APRIL 15, 2015| MARKETS COMMITTEE Non-Price Retirement Requests:
APRIL 15, 2015| MARKETS COMMITTEE Non-Price Retirement Requests: IMM Review and Mitigation Hemant Patil MARKET MONITORING Introduction In the November 5, 2014 memo the Internal Market Monitor (IMM) and ISO Management identified uneconomic retirement of capacity resources as a key issue At the January 15, 2015 Markets Committee meeting the IMM provided details of the market power concern with uneconomic retirements At the February 11, 2015 Markets Committee meeting the IMM provided conceptual framework to review Non-Price Retirement Requests (NPRR) and calculate the Uneconomic Retirement Charge 2 Proposal Highlights
The IMM review will determine whether a retiring resource is economically viable to operate during the commitment period and the resources economic life If the IMM review determines that the retirement is uneconomic then a supplier has to incur a Uneconomic Retirement Charge 3 Uneconomic Retirement Charge The Uneconomic Retirement Charge will be based on the suppliers estimated potential gains from an uneconomic NPRR and the economic life of the resource Deterrent and Reasonable Approximation The charge calculation will a reasonable approximation of portfolio gains based on known FCA parameters The charge will more than offset the total estimated portfolio gain from the uneconomic retirement Simplicity and Transparency Participants will be able to estimate the portfolio charge for a potential uneconomic NPRR before submitting a NPRR
4 IMM Cost Review Evaluate whether a resource associated with a NPRR can remain in operation profitably during and beyond the commitment year for which a NPRR is submitted The IMM will evaluate suppliers NPRRs if they are greater than 25 MW to ensure sufficient economic justification exists for the retirement The IMM will conduct a preliminary analysis of potential NPRRs prior to NPRR submission deadline and advise suppliers whether a NPRR is economic or, in the alternative, on appropriate Permanent De-List Bid price Only NPRRs for resources which have a supplier-estimated economic life less than or equal to five years will be reviewed for the preliminary cost analysis Preliminary cost review is not required before submitting NPRR 5 Post Preliminary Cost Analysis After the preliminary IMM analysis participant has following mutually exclusive choices:
Not submit any de-list bid and be a price taker in the FCA Submit a Static De-List Bid Submit a Permanent De-List Bid Submit a NPRR If a Permanent De-List bid is submitted for a resource and it does not clear in the FCA, the resource may only submit a Permanent De-List Bid or NPRR in subsequent FCAs Participant must demonstrate a significant change in market conditions or regulatory environment to request an exception 6 IMM Cost Review Show of Interest Window Closes Submission of Documents for
Preliminary Cost Analysis of Potential NPRR Preliminary Cost Analysis Notification NPRR Submission Deadline Economic NPRR and Uneconomic Retirement Charge Notification 7 IMM Cost Review The IMM review will be based on standard capital budgeting techniques to evaluate potential costs and benefits of a NPRR Commonly accepted framework for performing benefit-cost analyses
Frequently applied to corporate planning activities Consistent with existing IMM reviews of static de-list bids and new supply offers Discounted Cash Flow Model will be used to compare the expected cash flows from a resource under two scenarios 1. 2. Acquire a CSO and keep the resource operational Retire the resource and incur terminal costs associated with retirement 8 IMM Cost Review Consistent with de-list bid and new supply offer reviews, participants will be expected to provide resource-specific data and documentation to support the cost review Revenues: annual forecast of energy, ancillary and capacity revenue for five years Costs: annual forecast of avoidable operating expenses and capital expenditures for five years Decommissioning costs: forecast of terminal costs associated with
resource retirement A Risk-Adjusted Discount rate: Weighted average cost of capital 9 Net Present Value The NPV of a resource remaining operational for the five year period is the present value of all the future cash flows: NOP: Net Operating Profit CapEx: Capital Expenditure Rp: Risk-adjusted discount rate t : Capacity Commitment Period of the FCA for which NPRR is submitted TCF: NPV of terminal cash flow If a lumpy capital investment results in resources economic life extended beyond five years then the cumulative NPV of economic life beyond 5 years can be included as a separate component 10 Net Present Value NPV @ CCP1 Start CCP2
CCP1 CCP3 CCP4 CCP5 Net Operating Profit Capital Expenditure Capacity Revenue Discounted Cash Flow 11 Example 1: Net Present Value Determination Generator Retirement Capacity (MW) Discount Rate Capacity Commitment Period Net Operating Profit
$3,378,030 $2,500,000 $7,637,675 12 Determination of Economic Life Period of time a resource is likely to remain profitable given the expected cash flows Evaluation of the cumulative costs and required capacity market revenue (missing money) for each time period Economic life of a resource is the maximum value of i (i = 0,1,,4) for which the inequality above is true 13 Determination of Economic Life 22 Economic Life 13
6 14 9 12 12 Uneconomic to Operate 9 15 6 14 Example 2: Determination of Economic Life Capacity Commitment Period 1 2
3 4 5 ($4,746,400) ($11,981,800) $1,212,400 $378,030 Period 1 Period 1 to 2 Period 1 to 3 Period 1 to 4 ($34,545)
10.91 5.91 4.55 Uneconomic to Operate Cash Flow (Without Capacity Revenue) ($2,788,000) Cumulative NPV (Excluding Capacity Revenue) Period 1 to 5 15 Net Operating Profit Operating Revenue Energy Market Revenue Ancillary Services Revenue
Capacity Performance Payments Operating Costs Plant Maintenance Plant Personnel (wages, benefits, etc) Plant Administrative and General Net Operating Profit = Operating Revenue Operating Costs 16 Capacity Performance Payment Forecasted Availability A Forecasted Shortage Event Hours H Forecasted System Balancing Ratio During Shortage Events BR Risk Premium Risk of a worse than expected RPA
Risk of greater than forecasted RPH Risk of a Significant Decrease RPP Stop Loss: FCA Starting Price, less the FCA offer excluding risk premium components 17 Capital Expenditure Required expenses to keep the resource operational Environmental upgrades Major maintenance Supporting documents relating to the proposed capital investments will be required. Engineering Studies Capital Investment Plans (long and short-term) Historic maintenance schedule Compliance analysis and regulatory filings (environmental upgrades)
Capital Investment Schedule Example ($ in 000's) Project Retube Boiler Turbine Blade Replacement Dispatch System Upgrade Water Treatment System Storage Tank Overhaul Total $ $ Capital Investment Schedule Analysis Period 1 2 3 4 200 $ - $ - $ - $
The IMM will develop forecast of capacity prices The IMM will consult with the participant if the participants capacity price forecast is outside the range of the forecast developed by the IMM 19 Discount Rate Weighted-average cost of capital (WACC) Participant submits breakdown of capital allocation between debt and equity along with the costs associated with each The IMM will calculate a benchmark range for cost of capital The Return on Equity (RoE) will be based on the RoE for publicly traded power companies in US The cost of debt will be based on the historical average of bond yields of publicly traded power companies The IMM will consult with the participant if the WACC is
outside the benchmark range 20 Review Process Participant submits a NPRR and related documents for cost review Expected costs and revenues Expected capital Expenditure Appropriate discount rate (weighted-average cost of capital) Participants forecast of capacity clearing prices IMM reviews and finalizes participant submitted cost data Involves extensive consultation with participants IMM determines reasonableness of economic life, based on the costs and benefits of maintaining a CSO and being operational over the 5-year forecast period
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