1. 1 PRR 776 in the Context of the ERCOT Market Design Eric S. Schubert Regulatory Affairs Advisor BP Energy Company

2. 2 Concerns about PRR 776 PRR 776 could undermine successful ERCOT energy-only market design Unintended consequences of proposal – PRR 776 could be problematic Ancillary service procurement Real-time reliability Long-term resource adequacy – Demand-response justification likely undermined by the consequences of parameters in PRR 776 Haste makes waste – Very little debate and review of proposal relative to market impact – RDF proposal was significantly improved by being remanded

3. 3 Pricing in the ERCOT Balancing Energy Market Limited debate over PRR 776 has shown some potential misunderstandings – “Spot market prices always settle at short-run marginal costs in other U.S. markets” – “High offers by generators that cause high MCPEs in ERCOT are inappropriate” Need to put market offers and clearing prices in ERCOT into larger perspective

4. 4 Resource Adequacy in Non-ERCOT Markets in the United States Loads: Mandatory contracting to cover spot market exposure – Centralized capacity auction (PJM, ISO-NE; 3-5 years ahead) – Bilateral capacity contracts (MISO: 30 days or more ahead) Generators: Mandatory participation in spot market – Earn revenues above their marginal costs outside the spot market – Accept a “must-offer” requirement into spot market Loads cover investment risk of generators in exchange for limited price risk associated with real-time redispatch FERC has recognized the need for shortage pricing to maintain – Reliability in real-time – Resource adequacy in the long run

5. 5 Resource Adequacy in the ERCOT Market Resource adequacy mechanism in PUCT Substantive Rules 25.504 and 25.505 is unique within the U.S. – Allows retail and wholesale markets flexibility in contracting by placing Investment risk on generators Price risk on loads – Addresses system-wide market power through “small fish swim free” During the rulemaking process, the PUCT was told by – Retailers and industrial loads that they would accept price risk to avoid capacity payments seen in PJM – Generators would accept investment risk if they were allowed to make offers above short-run marginal costs Resource adequacy in ERCOT functions when investment risk for generators and price risk for loads are in rough balance “Small fish swim free” approach was approach chosen by PUCT to balance investment risk and price risk

6. 6 Unintended Consequences of PRR 776 Disrupts balance between price risk and investment risk Artificially lowers spot price – Resource Adequacy impact: Reduces ability of generators to cover their fixed costs – Reliability impact: Increases demand and lowers supply for real-time energy Forces ERCOT to procure more RPRS – Increase uplift to loads because of a lack of direct assignment of RPRS procurement costs – Loads that short the market will have other loads pay for starting generation that was out of the money

7. 7 Demand Side Fallacy Beginning Nov. 1 st, NSRS has been procured for all intervals – The $175 cap could serve as a de facto hard price cap for the real-time market – ERCOT will procure RPRS or OOMC to cover the shortfall – If RPRS or OOMC is procured, real-time price for energy often falls and undermines the price signal needed for demand response

8. 8 PRR 776 Could Endanger ERCOT Energy-Only Market ERCOT is unique – Allows loads to prudently manage their contracts up to real- time – Designed to work with successful ERCOT retail market There is no free lunch for loads that want to chronically short the market – Greatly upsets the balance between supply and demand, price risk and investment risk – Alternatives to current market design would greatly reduce the ability of loads to manage risk through voluntary bilateral contracting

9. 9 Requested Action by TAC Remand PRR 776 to WMS on a timeline to address issues Review tradeoffs in ancillary service pricing, uplift, reliability, and long-term resource adequacy Work with ERCOT staff and ERCOT IMM to determine software capabilities and parameter estimates