Potential Effectiveness of the Demand Curve Approach for Mitigation - PowerPoint PPT Presentation

California Independent System Operator Corporation Potential Effectiveness of the Demand Curve Approach for Mitigation of Local Market Power in Capacity Markets Eric Hildebrandt, Ph.D Department of Market Monitoring California Independent System Operator CRRI Advanced Workshop in Regulation and Competition 21 th Annual Western Conference Monterey, California June 19, 2009

California Independent System Operator Corporation Background  CPUC and CAISO leading ongoing effort to consider centralized capacity market in California.  Local market power mitigation key part of any centralized capacity market design in CA. – Ownership of supply within major local pockets in California highly concentrated (e.g., 2 major suppliers).  Two major approaches proposed: – Demand curve approach (NYISO-style) – Direct bid/price mitigation (similar to PJM, ISO-NE)

California Independent System Operator Corporation Demand Curve Approach  Relatively high bid cap on suppliers – e.g., 160% of the Net Cost of New Entry (CONE)  Administratively set demand curve used to establish “demand elasticity” $225 $116 Net CONE (NYC) 160% Net Cone for NYC $200 $92 Net CONE (NYCA) $70 Net CONE (LI) $175 $150 Net Cone for NYC $/kW-Year $125 $100 $75 118% of Area Requirement $50 100% of Area Requirement $25 $0 Local Area Capacity (MW)

California Independent System Operator Corporation Analysis of Demand Curve Approach: Methodology  Shape of administrative demand curve based on NYISO demand curve for New York City area  Data on local area capacity requirements and available supply based on CAISO 2007 and 2008 CAISO Local Capacity Area (LCA) studies  The major LCAs examined: – San Diego – Western LA Basin (sub-area of LA Basin LCR) – San Francisco Bay Area  Two approaches for modeling market power: – Pivotal Supplier (Unilateral model) – Cournot Equilibrium (Duopolistic reaction function model)

California Independent System Operator Corporation San Francisco Bay Area: Local Area Requirements and Supply Bay Area Capacity Requirement 4,688 MW Bay Area Supply Calpine 2,573 MW (41% of supply) Mirant 2,347 MW (38% of supply) PG&E 613 MW (10% of supply) Other 681 MW (11% of supply) Total 6,215 MW (132% of requirement)

California Independent System Operator Corporation Supply and Demand Balance (Bay Area) 12,000 10,000 Calpine Capacity 8,000 Mirant Capacity MW 6,000 4,000 Other Suppliers 2,000 Maximum Net 0 Import Load Supply

California Independent System Operator Corporation Profit Maximimizing Level of Sales by Largest Supplier under Unilateral Model of Market Power $200 $175 MCP Price Cap $150 MCP ($/kW-Year) $125 Net CONE $100 $75 Sales by Witholding Largest by Largest Residual $50 Supplier Supplier Supply $25 $0 0 1000 2000 3000 4000 5000 6000 MCQ (MW)

California Independent System Operator Corporation Reaction Functions of Largest Two Suppliers in Bay Area 2,500 Calpine Mirant Calpine Reaction Function (MW Sold 2,000 1,500 1,000 Under Cournot equilibrium, two suppliers sell combined total of about 500 2,800 MW @ $145 Price Cap 0 0 500 1,000 1,500 2,000 2,500 Mirant Reaction Function (MW Sold)

California Independent System Operator Corporation Profit Maximimizing Level of Sales by Largest Suppliers under Duopolistic Model of Market Power $200 $175 MCP Price Cap $150 MCP ($/kW-Year) $125 Net CONE $100 $75 Calpine & Mirant Sales Residual $50 (Duopolistic Solution) Supply Witholding $25 $0 0 1000 2000 3000 4000 5000 6000 MCQ (MW)

California Independent System Operator Corporation Reaction Functions of Largest Two Suppliers with Addition of 350 MW of Residual Supply 2,500 Calpine Mirant Calpine Reaction Function (MW Sold 2,000 1,500 1,000 Under Cournot equilibrium, two suppliers each sell about 1,260 MW 500 @ $138/kW/yr 0 0 500 1,000 1,500 2,000 2,500 Mirant Reaction Function (MW Sold)

California Independent System Operator Corporation Comparative Analysis of Potential Local Market Power Using Unilateral and Cournot Approaches Market Shares Unilateral Approach Cournot Approach Supply % Net % Net Margin Calpine Mirant MCP CONE MCP CONE 2008 LCA Study 132% 41% 38% $98 106% $145 158% 100 MW of New Supply 135% 39% 37% $92 100% $145 158% 350 MW of New Supply 140% 38% 36% $78 85% $138 150% 825 MW of New Supply 150% 35% 33% $53 57% $120 131% 1,300 MW of New Supply 160% 33% 31% $27 30% $103 112% 1,610 MW of New Supply 167% 32% 30% $ 0 0% $ 92 100% 1,775 MW of New Supply 170% 31% 30% $ 0 0% $ 86 93%  Under unilateral model, addition of 100 MW would lower MCP to 100% Net Cone. – Supply = 135% of local capacity requirement  Under duopolistic model, addition of 1,610 MW would be needed to lower MCP to 100% Net Cone. – Supply = 167% of local capacity requirement

California Independent System Operator Corporation Comparative Analysis of Potential Local Market Power Using Unilateral and Cournot Approaches MCP - Cournot Model $150 $140 MCP - Unilateral Model $130 Capacity Market MCP ($/kW/year) $120 $110 $100 Net Cost of New Entry ($92) $90 $80 $70 $60 $50 $40 2008 LCA Study Conditions $30 $20 $10 $0 130% 135% 140% 145% 150% 155% 160% 165% 170% 175% Supply (Percent of LCA Requirement)

California Independent System Operator Corporation Conclusions  NYISO-style demand curve approach unlikely to be effective at mitigating local market power within CAISO’s major load pockets (LCAs)  Unilateral models of market power likely to dramatically underestimate degree of local market power.  Even if significant new capacity by “residual suppliers” could be added in these areas, this would probably be economically inefficient – Very high supply margins in excess of actual capacity requirements would be needed to mitigate local market power of existing suppliers.  Direct bid/price mitigation such as that used in PJM and ISO- NE likely to be more effective and economically efficient.

California Independent System Operator Corporation Additional Materials

California Independent System Operator Corporation Western LA Basin: Local Capacity Requirements and Supply Local Capacity Requirements and Available Supply Western LA Basin Sub-Area Sub-Area Area Requirement 3,788 MW (2007 LCA Study) Sub-Area Supply Williams (Bear Stearns) 2,019 MW (45% of sub-area supply) Other Suppliers 2,376 MW (55% of sub-area supply) Total Sub Area 4,432 MW (117% of sub-area requirement)

California Independent System Operator Corporation Western LA Basin – Base Case $200 $175 MCP $150 $125 $/kW-Year Net CONE $100 $75 Profit Maximizing $50 Sales by Major Supplier Residual Supply Withholding $25 $0 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 MW

California Independent System Operator Corporation Western LA Basin – Scenario Analysis Table 1. Potential Impact of New Supply on Capacity Market Results Western LA Basin Capacity Market Outcomes Supply Scenario Supply as % of Owned by MCP as % Scenario Assumptions LCA Largest MCP of Net MCQ (New Supply) Requirement Supplier ($/kW/yr) CONE (% of Req.) 2007 LCR none 117% 45% $138 150% 91% 1 300 MW 125% 42% $118 128% 95% 2 500 MW 130% 41% $104 114% 98% 3 680 MW 135% 39% $92 100% 100% 4 870 MW 140% 38% $79 86% 102%

California Independent System Operator Corporation San Diego LCR: Local Capacity Requirements and Supply Table 1. Local Capacity Requirements and Available Supply San Diego Area San Diego Area Requirement 2,957 MW San Diego Area Supply NRG 1,133 MW (38% of supply) Dynegy 702 MW (24% of supply) SDG&E 777 MW (26% of supply) Other Suppliers 335 MW (12% of supply) Total Sub Area 2,959 MW (~100% of requirement)

California Independent System Operator Corporation San Diego LCR – Scenario Analysis Table 1. Potential Impact of New Supply on Capacity Market Results San Diego Area Capacity Market Outcomes Supply Scenario Supply as % of Owned by MCP as % Assumption LCA Largest MCP of Net MCQ Scenario (New Supply) Requirement Supplier ($/kW/yr) CONE (% of Req.) 2008 LCR Study None 100% 38% $143 156% 90% 1 300 MW 110% 35% $118 128% 95% 2 600 MW 120% 32% $92 100% 100% 3 890 MW 130% 29% $67 73% 105%

California Independent System Operator Corporation Direct Bid/Price Mitigation Approach  Existing Suppliers subject to price impact test if: – Bid >60% of net CONE, and  Controls >20% of capacity in local area or  Is individually pivotal in local area  Price Impact Test – Auction first run with participant’s bid, and then with net Avoidable Cost Rate (Net ACR) – If use of unmitigated market bid increases capacity market price >5%, then mitigated bid (Net ACR) used in final auction  Physical withholding prevented in local market by provisions that allow “de-listed” capacity to count toward local area requirement.  Overall market price cap of 140% of Net Cone mitigates potential market power if price set by new supply.