1 Independent Market Monitoring in the Midwest ISO Presented to: Federal Energy Regulatory Commission David B. Patton, Ph.D. Independent Market Monitor May 18, 2006

- 2 - The Role of Market Monitoring Deregulation is premised on the benefits of replacing price regulation with competitive forces to guide generation and transmission usage in the short-term and investment decisions in the long-term.Deregulation is premised on the benefits of replacing price regulation with competitive forces to guide generation and transmission usage in the short-term and investment decisions in the long-term. Market monitoring is intended to help ensure that the markets operate competitively and efficiently so these benefits are realized.Market monitoring is intended to help ensure that the markets operate competitively and efficiently so these benefits are realized. In particular, market monitoring is designed to identify:In particular, market monitoring is designed to identify: Flaws in market rules that create inefficient incentives or gaming opportunities; Flaws in market rules that create inefficient incentives or gaming opportunities; Potential efficiency improvements in the operation of the market; Potential efficiency improvements in the operation of the market; Market power; Market power;

- 3 - Independence of Market Monitoring In the Midwest, States and participants designed the market monitoring function to be independent of the ISO – performed by an independent entity (i.e., the independent market monitor or IMM).In the Midwest, States and participants designed the market monitoring function to be independent of the ISO – performed by an independent entity (i.e., the independent market monitor or IMM). Independence of the Market Monitor from the RTO is important due to its role in monitoring the RTO’s rules, procedures, and operations.Independence of the Market Monitor from the RTO is important due to its role in monitoring the RTO’s rules, procedures, and operations. Independent monitoring of the actions of the MISO was a high priority of the States and many participants. Independent monitoring of the actions of the MISO was a high priority of the States and many participants. The actions of a market operator generally have a larger impact on the market outcomes than any single participant. The actions of a market operator generally have a larger impact on the market outcomes than any single participant. Manual actions taken to maintain reliability can distort the market outcomes -- the rules and operating procedures can often be modified to improve the consistency of the market and reliability requirements.Manual actions taken to maintain reliability can distort the market outcomes -- the rules and operating procedures can often be modified to improve the consistency of the market and reliability requirements.

- 4 - The Role of Market Monitoring The market monitoring function requires an interdisciplinary team of experts, including:The market monitoring function requires an interdisciplinary team of experts, including: Economists, Economists, Power system engineers; Power system engineers; Generation engineers; Generation engineers; Software developers; and Software developers; and Other professionals with math and statistics. Other professionals with math and statistics. Potomac Economics currently has 14 staff to perform market monitoring.Potomac Economics currently has 14 staff to perform market monitoring. The market monitoring function also requires an extensive market monitoring software system and data interfaces with the ISO.The market monitoring function also requires an extensive market monitoring software system and data interfaces with the ISO.

- 5 - Market Monitoring Activities The monitoring function includes:The monitoring function includes: Real-time screening and analysis to identify circumstances that require further investigation. Real-time screening and analysis to identify circumstances that require further investigation. Investigations of market operations or conduct identified through the daily screening or complaint processes. Investigations of market operations or conduct identified through the daily screening or complaint processes. Periodic analysis and reporting; Periodic analysis and reporting; The market monitoring function does not include:The market monitoring function does not include: Enforcement authority or powers delegated from FERC; Enforcement authority or powers delegated from FERC; Actions to compel participants to change their conduct; Actions to compel participants to change their conduct; Authority to change market rules or procedures; or Authority to change market rules or procedures; or Any other discretionary authority to affect market conduct or outcomes, with the exception of periodic adjustments to the reference levels used in the mitigation measures. Any other discretionary authority to affect market conduct or outcomes, with the exception of periodic adjustments to the reference levels used in the mitigation measures.

- 6 - Real-Time Market Monitoring Effective real-time monitoring requires a highly automated software system to continuously receive data and screen the market results for:Effective real-time monitoring requires a highly automated software system to continuously receive data and screen the market results for: Attempts to exercise market power by withholding resources; Attempts to exercise market power by withholding resources; Running a generator uneconomically and causing a transmission line to become overloaded; Running a generator uneconomically and causing a transmission line to become overloaded; Other inefficient conduct that may indicate potential market design flaws; Other inefficient conduct that may indicate potential market design flaws; Operator actions or actions of control area operators that may undermine the efficiency of the market; Operator actions or actions of control area operators that may undermine the efficiency of the market; The market monitoring system generates automated alerts sent to the beepers and s of IMM staff to ensure real-time monitoring is effective on a 24-7 basis.The market monitoring system generates automated alerts sent to the beepers and s of IMM staff to ensure real-time monitoring is effective on a 24-7 basis. The real-time market monitoring also includes the implementation of prospective mitigation of economic withholding.The real-time market monitoring also includes the implementation of prospective mitigation of economic withholding.

- 7 - Investigations and Complaints Investigations are most often triggered by the real-time monitoring, but can be initiated in response to requests from the States, FERC, market participants, or the MISO staff or Board of Directors.Investigations are most often triggered by the real-time monitoring, but can be initiated in response to requests from the States, FERC, market participants, or the MISO staff or Board of Directors. Investigations are often necessary to evaluate certain conduct that may or may not be anticompetitive.Investigations are often necessary to evaluate certain conduct that may or may not be anticompetitive. For example, we conduct physical audits of certain generator or transmission outages to identify physical withholding; For example, we conduct physical audits of certain generator or transmission outages to identify physical withholding; Although we consult with participants to gather information, we do not attempt to compel participants to change their conduct. Although we consult with participants to gather information, we do not attempt to compel participants to change their conduct. Investigations that indicate anticompetitive conduct or gaming will result in referrals to FERC under a) the sanction provisions of the MISO tariff or b) enforcement provisions of the Energy Policy Act.Investigations that indicate anticompetitive conduct or gaming will result in referrals to FERC under a) the sanction provisions of the MISO tariff or b) enforcement provisions of the Energy Policy Act.

- 8 - Periodic Reporting on Market Performance The primary product of the periodic reporting is an annual State of the Market report that contains:The primary product of the periodic reporting is an annual State of the Market report that contains: An assessment of the overall performance of the RTO markets; An assessment of the overall performance of the RTO markets; Recommendations for changes in the market rules or other provisions to improve the efficiency of the market; and Recommendations for changes in the market rules or other provisions to improve the efficiency of the market; and An evaluation of the conduct of market participants and recommendations regarding changes to the mitigation measures. An evaluation of the conduct of market participants and recommendations regarding changes to the mitigation measures. We also report on the performance of the market to:We also report on the performance of the market to: To FERC staff in regular weekly and monthly meetings; To FERC staff in regular weekly and monthly meetings; The States on a quarterly basis and on specific topics as needed; The States on a quarterly basis and on specific topics as needed; The MISO Board on a monthly basis; and The MISO Board on a monthly basis; and Market participant committees as requested; Market participant committees as requested;