1. 1 WHY WE NEED AN ICAP MARKET IN NEW ENGLAND Presentation By: Dr. Richard A. Rosen Tellus Institute Boston, MA To: Massachusetts Electric Restructuring Roundtable Date: February 16, 2001

2. 2 Key Role for an ICAP Market 1.Without an enforceable ICAP market you get supply shortage like California. 2.Without a workably competitive ICAP market there is no other way to have a workably competitive energy market. (I will ignore ancillary services for simplicity.)

3. 3 Key Role for an ICAP Market (Continued) 3.You could not monitor the energy market if there is no ICAP market to determine if it is competitive. 4.Because, the recovery of energy and capacity costs get conflated with each other.

4. 4 Consequences 1.If you can not establish a workably competitive capacity market, you have to abandon trying to create a competitive spot market. 2.You need to rely primarily on bilateral contract market, with a minor (less than 5%?) energy balancing function, as FERC has proposed for California. 3.Remaining Question – Can a pure bilateral contract market be made workably competitive? (Maybe not)

5. 5 What is Wrong with the ISO-NE ICAP Market? 1.It is monthly, not seasonal or annual. This makes no sense for installed capacity. 2.The monthly charge is too low for peak season/annual demands, thus price signal to get capacity in the ground is wrong. 3.Thus, the $8.75/kW-month cap should become something like $40/kW-year, pure peaking capacity on an annual basis. (Actually, the market may clear lower due to fixed margins in the energy market.)

6. 6 Problems with Monitoring for Market Power in the Energy Market 1.Without an ICAP market, one can not know how much of the energy market clearing price is the cost of energy vs. the cost of capacity. 2.Therefore, no challenge to any particular set of energy bids is possible based on a claim of the exercise of market power. 3.Could only detect market power by analyzing the profit margins of all of an owners generating unit in a given market. (No one has supported this approach because what would you do once you know?)