MA AGO 1

Capacity Demand Curve for the Office of the Massachusetts Attorney General

Prepared By: Randell Johnson Andrew Bachert

Energy Exemplar

Feb. 27th , 2014

27 February, 2014

MA AGO 2

Guiding Principles

• Determine a peak price of capacity curve that will minimize the build costs, production cost (E&AS), and shortage costs (VOLL*Unserved Energy) to achieve on a target 1 day in 10 year LOLE reliability metric

• Consider load risk impact during LOLE simulations• Assess price volatility of the capacity demand curve• Reconcile results with other regional markets• Review magnitude of incentives at peak price and rate of return on equity for

investments

27 February, 2014

MA AGO 3

Description of Optimization

• PLEXOS optimization determines the minimum net present value (NPV) of the system in terms of investments, production cost, ancillary services cost, and shortage costs– Subject to constraints of:

• Meeting demand• Feasible builds• Feasible production• 1 in 10 LOLE reliability standard• and others

• Investments are additional production, demand response, or other equipment of the system to meet constraints and at lowest cost

• Production cost is the short run marginal cost of the system to supply load subject to constraints• Ancillary services cost is the additional costs for meeting reserve provisions • Shortage Costs are costs when there is loss of load and these costs are a value of lost load (VOLL)

multiplied by the unserved energy• Capacity payments help to minimize shortage costs

Capacity Demand Curve has impact to least cost optimization27 February, 2014

MA AGO

Least Cost Optimization

Cost $

Investment x

Production Cost P(x)

Investment cost/ Capital cost C(x)

Total Cost = C(x) + P(x)

Minimum cost plan x

4

• Chart shows the minimization of total cost of investments and of production cost

• As more investments made production cost trends down however investment cost trends up

27 February, 2014

Objective: Minimize net present value of the sum of investment and production costs over time

MA AGO 5

Cost Minimization with Capacity Curve Peak Price Cont.

• Objective:– Minimize net present value of capital costs, production costs, ancillary costs, ancillary shortages,

demand shortages

• Minimize: – [Build Cost]+[Production Cost]+[Demand Shortage Cost]+[Ancillary Services Shortage Cost]

• Subject to:– [Electric Production] + [Electric Shortage] = [Electric Demand] + [Electric Losses]– [Ancillary Service Provision] >= [Ancillary Services Requirements]– [Electric Production] and [Ancillary Services Provision] feasible– [Build]<=[Max Build]– [Production]<=[Production Max] – [Intergrality] i.e. whole blocks of capacity – others

27 February, 2014

MA AGO 6

Illustrative Least Cost Optimization

VOLL Unserved Energy

Individual Unit Production Cost

Individual Unit Production

Individual Unit Build Cost

Amount Built

Investment Cost Production Cost

27 February, 2014

This simplified illustration shows the essential elements of the PLEXOS mixed integer programming formulation for determination of a demand capacity curve that would achieve a target reliability level of LOLE at 1-in-10.

PLEXOS also has many other variables and costs as part of the optimization such as capacity payments as well as other possible constraints

Due to time constraints method partially tested with

one year optimization

= for all= year = interval = unitY = Horizon

MA AGO 7

Least Cost Optimization with Capacity Demand Curve Explanation of Terms

• = Capital Cost • = Capacity Built by Type • • = Individual Unit Production• = VOLL• = Unserved Energy

27 February, 2014

• = MW Demand• = Max Capacity of individual Units• = Max Build Capacity by Type• = Target LOLE• Symbol means: for all• ∑ Symbol Means: sum up the individual items

MA AGO 8

Features of Capacity Demand Curve

27 February, 2014

Capacity Demand Curve Feature Observations for Feature

Peak Price- Determine a peak price of capacity curve that will minimize the build costs, production cost (E&AS), and

shortage costs (VOLL*Unserved Energy) to achieve on average a 1-in-10 reliability metric- Review the ROE of new plant at the peak price - Compared to NY-ISO peak price

Start of downward slope at less than 100% NICR

- Considered slope feature of other regional markets when quantity is less than NICR- Noted that the Initial Candidate Curve can peg capacity price at 2x CONE for an estimated 2.8% shortage

of 948 MW from 2017/18 NICR of 33,855- Considered a slope feature to reduce volatility

Curve crossing point over 100% NICR- Simulated 1 in 10 LOLE of 0.1 for crossing NICR above Net CONE- Consider load risk impact during LOLE simulations- Considered NICR crossing levels of other regional markets

Kink point- Set kink point to reduce volatility via more gradual slope compared to initial candidate curve- Capacity Prices of 70% and 80% Net CONE exceed many existing unit FO&M- Considered downward slopes of other regional markets in relation to foot of capacity demand curve

Foot- Adopted foot of initial candidate curve since the initial candidate curve has a foot at approximately 22%

ICAP and exceeds the LOLE 1 in 10 day criteria- Considered foot location for other regional markets

MA AGO 9

90.0

%

91.0

%

92.0

%

93.0

%

94.0

%

95.0

%

96.0

%

97.0

%

98.0

%

99.0

%

100.

0%

101.

0%

102.

0%

103.

0%

104.

0%

105.

0%

106.

0%

107.

0%

108.

0%

109.

0%

110.

0%

111.

0%

112.

0%

113.

0%

114.

0%

115.

0%

116.

0%

117.

0%

118.

0%

119.

0%

120.

0%

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

% of NICR

Price

(% o

f Net

CO

NE)

MA AGO Capacity Demand Curve

27 February, 2014

NICRLOLE: 1-in-10

Peak Price

NICR CrossingPoint

Start of Downward

Slope

FootKink

MA AGO 10

90.0%91.5%

93.0%94.5%

96.0%97.5%

99.0%100.5%

102.0%103.5%

105.0%106.5%

108.0%109.5%

111.0%112.5%

114.0%115.5%

117.0%118.5%

120.0%0.00

0.50

1.00

1.50

2.00

2.50

Initial Candidate Curve (xNet CONE)NY Curve (xNet CONE)PJM Curve (xNet CONE)MA AGO Curve (xNet CONE)

% of NICR

Price

(% o

f Net

CO

NE)

Comparison of Capacity Demand Curves

Initial Candidate Curve, NY Curve, PJM Curve coordinates estimated from MC materials: “Draft Recommendations for a Capacity Demand Curve in ISO-NE”, Slide 15, Jan 14, 2014

NICRLOLE: 1-in-10

27 February, 2014

MA AGO 11

Calculated 1-in-10 LOLE

27 February, 2014

28325

28590

28940

29340

29790

30265

30750

31445

32210

32900

32000 33000 34000 35000 36000 37000 38000

Installed Capacity (MW)

Sum

mer

201

7 Pe

ak Lo

ad F

orec

ast D

istrib

ution

(MW

)

ForecastProbability

2017Peak LoadForecast

10/90 28,32520/90 28,59030/70 28,94040/60 29,34050/50 29,79060/40 30,26570/30 30,75080/20 31,44590/10 32,21095/5 32,900

160 PLEXOSSimulations of High LevelISO-NE Control AreaModel

Results: NICR = 33,855 MW LOLE = 0.1 - Simulated load risk in calculating LOLE

- Simulated multiple capacity levels

MA AGO 12

Net CONE: many multiples of plant FOM

27 February, 2014

New Entrants Net CONE 11.71 % of Net CONEReference Technology

Capacity (MW)

Fixed O&M ($/kW-m) NET CONE/FOM 80% NET CONE ($/kW-m) 70% NET CONE ($/kW-m)

4x0 LM6000 173 3.26 3.6 9.4 8.22x0 LMS100 188 2.85 4.1 9.4 8.22x0 Frame CT 417 1.52 7.7 9.4 8.22x1 CC 715 2.4 4.9 9.4 8.2

Existing UnitsVarious sources of FOM data for existing units can range from 1 to 9 ($/kW-m) depending on type, size, and ageMany existing units would earn far in excess of FOM for capacity price of $11.71/kW-m

Source: New Entrants Data from MC Feb 27 Net CONE presentation

MA AGO 13

MA AGO Curve Reduces Price Volatility Compared to Initial Candidate Curve

27 February, 2014

Consumer Cost Items $ Billion SourceWholesale Electricity Markets $9.2 http://www.iso-ne.com/nwsiss/grid_mkts/key_facts/index.htmlTraded Energy Markets $8.0 http://www.iso-ne.com/nwsiss/grid_mkts/key_facts/index.htmlTraded Capacity and AS $1.2 http://www.iso-ne.com/nwsiss/grid_mkts/key_facts/index.html

NICR Capacity Procurement at capacity price of $11.71/kW-m $4.8 Calculation

Swing in Consumer Cost for Initial Candidate Curve from 102% to 100% NICR $3.4 EstimatedSwing in Consumer Cost for PLEXOS Curve from 102% to 100% NICR $1.6 Calculation

MA AGO 14

Net CONE Benchmarks

27 February, 2014

Net CONE Assumes a 13.8% Equity Rate of Return for the following technologies:

• 4 x LM 6000: $20.60/kW-m• 2 x LMS 100: $17.85/kW-m• 2 x Frame CT: $ 8.95/kW-m• 2 x 1 Combined Cycle: $11.71/kw-m

This was done by solving the Net CONE value in $ / kW-month for each technology given a specific rate of return for equity of 13.8%. The financial models for these calculations are complex and include a number of different assumptions and properties.

The following analysis reviews the equity rate of returns for these same projects assuming different Net CONE assumptions.

Source: MC Feb 27th Net CONE Presentation

MA AGO 15

Net CONE Benchmarks (continued)

27 February, 2014

First, we benchmarked each technology based on their Net CONE values and the 13.8% equity rate of return.

Economic Life: 20 yearsDebt Leverage: 50% of Overnight Project CostDebt Amortization: standard amortization over 10 yearsDebt Interest rate: 7.0%Tax Depreciation: MACRS 15 Year Depreciation for the LMS and CT and 20 Year for CCCorporate Tax Rate: 35%Inflation Rate: 2.25%Size and cost of plant as per the Feb 27, 2014 Presentation

Source: MC Feb 27th Net CONE Presentation

MA AGO 16

ROE for Peak Price

27 February, 2014

Return on EquityNet CONE$/kW-m

Penalty Price Net CONE Multiplier 4 x LM 6000 2 x LMS 100 2x0 Frame CT 2x1 CC

11.71

1.60 11.96% 14.8% 35.0% 25.3%

2.00 16.50% 19.9% 45.3% 33.1%

MA AGO 17

Capacity Clearing Price of 1.6 x $11.71/kW-m

27 February, 2014

Assuming a capacity price of $18.73/kW-m for the new Capacity Resources, the Equity Rate of Return for these same hypothetical projects would be a follows:

• 4 x LM 6000: 12.0%• 2 x LMS 100: 14.8%• 2 x Frame CT: 35.0%• 2 x 1 Combined Cycle: 25.3%

Again, the LM 6000 project would face a slight degradation of equity returns from 13.8% to 12.0%, but the other projects have a significantly improved results relative to their original position. These results also suggest that the returns are far in excess of market expectation at that capacity price for several technologies.

MA AGO 18

Capacity Clearing Price of 2 x $11.71/kW-m

27 February, 2014

Finally, assuming a value 2 x $11.71 /kW-m, the Equity Rate of Return for these same hypothetical projects would increase as follows:

• 2 x LM 6000: 16.5%• 2 x LMS 100: 19.9%• 2 x Frame CT: 45.3%• 2 x 1 Combined Cycle: 33.1%

In this case, all projects have a significantly improved results relative to their original net cone economics. These results also suggest that the returns are far in excess of market expectation at that capacity price for several technologies.

MA AGO 19

ROE Comparison for Net CONE Multipliers of 1.6 and 2

27 February, 2014

With Net CONE of 11.71and 2x Net CONE MultiplierExcess Equity Returns Possible

MA AGO 20

Recommendations of Future Capacity Demand Curve

– Consider a 20 year outlook for development of Capacity Demand Curve shape– Consider least cost constrained optimization of short run and long run marginal costs

including minimization of the value of lost load– Run multiple scenarios of technologies, demands, fuel prices, and possibly others and

allow the optimization to deactivate units if necessary for least cost system development– Use a stakeholder driven process for the above

27 February, 2014