Why the Electricity Markets Do Not Work It’s The Load Duration Curve Ken Bekman Restructuring Roundtable October 18, 2002

Introduction The Load Duration Curve Basic Assumptions Analysis of 2001 Curve How Did This Happen Conclusion Fixing the Problem

Basic Assumptions 2001 Load System Peak of Approximately 25,000 MWs Reserve Requirement of 12% Total Capacity Requirement 28,000 MWs Demarcation Between Base Load and Other Resources Arbitrarily Set at 15,000 MWs

Analysis of Curve 28,000 MWs of Capacity is a REQUIREMENT to assure reliability. The first 15,000 MWs Represent the ‘True’ Commodity Portion of the curve. The Top 13,000 MWs will NEVER exhibit the properties of a commodity. There is NO competitive industry that can rationalize building 45% of its capacity to operate at a 7% Capacity Factor to serve 6.2% of its load. An analysis of the top 500 Hrs (energy supplied by peakers) shows a revenue requirement in excess of $500/MWHr above fuel cost to recover capital costs and a reasonable return.

How Did This Happen? The Good Old Days. Capital Costs were recovered through rates. Surplus Energy was traded at close to marginal cost. Expected Results of Deregulation. Capital Costs will be recovered from capacity markets or ‘option’ premiums (reservation fees). Energy would trade at close to marginal costs or absent capacity markets exhibit high volatility. Reality. Capacity markets failed to materialize. Volatility suppressed by market rules and fear of price gouging and gaming (California/ENRON fallout). Without volatility there is no need to hedge hence no ‘option’ market.

Conclusion The current market model fails to compensate generation for capital at risk. The market design failed to address the fact that almost half the capacity supplies less than 10% of the energy. Without a significant change in the market design the current liquidity crisis can only grow and the possibility of a reliability crisis only looms larger (Southwest Ct) because of: Economic failure of current participants. Failure to attract new entrants.

Fixing the Problem Requires Collaborative Process Should Build on Current Work Joint Capacity Adequacy Group (JCAG) NYISO ICAP Working Group Applicable for all the 3 Northeast Pools Working Group Established in ISO-NE Kick-off Meeting 10/02/2002