Overview of the Capacity Markets in the United States 2008 APEX Conference in Sydney, Australia October 13-14, 2008 Hung-po Chao Director, Market Strategy and Analysis

Presentation Title © 2007 ISO New England Inc. 2 The Need for Capacity Markets To provide long-term financial commitment to obtain adequate resources to meet customers’ needs –To attract new investments in generation capacity and demand resources –To defer old capacity retirement Electricity markets continue to evolve –Demand side does not yet fully participate –Price cap is still needed

Capacity Markets in the U.S. ISO New England –Forward Capacity Market (FCM) PJM ISO/RTO –Reliability Pricing Model (RPM) New York ISO –Installed Capacity Market (ICAP) © 2008 ISO New England Inc. 3

The Forward Capacity Market (FCM) at ISO New England

The Forward Capacity Market (FCM) in New England © 2007 ISO New England Inc. 5 Background Historically, New England has had a monthly Installed Capacity (ICAP) market –Very low prices –Many Reliability Must Run (RMR) contracts ISO developed Locational ICAP (LICAP) States and some stakeholders objected Result was settlement process which led to FCM –Settlement reached March 2006

Transition Payments DatePayment ($/KW-month) Estimated Total Payment ($Billion) 12/01/2006 – 05/31/2007$ /01/2007 – 05/31/2008$ /01/2008 – 05/31/2009$ /01/2009 – 05/31/2010$ © 2008 ISO New England Inc. 6 Effective December 2006 through May 2010 Fixed capacity payments to all resources Payments adjusted for historical unit availability

The Forward Capacity Market (FCM) in New England © 2007 ISO New England Inc. 7 FCM – Design Features Primary auction for capacity approximately three years before the delivery year Allow new proposed capacity projects to compete in the market and set price Facilitate participation by all resources: supply and demand Market buys just enough capacity to meet New England’s Installed Capacity Requirement (ICR) Zonal purchases Pay-for-performance and energy price hedge for load

The Forward Capacity Market (FCM) in New England © 2007 ISO New England Inc. 8 FCM Design – Major Components Qualification –Ensure that auction participants are real –For both existing and new capacity resources Forward Capacity Auction (FCA) –Zonal purchase of capacity resources –Declining clock auction Reconfiguration Auctions –To buy and sell (exchange) capacity obligations before and during the commitment period Capacity Product –Must offer in day-ahead energy market –Measure and pay-for-performance during shortage events –Financial obligation to provide energy during high priced periods Financial Assurance –Help to ensure that New capacity offers deliver on commitment

Forward Capacity Market Results Capacity market transition payments of $3.05/kW-month were made to all ICAP resources in accordance with the FCM Settlement Agreement The ISO evaluated over 13,000 MW of new capacity projects submitted in the qualification stage for the first Forward Capacity Auction The first FCA was successfully completed in February 2008 with competitive offers from 6,102 MW. A total of approximately 1,813 MW of new resources was selected © 2008 ISO New England Inc. 9

10 Forward Capacity Auction Results The first FCA held February 4-6, 2008 –Procurement met regional ICR for Commitment Period –FCA was successful and went smoothly No technical problems or observed anti-competitive behavior Prices –FCA starting price was $15.00/kW-mo –FCA ending price was $4.50/kW-mo Floor price negotiated as part of Settlement Agreement Over 1,800 MW of new Supply and Demand Resources cleared the auction,

© 2008 ISO New England Inc. 11 Total Resources Cleared in FCA-1: 34,352 MW; Total Resources Needed: 32,305 MW Values represent MW and percent

© 2008 ISO New England Inc. 12 New Supply Resources Cleared in FCA-1: Traditional fuel still dominates supply Total: 626 MW Values represent MW and %

© 2008 ISO New England Inc. 13 New Resource Show of Interest for FCA#2 in December, 2008 More Show-of-Interest (SOI) applications in FCA-2 than FCA-1 Approximately 15,864 MW of New Resources seeking qualification –8,985 MW of new generation Includes 581 MW of Wind, primarily in ME and NH Includes 8,046 MW of CC and CT Also includes Hydro, Fuel Cells –5,098 MW of new imports –1,781 MW of new Demand Resources

The Reliability Pricing Model (RPM) at PJM ISO/RTO

Background The RPM replaced the previous PJM capacity market construct to ensure PJM’s long term resource adequacy –It was implemented on June 1, 2007 The RPM design was developed through a multi-year stakeholder discussion and a FERC settlement process The primary driver was to address projected reliability concerns and infrastructure investment issues –PJM was facing the prospect of persistent and worsening imbalances between supply and demand Four auctions have been conducted so far © 2008 ISO New England Inc. 15

RPM- Design Features Three Year Forward Auctions –Residual auction after specification of self-supply and bilaterals. –Provides price signal and forward commitment process that allows new entry to participate or existing units to retire with forward notification. Locational Constraints –Recognize limited ability to import capacity in certain areas due to transmission, voltage, or stability limitations (as identified in PJM’s RTEP analysis). –Higher capacity prices in constrained areas –Lower capacity prices in areas with significant excess capacity © 2008 ISO New England Inc. 16

RPM- Design Features (Cont’d) Variable Resource Requirement (VRR) –Recognizes the Cost of New Entry. –Recognizes the value of additional capacity above the reserve margin thereby reducing volatility in capacity prices. –Sloped demand curve reduces market power concerns. Ability of Transmission and Demand Resources to participate –Allows direct competition between various options including new generation resources and demand response to address reliability requirements. –Provides opportunity for incremental transmission upgrades to provide solutions to capacity import limitations © 2008 ISO New England Inc. 17

Capacity Supply and Demand in the 20011/2012 Base Year Auction © 2008 ISO New England Inc. 18

Summary of RPM Clearing Prices © 2008 ISO New England Inc. 19

Trend of Demand Response Participation before and after RPM Implementation © 2008 ISO New England Inc. 20

The Installed Capacity Market (ICAP) at New York ISO

Background The design of the Northeastern installed capacity markets was born of the pre-existing planning and operating practices of the power pools in the Northeast. The New York market structure addresses the need for: –system reliability (insured through installed capacity requirements); –overall market design coordinating energy, capacity and ancillary services –reining in potential market power –encouraging robust competition –mitigating potential barriers to trade –certainty, market stability –recognizing the political realities of energy price caps and regulatory oversight © 2008 ISO New England Inc. 22

NYISO ICAP- Design Features ICAP Requirements: –Are based on a Reserve margin set in advance for the upcoming Capability Year by the New York State Reliability Council (NYSRC) All ICAP Requirements are translated into UCAP (Unforced Capacity) Requirements –Unforced Capacity is a measure of the expected supply based on the historical performance of each resource when in demand (dispatched) © 2008 ISO New England Inc. 23

NYISO ICAP- Design Features Load Serving Entities (LSEs) meet their NYISO-allocated UCAP requirements by: –Self-Supply or Bilateral Transactions with Suppliers –Purchasing in the Capability Period Auctions (6-month strip) –Purchasing in the Monthly Auctions (for balance of Capability Period) –Paying for the balance of their obligation procured on their behalf in the Spot Market Auction (1-month) using a Demand Curve All supply is certified and checked out monthly. © 2008 ISO New England Inc. 24

NYISO ICAP- Locational Features Due to transmission constraints into certain localities, areas or zones, some LSE’s must procure a substantial portion of their ICAP/UCAP requirements from local resources There are two such transmission constrained zones in New York: –New York City –Long Island © 2008 ISO New England Inc. 25

NYISO ICAP “Demand Curve” Initially a monthly auction was designed as a deficiency auction where LSEs that were short were required to buy the balance needed at the clearing price in the NYISO deficiency auction The market price could be anywhere between a preset maximum deficiency price and zero, essentially following a vertical demand curve This design resulted in volatile market outcomes and eroded the quality of any price signals The deficiency auction is replaced by a spot auction (one month) that relied on a sloped demand curve, which would lead to more certain and rational price signals © 2008 ISO New England Inc. 26

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