that must be met.
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The table also includes prices for each of the services being purchased, energy,
regulation, spinning reserve, non-spinning reserve and replacement reserve for
each demand level and evaluation technique. Further, the table lists the costs
and revenues for energy and reserves for each demand level. These results will
be discussed for each level of demand. The levels of demand were chosen
randomly.
Full simul seq-sim Full seq full simul seq-sim Full seq full simul seq-sim Full seq
---------- ------- -------- ---------- ------- -------- ---------- ------- --------
Demand 2650 2650 2650 3649 3649 3649 5341 5341 5341
Energy price 2.49 2.30 2.30 2.68 2.50 2.50 3.20 2.90 2.9
Reg price 2.49 2.49 2.49 2.68 2.68 2.68 2.96 3.20 2.96
Spin price 2.49 2.49 2.49 2.68 2.68 2.68 3.20 3.20 3.2
Non-spin price 2.49 2.49 2.49 2.68 2.68 2.68 3.20 3.20 3.2
Repl price 2.49 2.49 2.49 2.68 2.60 2.68 3.20 2.96 2.96
Total cost $6,223 $6,223 $6,223 $ 9,095 $ 9,095 $ 9,095 $14,559 $14,574 $14,577
AS Cost $ 846 $ 848 $ 848 $ 1,215 $ 1,237 $ 1,237 $ 1,976 $ 2,075 $ 2,078
Energy cost $5,377 $5,375 $5,375 $ 7,880 $ 7,858 $ 7,858 $12,583 $12,499 $12,499
Total Revenue $7,456 $6,953 $6,953 $11,051 $10,379 $10,394 $19,300 $17,647 $17,634
AS Revenue $ 858 $ 858 $ 858 $ 1,271 $ 1,257 $ 1,271 $ 2,209 $ 2,158 $ 2,145
Energy Revenue $6,599 $6,095 $6,095 $ 9,779 $ 9,123 $ 9,123 $17,091 $15,489 $15,489
2. INTERPRETATION OF RESULTS
The first demand level was 2650MW. Given the portfolio bids, this is a medium
level of demand. Because the demand level is relatively low there are fewer
opportunities for substitution. Total costs are the same across all three
models. Thus, there was no resulting efficiency gain from simultaneous
consideration. However, the split of costs differs between the three models.
Energy costs are higher (while AS costs are lower) under the fully simultaneous
approach. This is evidence of the substitution of low cost energy for higher
cost reserves taking place. Further, this substitution has a material impact on
consumers since energy prices are higher. Due to higher energy price, consumers
pay $504 more although there is no overall savings in costs. In this case, the
simultaneous evaluation simply facilitates a transfer from consumers to
producers.
The same result can be seen at the second level of demand, 3649MW. Under the
fully simultaneous approach, costs are shifted from ancillary services to
energy, but there are no overall savings. Again, energy prices are higher
resulting in more revenue to generators at the expense of consumers.
The comparison between the sequential-simultaneous and the fully sequential
approaches is also revealing. Because energy is optimized first in both cases,
the two approaches will always produce the same energy costs and revenues. The
substitution can only take place among ancillary services. At this second level
of demand, the price of replacement reserves is lower
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under the simultaneous approach. Substitution uses all the high cost capacity to
meet the lower quantities of regulation, spin and non-spin while leaving the low
cost capacity to meet the higher quantity of replacement reserves. While this
does not yield an overall cost saving, it does lower costs to consumers.
The third level of demand, 5341MW, shows substitution effects can save costs.
Under the fully simultaneous approach, the total costs are lower than the other
two approaches by some $15-18 dollars. Again, energy costs are higher and
ancillary service costs are lower. The substitution of a fully simultaneous
market can lower overall costs. However, the cost to consumers is more by some
$1600 since the price of energy is again higher. This again is a substantial
transfer from consumers to producers.
This third level of demand also provides insight into the savings from
substitution. In comparing the energy costs and prices between the
sequential-simultaneous approach and the fully sequential, they are identical.
However, the impacts on ancillary services are not. In this case, the
simultaneous approach reduced costs in comparison to the fully sequential by
some $3. Thus, there is an efficiency gain from the simultaneous evaluation.
However, the prices move in opposite direction, costing consumers some $13 more.
This is a result of a higher price for regulation, a consequence of
substitution.
3. SUMMARY OF RESULTS
It should be highlighted that the simultaneous approach in all of these examples
has a tendency to equate the price of ancillary services with that of energy.
This, to a large degree, defeats the desired result of unbundling there
services. Namely, that the energy prices reflect the costs of energy while the
prices for ancillary services reflect the costs of ancillary services. If the
methodology incorporated produces the same price for different products on a
consistent basis, then no real unbundling has taken place.
The results for the last two levels of demand for the fully sequential and
sequential-simultaneous approach illustrate countervailing impacts from the
substitution allowed by simultaneous consideration. Substitution will have a
tendency to raise the prices of near-term reserve markets and possibly lower
those of further-out markets. The net impact on consumers depends on the
magnitude of the relative price changes. Given these limited examples, neither
approach is clearly superior to the other. It is likely to be dependent on the
bids as well as the level of demands, neither of which was assumed to be close
to reality in these examples. Further experimentation with more realistic
portfolios and demand levels would throw more light on this question.
The results from this quantitative analysis confirm the assertions made in the
previous section. Namely, there are societal cost savings to be had from
simultaneous procurement of energy and ancillary, but these costs savings will
not necessarily lead to lower prices for the consumers of these services.
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XI. ASSESSMENT OF SIMULTANEOUS AND SEQUENTIAL EVLAUATION OF JOINT ENERGY
AND ANCILLARY SERVICES MARKETS
The framework presented here has required that the suppliers of energy into the
PX market also be willing to sell AS to the PX. Although the bidders ultimately
have the choice to participate in the PX's energy only or energy and ancillary
services market, there is a requirement that the bids for capacity to produce
energy are identical to capacity bids to produce ancillary services. This is a
significant improvement on the existing framework regardless of whether the bids
are evaluated sequentially or simultaneously.
However, this approach is not without costs. While bidders still have the option
to make portfolio bids, this approach requires them also to incur more costs in
the formulation of these bids over their current techniques. Bidders must now
take into account how they plan to commit units to meet both energy and
ancillary service requirements in deciding their bid prices, quantities and ramp
rates. Further, there are potential difficulties in dis-aggregating their
awarded quantities into unit schedules. These problems can be mitigated
significantly by reducing the number of units contained in a portfolio.
Similarly, this framework also imposes burdens on producers and consumers by
extending their choices for the provision of ancillary services. While, in
general, more choices are preferred to fewer, they come at the cost of
understanding what the differences are and making a choice.
Further the approach imposes more costs on the PX. In particular, there is the
issues of over and under self-provision and how it should be handled. To a large
degree this discretion opens the PX to taking positions in ancillary services
markets. However, to the extent that the PX makes mistakes, its customers and
suppliers can choose not to participate in the PX's markets. Ultimately
arbitrage between the PX's and ISO's market will work to make both markets more
efficient. This arbitrage may also increase the volatility of ancillary service
prices in both markets.
The advantages of the simultaneous approach are largely the disadvantages of the
sequential approach and vice versa. The simultaneous approach will produce lower
overall societal costs of producing energy and ancillary services. However, it
also produces higher prices for consumers. From the evidence in the last
section, the cost-saving comes at large price impact. This is because ancillary
services are a smaller part of the combined market than energy. This means a
small price increase translates to a large dollar value of revenue. The cost
saving are miniscule in comparison to the price impacts. Simultaneous evaluation
also has the tendency to equate the prices of energy with all other ancillary
services. In this way it does not keep the services separate and unbundled.
The proposed framework does not address a significant problem in the pricing of
ancillary services. The current ISO methodology pays both a capacity payment to
stand ready and an energy payment when called. It makes no reference to the
forward energy price and thus ignores the incentives to sell into either market.
From an economic point of view, in
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equilibrium, generating capacity should be indifferent between providing energy
or capacity for ancillary services. The current ISO methodology, and the one
here, pays capacity more for providing reserves than for providing energy. This
is a shortcoming of the ISO's procedure and the methodology proposed here. This
framework has not been addressed this adverse incentive because of the
difficulty of solving the problem for the ISO. Addressing this problem correctly
would require significant changes to the ISO methodology. This framework could
more easily provide an even handed incentive by providing the correct economic
signal; however, doing so would make PX procured AS at a price significantly
lower than the ISO's price. Because there would be arbitrage between the
markets, the pricing rule proposed in this framework more closely resembles the
ISO pricing mechanism than the correct economic mechanism.
XII. CHANGES REQUIRED TO IMPLEMENT THE PX MARKET
A. ISO OPERATIONS
The proposed framework assumes the ISO is not planning to make major changes to
its ancillary services markets. Although the ISO may change to its evaluation
procedures, no significant changes will be made to the bidding procedure, the
form of the bids, the timing of the market, and pricing of these services.
Further the proposed framework does not require that the ISO make any changes in
any of these areas.
If the correct economic incentives were to be provided, then the ISO must change
its AS market pricing. This report has assumed that such changes are out of it
purview and has not addressed how the ISO might change its pricing rules for AS.
Greater efficiency may be possible with this adjustment.
B. PX OPERATIONS
The required changes for the PX to self-provide ancillary services are
significant. Perhaps the largest change is to the PX's tariff to describe how
the PX would operate its reserves market and how it would self-provide these
services. Because of the inertia built into the current system, these changes
may be difficult to get approved. The fully simultaneous approach would
primarily benefit the producers of energy and ancillary services at the expense
of consumers. It is not clear whether a sequential-simultaneous approach is
preferred to a fully sequential one. Consumers will gain the benefits of having
a competing source for ancillary services other than the ISO's market. Relying
on the joint revelation about willingness to provide capacity, the depth in the
ancillary services market should be enhanced. Producers will face increased
costs of building their portfolio bids and dividing up awarded capacity in the
markets into generator schedules.
Further the PX must build the infrastructure to handle such a market. Under the
sequential approach, the PX will be able to use its existing software to clear
the energy market. However,
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the PX will need software that will take the energy bids, adjust them for
ramping constraints and awarded energy and optimize the reserve markets. Further
the PX will have to modify its settlements software to handle the options open
to consumers. Namely, consumers will have the choice of participating in the
PX's market, the ISO's market or some combination of the two. This software
modification could impose a significant cost burden in implementing this
framework.
XIII. CONCLUSIONS AND RECOMMENDATIONS
The general conclusion of this report is that the introduction of a simultaneous
market for energy and ancillary services could lead to marginally lower costs
and significantly higher prices for end consumers. It would be much better to
introduce a market that would use the bids in the energy market as indications
of willingness to provide capacity for ancillary services. The real benefit from
this framework is that it requires suppliers to offer capacity for ancillary
services on a consistent basis with itself and its offers to sell energy.
More analysis needs to be done to indicate whether a fully sequential approach
or a sequential-simultaneous approach is more desirable. Besides examining
different levels of demand, it would also be instructive to examine how bidding
behavior might differ between these market structures.
This framework could produce more desirable results through a sequential
evaluation mechanism that clears the energy market before evaluating the same
bids for each of the ancillary services markets. The PX could use this framework
to self-provide ancillary services and compete with the ISO's ancillary services
market.