Prepared by John D. Chandley for PJM and Midwest ISO States May 2008 RTO 101: What RTOs Do and Why S ession 1 - System Operations Session 2 - RTO Spot Markets

2 Topics for This Meeting Session 1: Understanding System Operations System operations, dispatch and reliability Many control areas but one grid How RTO dispatch replaces local dispatches to improve reliability How the RTO dispatch automatically creates a spot market Session 2: Advanced RTO Spot Markets Inter-RTO coordination and Joint/Common Markets Day-ahead and real-time markets – two-settlement systems How RTOs support DR, contracting, renewables, climate issues EXTRA: How RTOs meet FERC’s open access requirements

3 Topics for This Meeting (cont.) Session 3: Locational Marginal Pricing Why LMP and not something else? LMP example and observations Session 4: Financial Transmission Rights How FTRs work How FTRs are allocated Are there enough FTRs? Session 5: Resource Adequacy in an RTO Framework The “missing money” problem Path B: Capacity payment approaches to the problem Issues with earlier capacity approaches Reform approaches in NY, NE, and PJM’s RPM Path A: Can MISO avoid a capacity market? Convergence?

4 Understanding System Operations

5 A Utility Is Commonly Thought of as Having Three Major Operational Functions: Distribution... Generation... Transmission... But there is another function – SYSTEM OPERATIONS

6 ISOs and Most Utilities Have a Control Room for System Operations (This is MISO’s; PJM & large utilities have them)

7 System Operators Work in Local Dispatch Centers That Manage “Control Areas” A control area may cover one utility grid/service area, or two or more interconnected grids. An RTO may cover a broad region. There are over 140 control areas in the United States alone. Each control area manages only a piece of an interconnection. In fact, there are only three very large “interconnections.” Dozens of separately owned grids/control areas are interconnected. And energy flows travel throughout each interconnection along all possible paths – the laws of physics dictate this. Each interconnection functions like one huge electrical machine.

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9 Essential Reliability Functions Center Around Each System Operator’s Dispatch Security- Constrained Economic Dispatch & Regulation Security- Constrained Economic Dispatch & Regulation Congestion Redispatch (internal only?) Real-Time Balancing Coordinate Inter-utility Flows w/Others Keep Flows Within Limits Maintain Voltage and Frequency Monitor Flows, Limits & Contingencies Grid Operating Instructions Manage Operating Reserves TLR

10 A System Operator’s Dispatch Matches Supply and Demand Every Second Dispatchers instruct generators how much to generate at each location in each dispatch interval (usually every 5 minutes). = + Losses There’s virtually no “storage” in electricity, so electricity must be generated as it is consumed. Automated “regulation” fine tunes output in seconds to balance supply/demand at all times. Energy dispatch keeps frequency at 60Hz Reactive power dispatch keeps voltage stable These and other actions keep the lights on Supply Total MW Demand Total MW =

11 The System Operator’s Dispatch Also Tries to Meet Demand At Lowest Cost West Nuke East Coal South Gen West Gas East Gas System Load UNCONSTRAINED MERIT ORDER DISPATCH Must run? Running Costs/ Bids ($/MWh) Capacity (MW) Operators try to dispatch economically. $40 $35 $30 $20 $/MWh $50

12 $0 $10 $20 $30 $40 $50 $60 A B D C E F J G H I K M L N O P Q Constrained-Off Unit Constrained-On Unit Unconstrained Merit Order Marginal Cost Or Clearing Price Demand Security-Constrained Economic Dispatch : Congestion Requires Operators to Dispatch Out of Merit Order to Avoid Overloading Transmission. “Redispatch” is Needed, but It Raises Costs Least cost Redispatch Units H & N are the most cost-effective to constrain off and on to relieve the constraint

13 RTOs Are Regional Open Power Pools Power pools solve important reliability and network coordination problems that cannot be ignored. Pools were inevitable.  PJM, ISO-New England and NY ISO started as power pools  California ISO is a power pool for the three large private utilities  ERCOT is a power pool for most of Texas’ utilities  MISO is a new power pool for many utilities in the Midwest.  Large non-RTO utilities created closed pools (Southern, Entergy) How these pools operate explains the basic structure of wholesale electricity markets.

14 An RTO Uses a Regional Dispatch To Replace Local Control Area Dispatches Original Control Area D Original Control Area B Original Control Area C Original Control Area A Regional Security- Constrained Economic Dispatch Regional Security- Constrained Economic Dispatch Manage Congestion Real-Time Balancing Coordinate Flows Keep Flows W/in Limits RTO Functions Monitor Grid Control Grid Operations Manage Reserves Maintain Voltage and Frequency Coordinate with other RTOs TLR

15 RTO Open Power Pools Create Spot Markets Once you create a dispatch power pool, and open it to everyone, it automatically creates a spot market.  Quantity/price offers/bids determine who gets dispatched.  ISO-Pool has to pay generators/sellers for the energy they inject.  ISO-Pool has to charge loads/buyers for energy they withdraw.  ISO-pool has to charge/pay everyone for their imbalances.  ISO must charge/pay for redispatch to relieve congestion. A spot market and spot prices flow directly from the dispatch.

16 RTOs with Standard Core Features Enhance Grid Reliability – And Create Spot Markets RTO Functions Self Schedules In at A, out at B, C to D, etc Bilateral Schedules e.g., A to B Load Bids $/MWh at B Generator Offers $/MWh at A Transmission Usage Charge Pay (LMP B - LMP A) Financially Firm Rights Receive (LMP B - LMP A) Allocate Firm TX Rights Market Inputs Market Support Ensure Reliability Reserves Regional Security- Constrained Economic Dispatch Regional Security- Constrained Economic Dispatch Congestion Redispatch (In lieu of TLR) Real-Time Balancing Co-Optimized Cover Imbalances Buy and Sell Spot Energy Reliably Serve All Loads Use LMPs for Settlements $$$ Calculate Dispatch Prices (LMP) Calculate Dispatch Prices (LMP) $$$

17 Reliability and Spot Markets Are Linked An open spot market arises naturally from...  The reliability necessity of a security-constrained dispatch  The desirability of having an economic (“least-cost”) dispatch  The commercial necessity of paying/charging all parties that use the dispatch at market prices Reliability is supported by spot market prices linked to dispatch.  Prices consistent with the dispatch and offers/bids encourage parties to follow dispatch instructions and use the grid efficiently.  If prices are inconsistent with dispatch, reliability can suffer. (e.g., early PJM, California, etc)

18 The Energy Spot Markets Are “Voluntary” No one is forced to buy energy from the RTO spot markets or sell energy into the spot market Any LSE/utility can self-schedule its own generation to its own loads – load is served at the LSE/utility’s generation costs Any entity can arrange pt-to-pt contracts to serve its loads – load is served at the price of the bilateral contract But parties that use the dispatch/spot market must accept its settlements Parties that have imbalances/deviations settle at spot prices Parties that buy/sell “extra” energy through the dispatch also settle at spot prices.

19 Session 2. Common Features of RTO Spot Markets Day-ahead and real-time markets Inter-RTO Coordination and Joint Market How RTOs support policy options

20 RTO May Operate Multiple Spot Markets There is always a “real-time” spot (balancing) market The Real-time market flows from the real-time dispatch But US RTOs use the same approach to create a day- ahead spot market Day ahead, the RTO accepts schedules, offers and bids. It arranges a day-ahead security-constrained economic dispatch The RTO then prices the dispatch to define day-ahead LMP prices for spot energy and day-ahead usage charges

21 Day-Ahead Market for Day-Ahead Trades Sets Up Real-time Reliability and Dispatch RTO DA Functions Imports and Exports Self Schedules (and virtuals) Load Bids and Forecasts Generator Offers Cash Out FTRs MW * (LMP B - LMP A) DA Inputs DA Outcomes Commitment DA Regional Security- Constrained Economic Dispatch DA Regional Security- Constrained Economic Dispatch Co-Optimized Day-Ahead Schedules Buy and Sell Energy DA (at DA LMPs) Enough Capacity Committed to Meet RT Loads 1 st Settlement at DA LMP Prices Calculate DA LMPs Calculate DA LMPs Reserves Pay Usage for DA Schedules MW * (LMP B - LMP A) Co-Optimized Bilateral data (Financial) (Later) $$$

22 PJM/MISO Use A “2-Settlement” System A party that schedules (or buys/sells) in the Day-ahead (DA) market is in the 1 st settlement: Energy spot sales and purchases at DA spot prices = LMP DA Pays for spot transmission at DA transmission usage prices –Usage charge = MW times (LMP sink – LMP source ) –FTR Credit = MW FTRs times (LMP FTR Sink – LMP FTR Source ) –So... If FTRs match the actual schedule, the FTR credits effectively “hedge” (offset) the transmission usage charge. A party that deviates from its day-ahead schedules in real time is in the 2 nd Settlement: Settles the deviations at the real-time spot prices = LMP RT

23 Real-Time Market = Real-Time Dispatch Deviations From DA Settled at Real Time Prices RTO RT Functions Hour-ahead Import/Export Self Schedules Load Bids Generator Offers Settle DA v RT Deviations (at RT LMPs) Inputs Outcomes RT Regional Security- Constrained Economic Dispatch RT Regional Security- Constrained Economic Dispatch Day-Ahead Schedules Buy and Sell Energy RT (at RT LMPs) Reliably Serve All Loads 2 nd Settlement at RT LMP Prices Calculate RT LMPs Calculate RT LMPs Reserves Pay Usage for RT Schedules MW * (LMP B - LMP A) Co-Optimized Bilateral data (Financial) (Later) Real-time Schedules Uplift $ $$$

24 Interim Coordination Between RTOs Can Partly Reconfigure RTO Boundaries PJMMISO (1) MISO/PJM coordinate flows between them (2) PJM responsible for redispatch for some MISO transmission limits affected more by PJM generation and flows (3) MISO responsible for redispatch for some PJM Tx limits... (4) Substitutes more efficient inter-regional redispatch for TLRs

25 Future Coordination Between RTO Markets Can Create Joint/Common Market PJMMISO (1) MISO & PJM exchange data on constraints, bids, LMP prices (2) MISO & PJM readjust their respective dispatches (3) MISO & PJM exchange data again, etc. (4) Iterations lead to optimized inter-regional dispatch and prices (5) Forms basis for joint/common market = one unified dispatch

26 How RTOs Accommodate Traditional Utility Service Merchant Generation Wind/Renewables Demand Response Retail Choice Carbon Reduction Policies

27 RTOs with These Core Features Support Reliability, Renewables, DR and Contracts RTO Functions Self Schedules Bilateral Schedules Load Bids Generator Offers Transmission Usage Charge (LMP B - LMP A) Efficient Price signals Allocate & Auction FTRs Market Inputs Market Support Ensure Reliability Reserves Regional Security- Constrained Economic Dispatch Regional Security- Constrained Economic Dispatch Congestion Redispatch (In lieu of TLR) Real-Time Balancing Co-Optimized Cover Imbalances Buy and Sell Spot Energy Reliably Serve All Loads Settlements at Spot Prices $$$ Calculate Dispatch Prices (LMP) Calculate Dispatch Prices (LMP) $$$ Contracts Contract or Spot Prices Financially Firm Tx (LMP B - LMP A)

28 The RTO Structure Readily Accommodates Many Public Policy Options - Ownership Traditional utility-owned generation Any State with traditional cost-of-service regulation can continue within the RTO’s regional dispatch. Regulated utility can self-schedule it’s own plants to meet its own loads. If they have outages, they use spot purchases as backup. Utilities free to purchase extra power if needed from spot market, or to sell surplus power to spot market (same as “economy sales”). Retail rates remain under state regulation = cost of service. Independent power generation Merchant plants can contract with utilities and schedule with the ISO. Or they can offer power to the ISO dispatch and sell at spot price. Generators can cover their imbalances by buying from or selling to spot market. Doesn’t change state jurisdiction over retail rates.

29 The RTO Accommodates... Wind Intermittent and Distributed Generation Intermittent power, e.g., wind Wind generators don’t have to “schedule” an unpredictable output. When it generates, the wind generator is contributing to the dispatch, so it receives the spot price (LMP) at its location. Generators with contracts and scheduled deliveries can cover their imbalances from the ISO spot market. RTO accepts delivery at the generator’s location; transmission owner provides the interconnection (costs allocated per FERC rules) Distributed generation Can be treated same as wind. When it generates, it receives the spot price (LMP) at its location for the MWh it produces. It can use net metering settlement feature to account for on-site load Interconnection at the distribution level defined by local utility, and state regulation, just as today.

30 The RTO Accommodates... Demand-side Response/Real-time Pricing Customer demand-side response and real-time pricing RTO spot markets are wholesale; demand side response is either wholesale (by the utility or DR provider) or retail (end-use customers) Utility/DR provider faces the ISO spot prices as incentives. End-use customers face retail rates as incentives, but... With real-time pricing, customers can face spot prices as incentives. Customer sells back its bought energy, at the LMP spot price. Efficient demand side response reacts to the marginal cost of generation in real time. That’s what the RTO spot price is.

31 The RTO Accommodates... Retail Choice with Default Supply ISO spot market supports efficient retail choice and default supply options. All competitive suppliers and LSEs have open access to grid and the ISO spot market to support their supply contracts. Competitive suppliers use the spot market to cover their imbalances. Retailers pay their share of redispatch costs, so allowing retail choice does not shift power or delivery costs from those who shop (commercial/industrial) to those who don’t (residential). No matter what policy applies, the RTO handles grid reliability and wholesale spot market, leaving states free to regulate retail rates and service. Retail choice is a state option, not a federal mandate. The RTO/ISO is neutral on these policy choices.

32 State Default Supply Auctions (Some Retail Choice States Only) Retailer Genco Marketer Declining Clock Auction Picks Lowest Cost Suppliers Auction Bidders 3-yr Contract For Residential 2-yr Contract For small C&I 1-yr Contract For med C&I Auction Winners Sign Contracts with Utility Auction monitors: -- Independent auctioneer -- State PUC D S P p2 p1 Marketer

33 To Reduce Carbon Emissions, We Have to Displace the Coal Plants. It Won’t Be Easy. $/MWh Demand Supply offers Off-peak hours Shortage hours Peak hours Shoulder hours P Off-peak The Coal plants are typically baseload, near the bottom of the dispatch merit order. Without a mandate to retire, you need enough alternatives to push coal plants to the margin. P Shortage P Shoulder P Peak These plants not likely to be coal

34 How RTOs Provide Open Access To All Parties Without Discrimination

35 RTOs with These Core Features Provide Open Access Without Discrimination RTO Functions Self Schedules Bilateral Schedules Load Bids Generator Offers Transmission Usage Charge (LMP B - LMP A) Efficient Price signals Allocate & Auction FTRs Market Inputs Market Support Ensure Reliability Reserves Regional Security- Constrained Economic Dispatch Regional Security- Constrained Economic Dispatch Congestion Redispatch (In lieu of TLR) Real-Time Balancing Co-Optimized Cover Imbalances Buy and Sell Spot Energy Reliably Serve All Loads Settlements at Spot Prices $$$ Calculate Dispatch Prices (LMP) Calculate Dispatch Prices (LMP) $$$ Contracts Contract or Spot Prices Financially Firm Tx (LMP B - LMP A)

36 What Does “Open Access” Mean? Since 1992, the Federal Power Act requires the FERC to:  Prohibit “undue discrimination” in the way jurisdictional transmission owners make their transmission systems available for use by others.  Promote competition by allowing competing generators to have fair access to the grid. In Orders 888/889 (1996) FERC translated this statutory mandate into an “Open Access” requirement:  Transmission owners must provide open access to their systems by others in ways that do not unduly discriminate against those users. Original FERC authority extends only to privately-owned utilities 2005 Energy Policy Act extends FERC authority to public-owned

37 The Golden Rule of “Comparable Access” Grid owners must “Do unto others as...” Under Order 888’s “golden rule”... A transmission owner is required to provide transmission service on its grid to other parties on essentially the same (or “comparable”) basis as the transmission owner provides to itself. But Order 888 doesn’t really apply this principle... And the Order misunderstood the key features of how the system actually operated, especially the meaning of “available transmission capacity” (ATC).

38 Two Basic Problems with FERC’s Approach 1. It ignores the dispatch: Access to transmission and ATC both depend on how the system operators dispatch the system. Changing dispatch changes ATC. 2. It ignores the physics: Scheduling along “contract paths” misses how electricity actually flows and causes congestion. Actual flows don’t follow contract paths.  Comments from NERC and utilities on the open access rules pointed out this serious flaw, but FERC ignored the comments in final rules.  To understand these flaws, and correct the problem, FERC needs to acknowledge how the system actually operates.

39 888: Contract Path Scheduling and TLRs Under Order 888 parties reserve transmission from the grid owner by reserving and paying for a “contract path” with sufficient ATC.  The contract path concept bears little relationship to physical flows.  The contract path is only one of many paths along which electricity actually flows from “source” to “sink” for any given schedule. Although a contract path may be able to accommodate the flows...other possible paths on which the flows actually travel may not be able to accommodate those flows without overloading.  When this happens, control areas must either “redispatch” or “unschedule” the overloaded lines to keep flows within security limits.  System Operators and Reliability Coordinators use “TLRs” -- Transmission Line Loading Relief = curtailment rules set by NERC.

40 Contract Path Scheduling Is Flawed Because It Ignores the Actual Flows/Physics Schedule with flows along the contract path... (not congested)... causes flows on all other paths Control Area A Contract path scheduling needs curtailments (TLRs) to “unschedule” the grid to get flows within security limits Control Area B Control Area C Loop flows can cause congestion (flows above line limits) anywhere along any path 100 MW

41 Why Didn’t FERC Require Redispatch? FERC did not understand transmission service fundamentals:  Dispatch/redispatch is the essential service that provides open access to transmission.  LMP identifies the marginal cost of redispatch. If you can price redispatch service, you can sell it to those who wish to avoid curtailment. Without this understanding, FERC’s Order 888 said that utilities do not have to offer redispatch to 3 rd parties. Instead, utilities may curtail the 3 rd party transactions that would otherwise require redispatch. Of course, without redispatch, operators must use TLR to curtail 3 rd party schedules to relieve congestion.

42 Can We Still Rely On TLRs For Reliability? There may have been a time when primary reliance of TLRs was sufficient to ensure reliable inter-control area grid coordination. With hundreds of TLR curtailments being called, that time is past. TLRs are inadequate because... TLRs can take too long – couldn’t have avoided 2003 blackouts. TLRs often curtail too many schedules, which leaves the grid under- utilized => creates artificial need for more grid investments TLR rules don’t cover all flows, so they discriminate TLRs curtailments ignore economics => higher costs

43 An RTO Uses a Regional Dispatch To Replace TLR within its Boundaries Original Control Area D Original Control Area B Original Control Area C Original Control Area A Regional Security- Constrained Economic Dispatch Regional Security- Constrained Economic Dispatch Manage Congestion Real-Time Balancing Coordinate Flows Keep Flows W/in Limits RTO Functions Monitor Grid Control Grid Operations Manage Reserves Maintain Voltage and Frequency Coordinate with other RTOs TLR

44 FERC Has Approved Inconsistent Access Rules. Only One Meets the Test of Non-Discrimination A non-RTO utility -- does not have to offer redispatch service and need not even make its dispatch open to 3 rd parties for balancing on the same basis as its own usage.  A utility will always redispatch generation and provide balancing to accommodate its own schedules to serve its own loads. No TLRs.  But it will not redispatch generation to accommodate 3 rd party schedules. It uses ATC limits without redispatch to limit access to the grid. It imposes TLRs and charges arbitrary prices for balancing.  This is inherently discriminatory and leads to higher cost (re)dispatch. An RTO -- offers redispatch service to every user willing to pay the marginal cost of redispatch; it also offers balancing to all at LMP.  It finds the lowest cost redispatch to solve congestion across the region.  It uses LMP to price this redispatch and LMP to price imbalances.  Redispatch marginal costs = the difference in LMP at A and LMP at B.  Every user willing to pay this cost receives redispatch service. No TLR.

45 All Previous FERC Orders Fell Short Order 888/889 – decreed “open access,” but conceptually flawed Based on contract path scheduling, inconsistent with physics Ignored access to dispatch, restricted access to balancing Without LMP, pricing for imbalances was discriminatory Allowed those with 888-compliant OATTs to continue discrimination Order 2000 – saw the need for a balancing market, but didn’t clearly connect this to the ISO’s real-time dispatch. The two are the same. Led to confusion about who/how to provide balancing market Slowed efforts to create regional dispatch and spot markets FERC liked LMP at PJM/NY, but didn’t require it in new ISOs Left confusion over ISO vs Transco, different RTO functions, etc. –“Alliance RTO” was a two-year waste of time, money FERC’s current Open Access Order 890 is a retreat to the flawed Order 888 model. It will sanction undue discrimination again.

46 The RTO Model Works. What Else Works? RTO Model is based on open access to a regional dispatch and associated spot market, using LMP. That model provides:  Regional power pool to lower costs, improve reliability  Open access to transmission without discrimination  Reliability supported by the right incentives  Support for markets and traditional cost-of-service regulation  Support for demand response and renewables (wind)  Compatible with physics and how the system actually works...  Preserves state jurisdiction at utility/retail level So far, no one has developed an alternative to this model that meets all of these criteria.

47 Extra Slides

48 RTO Reliability Functions and Benefits An RTO that offers a bid-based security-constrained economic dispatch and related monitoring tools across its region can... Internalize regional loop flows and congestion in a large region Solve congestion region-wide every 5 minutes, before it happens, and solve much of it day ahead with bid-based day-ahead markets Replace reliance on TLRs within its regional dispatch area Monitor and react quickly to grid problems on a regional basis Vastly simplify the coordination needed to ensure regional reliability Facilitate reserve sharing and reduce operating reserve requirements (diversity is more reliable and saves money)

49 Generators Depend on the Highest-Price Hours To Recover Most of Their Fixed Costs $/MWh Demand Supply offers Off-peak hours Shortage hours Peak hours Shoulder hours P Off-peak Low-price hours barely cover operating costs P Shortage P Shoulder P Peak Contributions to Fixed Costs

50 Before RTOs, Many Small Control Areas Made Reliability Harder and More Costly Actions here affect flows there – it’s one interconnected grid Coordination is challenging, unforgiving – every operator must do his/her job and let neighbors know quickly about problems. A single control area’s problems can black out a huge area -- the August 14, 2003 blackout began in Ohio, but quickly spread to NE. Economic dispatch is balkanized – each local dispatch is less efficient than it could be: we pay more in each area. Market power is easier to exercise -- the entity that controls the dispatch controls grid access, imbalance pricing, curtailments, etc.

51 State Auctions Don’t Decide ISO Dispatch State Auction Winners...  Receive contracts with the utility to serve a slice of the utility’s demand.  Can meet their contract obligations via self-generation, contract purchases or purchases from ISO spot markets.  These financial arrangements don’t dictate physical dispatch. All generators are eligible for ISO Dispatch  Every generator is free to offer it’s power to ISO for real-time dispatch ISO will select the lowest-cost offers that can meet demand and satisfy reliability requirements. Whether a generator has a default supply contract is irrelevant.  And any generator can sell power in ISO’s day-ahead market.

52 Security- Constrained Economic Dispatch & Regulation Security- Constrained Economic Dispatch & Regulation Congestion Redispatch (internal only?) Real-Time Balancing Coordinate Inter-utility Flows w/Others Keep Flows Within Limits Monitor Flows, Limits & Contingencies (with state estimator) Grid Operating Instructions (toTxowners) Manage Operating Reserves (with contingency analysis) TLR With Many Local Dispatches, the Weak Link in Reliability Is the Time It Takes to Readjust Inter-CA Flows. “Interchange” is Preset and Fixed Every Min Timing: Flows = near light speed AGC – regulation = seconds Internal/local dispatch = 5 min Adjust Inter-CA schedules = min Control Area A Control Area B Control Area C