1. Anjali Sheffrin, Ph.D. Chief Economist & Director, Market Design & Product Development Essential Features of California’s New Market Design Market Redesign and Technology Update (MRTU) APEx 2007 Program October 15-16, 2007

2. Anjali Sheffrin 2 Overview of California control area Serving 30 million consumers in PG&E, SCE, and SDG&E and many municipal utilities Heat storm in 2006 with peak load of 50,270 MW on July 24,2006 43,000 MW of available generation capacity at peak after derates for hydro, wind and outages 9,260 MW net imports on peak hour California ISO Markets  Real-time balancing energy  Day ahead and hour ahead operating reserves (Reg-Up, Reg- Dn, Spin, Non-spin)  Resolves zonal congestion day ahead  New locational marginal pricing market on March 30, 2008 Imperial Valley Miguel N.Gila Palo Verde Devers Lugo Mohave Eldorado McCullough Market Place Sylmar Pac DC Mead Vincent SF NP15 ZP26 SP15 Path 26 COI AZ3 Path 15 Mexico LA4 LA2

3. Anjali Sheffrin 3 Market prices spiked during the Energy Crisis, but have been stable over past six years

4. Anjali Sheffrin 4 What were the key causes of the California Energy Crisis of 2000 - 01? Acknowledged Causes of the Crisis  Lack of forward energy contracting  Unexpected dry hydrological conditions  Key transmission constraints  Flawed market rules  Insufficient enforcement tools for market manipulation and market power

5. Anjali Sheffrin 5 Essential Features of MRTU  Core features of MRTU: –Use of the Full Network Model –Day-Ahead Market consisting of an Integrated Forward Market and Residual Unit Commitment –Real-Time Market including an Hour Ahead Scheduling Process –Allocation of Congestion Revenue Rights –Market Power Mitigation measures –“Perfect Hedge” of congestion charges for existing contracts and transmission ownership rights  Establishes Resource Adequacy requirement but defers details to Local Regulatory Authorities (with ISO backstop)  Solicits Demand Response proposals

6. Anjali Sheffrin 6 How can California ensure the crisis will not re- occur?  Significant improvement in infrastructure and forward contracting issues –Long-Term Procurement and Resource Adequacy rules (CPUC, CEC, CAISO, Legislature, Stakeholders) –New infrastructure development process (CAISO, CPUC, CEC, Legislature)  Response to flawed market rules –MRTU (Nodal design rather than zonal)  New enforcement tools in place –FERC Market Behavioral Rules –FERC expanded enforcement under EPAct 2005

7. Anjali Sheffrin 7 How are existing design flaws being addressed? Current FlawSolution under MRTU 1. Infeasible schedulesEnforce 3,000 node detailed network model that creates feasible day-ahead transmission schedules 2. Lack of price transparencyProduces transparent marginal prices that reflect true cost of serving load, and more accurately allocates costs to grid users based on “cost-causation” principles. 3. Disconnect between generators operating incentives and grid reliability requirements Aligns market rules and prices with grid operating requirements (reliability) in producing locational prices which inform generator operation 4. Assumption that market-driven investment will produce sufficient supply Complements Resource Adequacy procurement to assure best mix of supply is operated to serve load 5. Vulnerability to manipulation and exercise of market power Local market power mitigation measures address market power concerns. Combined with forward-contracting requirements (RA), protects consumers from market power and manipulation.

8. Anjali Sheffrin 8 Steps in Preparation for MRTU Start-up  Several FERC Technical Conferences on: –Seams Issues –Resource Adequacy Import Capacity Allocation –Business Practice Manuals  Long-Term Transmission Rights Final Rule –Complete stakeholder process and comply with FERC Final Rule by filing proposal on January 29, 2007  Recent Outreach Activities with Western Parties –WECC Board and Subcommittee meetings –Meetings with WestConnect and WestTrans members –Seams Working Group being formed – first meeting in November 2006

9. Anjali Sheffrin 9 CAISO and Market Participant Readiness Will ensure that people, processes, and technologies are ready Market Readiness Metrics Over 100 metrics being developed to evaluate readiness Internal CAISO Readiness Business process definition, training and knowledge transfer External Market Participant Readiness Participant Readiness Advisory Group Implementation workshops and working groups Market Participant instructor-led and self-study courses MRTU Bulletin Board (Blog) to facilitate knowledge transfer Market Participant surveys targeting readiness tasks Market Simulation Program Step-by-step process – starting with basic connectivity tests leading to bid-to- bill market processes simulations

10. Anjali Sheffrin 10 Conclusion: MRTU is right for California and the West  MRTU combined with the CPUC’s Resource Adequacy rules directly addresses the causes of the 2000-01 Electricity Crisis.  Complements long-term procurement and transmission planning processes resulting in efficient and timely investment  MRTU will increase reliability, accommodate bilateral transactions, provide better information to guide locational operation and investment decisions, promote west-wide trading, mitigate seams issues, produce just and reasonable prices.