10/4/20021 Systems Analysis Advisory Committee (SAAC) Friday, October 4, 2002 Michael Schilmoeller John Fazio

Northwest Power Planning Council 2 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items

Northwest Power Planning Council 3 Background Description of decision framework, called Portfolio Analysis Overview –Review the approach and tools we have used in the past to prepare power plans –Describe what has changed –Describe the proposed approach Background

Northwest Power Planning Council 4 Traditional Resource Planning Determine mix of resources (power plants and demand-side measures) that minimize expected cost of meeting requirements 20-year or longer time horizon Regional perspective Considered uncertainty or variability in hydroelectric generation, loads, fuel prices, but did not value risk explicitly (Issac) Background

Northwest Power Planning Council 5 Existing Tools Aurora –systems analysis of Western System –market price prediction Genesys –reliability assessment focused on NW –addresses uncertainty in loads, resource availability and hydro energy Background

Northwest Power Planning Council 6 What has changed? Market prices: –Before – Uncertainties small relative to other sources of uncertainty Prices assumed predictable from supply and demand Regional loads and resources determined reliability Background

Northwest Power Planning Council 7 What has changed? Market prices: –Now – Market prices seen as significantly more volatile, “stickier,” less predictable from supply and demand Most utilities exposed to market for part of load Activities outside the region can be critical to market price Reliability can be influenced by credit problems Available markets provide hedging and risk management opportunities that are incorporated into capacity addition decisions Role of individual participants in the region was de- emphasized. Now we think of behavior as “bottom- up.” Relevance to the energy crisis. Background

Northwest Power Planning Council 8 Issues in the Fifth Plan incentives for generation capacity price responsiveness of demand sustained investment in efficiency information for markets fish operations and power transmission and reliability resource diversity and distributed generation role of BPA global change lessons learned from Background

Northwest Power Planning Council 9 Issues in the Fifth Plan The role of risk incentives for generation capacity price responsiveness of demand sustained investment in efficiency information for markets fish operations and power transmission and reliability resource diversity and distributed generation role of BPA global climate change lessons learned from Background

Northwest Power Planning Council 10 Issues in the Fifth Plan Examples Incentives for resource development –Energy value of a combustion turbine in traditional analyses is associated with expected generation –Capacity value is associated with the “insurance value” of the turbine (Important to dealing with hydro uncertainty) Price responsiveness of demand –Value depends on the number of hours of market prices over some relatively high threshold –Exact duration of future market prices at various levels is unknown Background

Northwest Power Planning Council 11 Existing Tools Aurora –Can test sensitivity to loads, hydro Genesys –Detailed analysis of reliability risks associate with hydro generation, loads, power plant availability But, –Both are computationally intensive –Neither is a generalized risk model –Neither can perform cost minimization subject to risk constraints Background

Northwest Power Planning Council 12 Portfolio Analysis Stock portfolio –Collection of risky assets with differing maturities –Correlation is important, risks can offset or reinforce each other –Maximize return, subject to a constraint on risk Analogous –Plants, conservation, and contracts are assets –Sources of risk are correlated –Roughly same objective But different. For example … –More than just price risk: also requirements and cost risk –Quantity of asset can vary with market prices Background

Northwest Power Planning Council 13 What is a “resource portfolio,” exactly? Hourly demand Coal Buy in Market Sell in Market Gas Fired Price-driven generation Hydro Contracts Hydro Total Resources Year 1 SummerWinter Year 2 SummerWinter Background

Northwest Power Planning Council 14 How do we determine risk for our “portfolio?” Choose a set of correlated values for monthly hydro, monthly loads, monthly fuel prices, monthly market prices for electricity, etc., etc. Calculate the cost of our portfolio Return to step 1 as many times as necessary to obtain a sample distribution that adequately describes the underlying distribution of costs Background

Northwest Power Planning Council 15 Portfolio Analysis Possible measures (“goal”, “objective”) –Minimize expected annual cost, given a fixed dollar constraint on 10 percent “worst outcomes,” or –Minimize the variance of rates over a given time frame, or –Minimize the likelihood of large rate increases, or …. Background

Northwest Power Planning Council 16 Portfolio Analysis, Example Before resource additions: We want minimum expected annual cost, such that the chance of exceeding $25,700 M is less than 10 percent …but portfolio analysis tells us we have a problem …. Background

Northwest Power Planning Council 17 Portfolio Analysis, Example After addition of CCCTs, renewables, conservation, price- responsive demand programs, and so forth, our objective is achieved, but at some increase in expected cost Frequency Chart of Annual System Cost Simulations $M Mean = % Risk limit = GoodBad Background

Northwest Power Planning Council 18 Portfolio Analysis Initial questions –Which measures make sense for the region in the short and long-term? –What kinds of portfolios would benefit, in terms of risk management, from which measures in the short and long term? How much benefit is there? This information provides the rationale for the policy choices necessary to achieve implementation of preferred portfolios Background

Northwest Power Planning Council 19 Portfolio Analysis Prototype model –Excel workbook running crystal ball –Sixty months of on- and off-peak data for (dynamic) thermal plant dispatch, hydro, loads, contracts, conservation, market purchases –Single 200 x 100 cell worksheet –500 simulations in one and a half minutes Background

Northwest Power Planning Council 20 Background Summary Reviewed the approach and tools we have used in the past to prepare power plans Described what has changed Described the new approach Background

Northwest Power Planning Council 21 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items Objectives

Northwest Power Planning Council 22 Objectives of SAAC Peer review of assumptions, data, and technique Sharing of techniques and information –What has worked; what has not –Which portfolios benefit from particular measures; which do not, and why –Operational or administrative rules for risk management Evaluate the specific Issues Developing a portfolio assessment tool for practitioners Objectives

Northwest Power Planning Council 23 Principles Significant to strategic risk issues –“Does this threaten our extinction?” Transparency Quantitative analysis, but in the service of insight and communication Objectives

Northwest Power Planning Council 24 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items Terms and Concepts

Northwest Power Planning Council 25 The Language of Decision Analysis Frequency-based vs subjective probabilities Volatility vs uncertainty Variation over time vs volatility Risk and risk metrics Operational vs financial risk Long and short positions Volume, price, and cost risk Markets: energy, capacity, operating and spinning reserve, load following, regulation; spot and forward Terms and Concepts

Northwest Power Planning Council 26 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items The Portfolio Model

Northwest Power Planning Council 27 What is a “resource portfolio,” exactly? Hourly demand Coal Buy in Market Sell in Market Gas Fired Price-driven generation Hydro Contracts Hydro Total Resources Year 1 SummerWinter Year 2 SummerWinter The Portfolio Model

Northwest Power Planning Council 28 Flow diagram: Monte Carlo The Portfolio Model

Northwest Power Planning Council 29 Flow diagram: Optimization The Portfolio Model

Northwest Power Planning Council 30 The 40,000 Foot View The Portfolio Model correlations and volatilities decision variables interest rate, hours per period chronological structure of uncertainty conservation assumptions conservation calculations

Northwest Power Planning Council 31 The 40,000 Foot View The Portfolio Model input calculation on-peakoff-peak random variables

Northwest Power Planning Council 32 The 40,000 Foot View The Portfolio Model annual and study cost calculations and metrics

Northwest Power Planning Council 33 The Excel Model A Tour A Demonstration Some Results Tour of Crystal BallCrystal Ball The Portfolio Model

Northwest Power Planning Council 34 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items Using Tools to Make Decisions

Northwest Power Planning Council 35 Study Flow Using Tools to Make Decisions

Northwest Power Planning Council 36 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items Outcomes and Milestones

Northwest Power Planning Council 37 SAAC Meetings Friday, Oct 4 Thursday, Oct 24 Friday, Nov 22 Thursday, Dec 19 Thursday, Jan 16 Thursday, Feb 20 Thursday, March 20 Outcomes and Milestones

Northwest Power Planning Council 38 Thursday, Oct 24 Metrics –Candidates and their application Representations in the portfolio model –** Plan Issues ** –thermal generation –hydro generation –conservation and renewables –loads –contracts –reliability Outcomes and Milestones

Northwest Power Planning Council 39 Friday, Nov 22 Natural gas prices –Sumas, AECO, Rocky mountains –historical and monthly forwards and volatilities –correlations with other variables –subjective forwards Hydro generation –historical and monthly forwards and volatilities –correlations with other variables Outcomes and Milestones

Northwest Power Planning Council 40 Thursday, Dec 19 Electricity prices –Mid-C, COB –historical and monthly forwards and volatilities –correlations with other variables –subjective forwards Loads –historical and monthly forwards and volatilities –correlations with other variables Outcomes and Milestones

Northwest Power Planning Council 41 Thursday, Jan 16 Review of risk management problems of –What worked and what did not Initial optimization for Region, using all mechanisms Outcomes and Milestones

Northwest Power Planning Council 42 Thursday, Feb 20 Identifying “ideal” portfolios for each measure price responsiveness of demand traditional supply-side alternatives sustained investment in efficiency transmission and reliability resource diversity and distributed generation Outcomes and Milestones

Northwest Power Planning Council 43 Thursday, March 20 Wrap up!! Outcomes and Milestones

Northwest Power Planning Council 44 Agenda Background Objectives Basic Terms and Concepts The Portfolio Model Using the Portfolio Model and Other Council Tools to make Decisions Milestones for the SAAC Process Action Items

Northwest Power Planning Council 45 Action Items for Oct 24 Be prepared to discuss items Locate sources for the kinds of information we will be needing at future meetings Action Items

Northwest Power Planning Council 46 See you on the 24th! Fine

Northwest Power Planning Council 47 Probability Frequency-based Probabilities –Volatility –A sample of the distribution is manifest hydro variability, load, gas price variability within the relevant time period (year); mean is relevant –Normal variation in gas prices within a year Subjective Probabilities –Uncertainty –Only one outcome will manifest –Example: carbon tax, economic recession Terms and Concepts

Northwest Power Planning Council 48 Risk and Risk Metrics Risk is probability of unfavorable outcomes –This definition is not universal Risk metrics are how we measure outcomes to determine whether one is worse than the other –Example of one-tailed test Terms and Concepts

Northwest Power Planning Council 49 Operational and Financial Operational Risk Financial Risk Terms and Concepts

Northwest Power Planning Council 50 Price and Volumetric Risk Long and Short Positions Price risk –potential exposure to unfavorable prices Volumetric risk –potential exposure to unfavorable quantities or positions Cost risk –potential exposure to unfavorable costs Terms and Concepts

Northwest Power Planning Council 51 Electricity Markets By its nature, distinct markets for electricity exists for different locations and times Terms and Concepts Variation vs Volatility The prices in the figure at the right have NO volatility

Northwest Power Planning Council 52 Electricity Markets Different markets exist for –Regulation –Load following –Spinning Reserve –Operating Reserve –other Capacity Terms and Concepts

Northwest Power Planning Council 53 Electricity Markets Different markets exist for –Forwards –Spot (hour-ahead forward?) Terms and Concepts