Automation and Improvements to Default Uplift Methodology (summary/white paper of a draft NPRR)

Overview This NPRR automates the current manual process for default uplifts provides reporting using the automation functionality improves the default allocation methodology by – netting energy purchases and sales to account for risk profiles, and – using the sum of dollar amounts (AMT) instead of the sum of MWh quantities (QTY)

Background The current methodology is not transparent and over-assigns risk to certain activity inappropriately. It was developed for the nodal market prior to go-live, because all default risk from the real-time market (and the zonal market) was allocated only to load on a load ratio share, while the nodal market was set to merely short pay sellers in the DAM, which raised significant concerns about liquidity drying up in the DAM in an ongoing default situation.

Background The current Protocols calculate each participant’s “Maximum MWh Ratio Share” in a somewhat onerous, manual work process for ERCOT. At a high level, ERCOT determines each Counter Party’s highest participation level, such as load, generation, CRR activity, or physical trading activity. – This is used as a numerator in the default allocation ratio. Then the sum of all Counter Parties Maximum MWh numerators is used as the denominator in the default allocation ratio.

The case for automation By automating the default uplift calculation, ERCOT Counter Parties can – get valuable insight into their default uplift risk – better manage that risk. Because a Counter Party can only calculate their own numerator, but the denominator is based on confidential information, no Counter Party can shadow or determine their default uplift risk – can be significant with today’s higher offer caps.

WMS Presentation ERCOT Staff gave a presentation on a theoretical November 2013 default using initial settlement data, which showed that: – 33% of the uplift went to Counter Parties whose Maximum MWh was from energy purchases – 31% of the uplift went to those whose Maximum MWh was from CRR ownership – 28% went to those whose Maximum MWh for the month was from energy sales – This led to more than 90% of the uplift being assigned to these Counter Parties.

First Issue Raised by Presentation plift methodology doesn’t allow for netting between firm energy trades – By disallowing netting of energy purchases and energy sales, the current methodology assigns default risk to Counter Parties that create zero risk – For example, NGX physical products – Same MWs can be bought and sold many times over the course of several months. – Strong incentive created for financial transactions instead of physical ones.

Second Issue Raised by Presentation The default uplift methodology uses the quantity of MWh instead of the amount of dollars. – This leads to the significant over-representation of CRR activity Energy trades, generation, and load settle at the full energy price in ERCOT settlements, because they represent the actual production, consumption, or transfer of energy, while CRRs only settle for nodal price differences – Yet they’re treated at the same value in the default formula – if a CRR issue led to the default, it is likely that CRR value will be much higher, leading to a higher allocation to CRR Counter Parties at the appropriate time.

Questions? Eric Goff