Summary of opportunity cost objectives - ISO New England

Summary of opportunity cost objectives - ISO New England

OCTOBER 9-10, 2018 | WESTBOROUGH, MA Opportunity Costs and Energy Market Offers (Phase 1) ISOs Proposal to Estimate Opportunity Costs for Oil and Dual-Fuel Resources with Inter-temporal Production Limitations Jonathan Lowell [email protected] | 413-540-4658 ISO-NE PUBLIC Opportunity Costs and Energy Market Offers (Phase 1) WMPP ID: 131 Proposed Effective Date: December 2018 ISO is proposing implementation in December of a system to daily estimate energy opportunity costs for oil and dual-fuel resources with limitations on energy production over a 7-day horizon No tariff changes are required MR-1 Appendix A already provides for the inclusion of opportunity costs in energy offers Todays presentation will focus on: Two simple numerical examples illustrating opportunity cost outcomes that are unique to dual fuel resources ISO-NE PUBLIC 2 SUMMARY OF OPPORTUNITY COST OBJECTIVES Factors motivating the ISO opportunity cost proposal

ISO-NE PUBLIC 3 An Enhanced Ability to Estimate Appropriate Generatorspecific Opportunity Costs Provides a Number of Benefits Facilitates efficient use of fuel-constrained resources over multi-day time horizons Improves both reliability and overall system cost-effectiveness Improves price formation by reflecting the opportunity cost of energy supply limitations in market prices Helps to avoid market dislocations and price distortions that can result from manual actions More information on the motivating factors, historical background, implementation notes and future plans is provided in the ISOs opportunity cost presentation at the September 2018 Markets Committee meeting: Opportunity Costs and Energy Market Offers (Phase 1) - Revision 2 ISO-NE PUBLIC 4 REVIEW OF PROPOSED METHODOLOGY How the ISO plans to calculate estimated opportunity costs ISO-NE PUBLIC 5 How is Opportunity Cost Defined? Think of the opportunity cost (OC) as the reduction in maximum Net Revenue (over the opportunity cost horizon) associated with a 1 MWH reduction in the available fuel supply Net Revenue is the difference between energy revenue (LMP x MWH) and cost of production for each MWH Cost of production includes fuel cost, emission allowance costs, VOM

These concepts are defined more precisely in the October 9, 2018 memo accompanying this presentation: Energy Market Opportunity Costs for Oil and Dual-Fuel Resources with Inter-temporal Production Li mitations Revised Edition ISO-NE PUBLIC 6 Important Input Assumptions to OC Calculations Covering the 7-day OC Horizon Hourly (zonal) electricity price projections Daily fuel spot price projections Algonquin (non-G) Oil (#2, #6 1% S, #6 0.3% S, Jet (kerosene) Emission allowance prices (SO2, NOx and RGGI CO2) Temperature forecast ISO-NE PUBLIC 7 Daily Spot Gas Price Projection for 7-Day OC Horizon Spot gas prices in the winter can change significantly from day-to-day Cold temperatures are a major factor influencing gas prices gas heating demand electric demand Gas-fired resources set the clearing price approximately 60% of the time A 7-day forecast of gas prices will be a key input in the estimation of opportunity costs for oil and dual-fuel resources. ISO-NE PUBLIC 8

Neural Network Model used to Project 7-Day Spot Gas Prices ISOs vendors for spot fuel price indices only provide next day prices To fill this gap, ISO has developed a neural network gas price forecast model to support the estimation of opportunity costs A number of econometric model formulations and driver variables were tested Neural network model performed best Key model inputs: Mean temperature (historical and forecast) Mean daily hub LMP (historical and forecast) Model specification and performance is described in the October 9, 2018 memo accompanying this presentation: Natural Gas Price Forecast Method for Energy Market Opportunity Costs ISO-NE PUBLIC 9 Opportunity Cost Model Design The OC model solves an optimization problem to find the feasible generation schedule producing the maximum Net Revenue over the 7-day OC horizon Fuel supply (inter-temporal production) limitations are modeled as constraints Operating characteristics (EcoMin, EcoMax, Min Run Time, etc.) are also modeled as constraints The difference in Net Revenue when the fuel supply is reduced by 1 MWH is the estimated energy opportunity cost The two new examples presented later illustrate the application of this design to dual fuel resources ISO-NE PUBLIC 10 OPPORTUNITY COST EXAMPLES

Illustration of Opportunity Cost Principles as applied to Dual Fuel Resources ISO-NE PUBLIC 11 The Accompanying Memo Provides Important Additional Detail The memo1 that accompanies this presentation provides A high-level mathematical formulation of the optimization problem A detailed explanation of examples #1 - #4 presented at the September Markets Committee meeting focused on oil-fired generators A detailed explanation of new examples #5 & #6 that explore aspects of opportunity costs for dual fuel resources The new dual fuel examples illustrate several outcomes and insights that might seem unusual or counterintuitive on initial review The insights are explained and will be helpful when evaluating and understanding actual ISO estimated OCs for dual fuel units this winter The October version of the memo includes two new examples: Impact of dual fuel optionality on oil-related opportunity cost Impact of dual fuel capability when gas is in merit but not called for in the optimal dispatch 1 Energy Market Opportunity Costs for Oil and Dual-Fuel Resources with Inter-temporal Production Limitations Revised Edition ISO-NE PUBLIC 12 Example 5: Dual Fuel Unit Optimal Dispatch with Both Fuel Types In Merit (1) Key Points to look for:

The optimal dispatch of a dual fuel unit with limited oil inventory may not necessarily use the oil when the oil produces the highest profit margin. The oil-related opportunity cost may be associated with the profit margin when burning gas In this example, the gas-related opportunity cost will be zero Gas is not stored on-site and is assumed to be available from the pipeline to be consumed on-demand ISO-NE PUBLIC 13 Example 5: Dual Fuel Unit Optimal Dispatch with Both Fuel Types In Merit (2) Assumptions Unit Characteristics Fuel Type EcoMax EcoMin Min Run Time Min Down Time Ramp Rate Oil 1 MW 0 MW No intertemporal constraints Fuel Information Tank Capacity Current Inventory Oil Replacement Cost Gas Replacement Price

Hr 1 Hr 2 Hr 3 2 MWH 2 MWH $120/MMBTU $123/MWH $135/MWH $125/MWH Hourly LMP Forecast Hour LMP 1 $ 140.00 2 $ 160.00 3 $ 130.00 Other Scenario Parameters OC Horizon 3 hours ISO-NE PUBLIC 14 Example 5: Dual Fuel Unit Optimal Dispatch with Both Fuel Types In Merit (3) Oil-only dispatch would run in hours 1&2 Hour

1 2 3 LMP $/MWh 140 160 130 Oil Price $/MWh 120 120 120 Oil Oil-Only Oil Margin Dispatch Net Rev $/MWh MWh $ 20 1 20 40 1 40 10 0 0 Total 60 Net revenue = $20 + $40 = $60

With dual fuel, the dispatch must consider the units margin on gas: Hour 1 2 3 LMP $/MWh 140 160 130 Simply selecting the fuel in each hour with the highest margin for dispatch produces: Hour 1 2 3 ISO-NE PUBLIC Gas Margin $/MWh 17 25 5 Oil Dispatch MWh 1 1 0

Gas Net Dispatch Revenue MWh $ 0 20 0 40 1 5 Total 65 With gas available, oil is pushed to hour 3 with a lower oil margin. This occurs because the oil margin exceeds the gas margin by a greater amount in hour 3 than in hour 1: Hour 1 2 3 Gas Price Gas Margin $/MWh $/MWh 123 17 135 25 125 5 Oil Margin $/MWh 20 40

10 Oil Margin $/MWh 20 40 10 Gas Margin $/MWh 17 25 5 Oil Dispatch MWh 0 1 1 Gas Net Dispatch Revenue MWh $ 1 17 0 40 0 10 Total 67 Net Revenue is increased to $67 15

Example 5: Dual Fuel Unit Optimal Dispatch with Both Fuel Types In Merit (4) With one less MWh of oil available, what happens to the optimal dispatch? Hour 1 2 3 Oil Margin $/MWh 20 40 10 Gas Margin $/MWh 17 25 5 Oil Dispatch MWh 0 1 0 Gas Net Dispatch Revenue MWh

$ 1 17 0 40 1 5 Total 62 Oil is no longer dispatched in hour 3 (the marginal hour) and gas is dispatched instead Net revenue is decreased by $10 of lost oil margin in hour 3, and increased by $5 of gas margin Net revenue becomes $62 ISO-NE PUBLIC Opportunity cost is the change in net revenue associated with a 1 MWh decrease in available fuel supply In this example, the opportunity cost for a 1 MWh decrease in oil supply is $67 - $62 = $5/MWh

The oil-related OC stems from the marginal hour in which the optimal dispatch burns gas 16 Example 5: Dual Fuel Unit Optimal Dispatch with Both Fuel Types In Merit (5) What are the appropriate offer schedules for this dual fuel generator? The oil offers should include the $5/MWh opportunity cost There is no opportunity cost for the gas Hour 1 2 3 Oil Price $/MWh 120 120 120 Oil Opp Cost $/MWh 5 5 5 Oil Offer Price $/MWh 125 125 125

Gas Offer Price $/MWh 123 135 125 With these offer schedules, the optimal dispatch would use gas in hour 1 and oil in hour 2. The optimal dispatch in hour 3 is indifferent to fuel type. Either choice will still maximize net revenue. ISO-NE PUBLIC 17 Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (1) Key Points to look for: Dual fuel capability may not always improve net revenue, even if the generator is generally in-merit on both of the fuels The oil-related opportunity costs is determined by the difference in oil & gas margins in hours when both fuels are in merit ISO-NE PUBLIC 18 Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (2) Assumptions Unit Characteristics Fuel Type EcoMax EcoMin Min Run Time

Min Down Time Ramp Rate Oil 1 MW 0 MW No intertemporal constraints Fuel Information Tank Capacity Current Inventory Oil Replacement Cost Gas Replacement Price (all hours) 2 MWH 2 MWH $120/MWh $135/MWH Hourly LMP Forecast Hour LMP 1 $ 140.00 2 $ 160.00 3 $ 130.00 Other Scenario Parameters OC Horizon 3 hours Generator is nominally profitable in all hours on oil Only profitable on gas in hours 1 & 2 ISO-NE PUBLIC 19

Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (3) As in Ex. 5, Oil-only dispatch would run in hours 1 & 2 with highest margins Hour 1 2 3 LMP $/MWh 140 160 130 Oil Price $/MWh 120 120 120 Oil Oil-Only Oil Margin Dispatch Net Rev $/MWh MWh $ 20 1 20 40 1

40 10 0 0 Total 60 Net revenue = $20 + $40 = $60 Gas margins are only profitable in the first two hours: Hour 1 2 3 LMP $/MWh 140 160 130 Gas Price Gas Margin $/MWh $/MWh 135 5 135 25 135 -ISO-NE PUBLIC Moving oil dispatch to hour 3 to allow gas to run profitably in hour 1 or 2, but does not increase net revenue:

Hour 1 2 3 Oil Margin $/MWh 20 40 10 Gas Margin $/MWh 5 25 0 Oil Dispatch MWh 0 1 1 Gas Net Dispatch Revenue MWh $ 1 5 0 40 0 10 Total 55

Hour 1 2 3 Oil Margin $/MWh 20 40 10 Gas Margin $/MWh 5 25 0 Oil Dispatch MWh 1 0 1 Gas Net Dispatch Revenue MWh $ 0 20 1 25 0 10 Total

55 In both cases, net revenue decreases to $55 Optimal dispatch (with apologies to John Belushi) is No gas. Oil! 20 Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (4) With one less MWh of oil, the optimal dispatch will be to use gas in hour 1 and oil in hour 2 The OC is the change in net revenue for a 1 MWh reduction in oil inventory: $60 - $45 = $15/MWH Hour 1 2 3 Oil Margin $/MWh 20 40 10

Gas Margin $/MWh 5 25 0 Oil Dispatch MWh 0 1 0 Gas Net Dispatch Revenue MWh $ 1 5 0 40 0 0 Total 45 This is equivalent to the difference in the margin on oil and the margin on gas in hour 1: $40/MWh - $25/MWh = $15/MWh Similarly, the OC at the start of hour 2 the OC will be the lost margin on oil, offset by the gas margin gained $40/MWh - $25/MWh = $15/MWh ISO-NE PUBLIC

21 Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (5) Suppose the generator in Example 6 was not dual-fuel, and burned only oil With 1 less MWh of oil, at the start of hour 1, the OC would be the $20/MHr lost oil margin. Hour 1 2 3 LMP $/MWh 140 160 130 Oil Price $/MWh 120 120 120 Oil Oil-Only Oil Margin Dispatch Net Rev $/MWh MWh $ 20 1

20 40 1 40 10 0 0 Total 60 At the start of hour 2, the OC would be $40/MWh The single fuel OC is higher in both hours than the $15/MWh dual fuel OC ISO-NE PUBLIC 22 Example 6: Dual Fuel with Gas in Merit but not Used in Dispatch (6) How should the dual fuel resource offer? From the previous slides, we see the oil-related OC is $15/MWh in hours 1&2 The appropriate offer is the sum of the oil price plus the oil-related OC = $135 In hour 3, with no oil remaining in the tank, the offer price is irrelevant With no gas OC, the gas offer is simply the price of the purchased gas ISO-NE PUBLIC Hour 1

2 3 Oil Price $/MWh 120 120 120 Oil Opp Cost $/MWh 15 15 n/a Oil Offer Price $/MWh 135 135 n/a Gas Offer Price $/MWh 135 135 135 Note that to ensure the unit is dispatched on oil, the generator may choose to offer a small amount less then $135/MWh 23 QUESTIONS FROM SEPTEMBER 2018 MARKETS COMMITTEE MEETING

ISO-NE PUBLIC 24 What can I do to preserve limited fuel for an anticipated scarcity event? Some thoughts: 1. Buy more fuel. 2. Be sure to include the OC in your offer. The Daily OC (which is the maximum of the hourly OC estimates) will act to preserve the fuel for use in the highest priced hour(s). 3. That said, OCs are estimated using a Day-Ahead price forecast. It would be extremely unusual for the DAM to clear with a scarcity condition. 4. Scarcity events are likely caused by an unexpected contingency in real-time. If it could be foreseen, ISO typically would have taken preventive steps. ISO-NE PUBLIC 25 Will using a daily OC equal to the maximum of hourly OC estimates likely results in a generator setting high LMPs for many hours in the day? Thoughts: If the daily OC value was included in a generators offer throughout the day, it would result in the generator being dispatched only in the highest priced hour of the day, and being offline the rest of the day. The maximum hourly OC value will correspond to the hour with the maximum LMP When offline, the generator will not be participating in price formation and will not be setting price. ISO-NE PUBLIC

26 Should a generators offer strategy always include the full estimated opportunity cost? The ISO estimated OC reflected in a generators reference price will be the maximum of the hourly estimated OCs calculated for the day. As we have seen in the examples, hourly OCs may increase or decrease during a day as time passes and fuel is consumed. Ideally, Market Participants develop an internal forecast of expected prices during the day, and use that to inform the offer strategy Offers that include the full daily OC value risk missing out on profitable hours during the day. This is illustrated on the following two slides ISO-NE PUBLIC 27 Potential Impacts of Including OCs in Offers ISO estimated Daily OC will be the maximum of hourly OC values calculated for the day (1) From Example 2 September MC Mtg Day 1 Since hourly OCs will tend to increase1 as hours become history, including the full Daily OC value in all 24 hourly offers for the day may forego the chance to generate during early hours that would maximize net revenues

Day 2 OC = 20.42 OC = 22.15 OC = 39.04 OC = 54.07 This is true when input assumptions for the day are held constant. If real-time OC updates become feasible in the future, estimated OC values could decrease if the LMP forecast decreases. 1 ISO-NE PUBLIC 28 Potential Impacts of Including OCs in Offers (2) From Example 2 September MC Mtg Hour 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

19 20 21 22 23 24 LMP $ 24.72 $ 87.60 $ 52.49 $ 15.36 $ 148.53 $ 145.32 $ 43.14 $ 135.73 $ 20.87 $ 23.29 $ 25.26 $ 71.77 $ 47.40 $ 541.37 $ 74.57 $ 140.42 $ 142.15 $ 116.11 $ 96.98 $ 277.80 $ 24.99 $ 410.79 $ 159.04 $ 25.36 Hourly OC $ 20.42

$ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 20.42 $ 22.15 $ 39.04 $ 39.04 $ 39.04 $ 39.04 $ 39.04 $ 39.04 $ 54.07 Daily (Max) OC $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07

$ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 $ 54.07 Optimal Dispatch MWH Dispatch with Max OC MWH 170 170 170 170 110 170 170 170 170 170 170

Five hours of optimal dispatch that would lead to maximizing Net Revenue will be missed if every hourly offer price includes the Daily (maximum) OC value Consider an alternate strategy include less than 100% of Daily OC estimate in early hours ISO-NE PUBLIC 29 Conclusion Starting in December, ISO proposes to incorporate a daily estimate of opportunity cost into the reference price for oil and dual-fuel generators The OC estimates will be available to Participants by 9am each day Participants are encouraged to incorporate opportunity costs in generators energy market offers Doing so should improve reliability and the systems cost-effectiveness during constrained fuel conditions The ISO seeks information and comment from Participants to enhance the OC model to better address fuel and other real-world constraints that impact a generators ability to operate continuously at maximum output ISO-NE PUBLIC 30 Quick Quiz Test Your Knowledge! All generators are required to include opportunity costs in Day-Ahead offers (true or false) The best offer strategy is to always include the full amount of the ISOs estimated opportunity cost in a generators offer (true or false) ISO estimated opportunity costs will only be included in a generators reference price if requested by the Lead Participant (true of false) Opportunity costs included in reference prices it doesnt get any better than this! (true or false) ISO-NE PUBLIC

31 Stakeholder Schedule Stakeholder Committee and Date Scheduled Project Milestone Markets Committee August 3, 2018 Discussed ISOs plans for Opportunity Cost s for the coming winter Markets Committee September 12-13, 2018 Discussion of OC proposal details and deta iled examples for oil units Markets Committee October 2018 Further discussion of examples for dualfuel units Markets Committee November 2018 Discussion of market power issues related to opportunity costs Early/mid November 2018 Webex training targeted to back-office personnel responsible for energy offer submission December 2018 Implementation of OC estimates included

in oil/dual-fuel generator reference prices ISO-NE PUBLIC 32 ISO-NE PUBLIC 33 Acronyms Used in this Presentation IMMAC Internal Market Monitors Asset Characteristics interface CAMS Customer Asset Management System OC opportunity cost DAM Day-Ahead Market LMP Locational Marginal Price MRT Minimum Run Time SO2 Sulfur Dioxide NOx Nitrogen Oxide CO2 Carbon Dioxide RGGI Regional Greenhouse Gas Initiative ISO-NE PUBLIC 34

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