dr valuation ron-01 phase 2 proposal

DR Valuation RON-01 Phase 2 Proposal

January 31, 2006

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory

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Presentation Overview

• Objectives and Process

• Approach: Phase 1 Findings• Valuation Framework

• Standard Practice Approach

• Gaps in Standard Practice

• Phase 2 Proposal

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Objectives and Process


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Starting Point

1. Broad definition of DR: Our proposed valuation approach is suitable for evaluating

• Both Price-based (e.g., RTP, CPP and TOU) and Quantity-based (interruptible/ curtailable, cycling/ load control, and demand subscription) programs

• Programs implemented by utilities, scheduling coordinators, or CAISO

• Both voluntary and mandatory rates

2. Integration of value and rates: Our DR Valuation and DR Rate Design research proposals are integrally tied together


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Linking DR Valuation & Rate Design• Overall objective of Phase 2: Integrate DR

Design and DR Valuation to maximize benefits for California energy consumers

Develop High PotentialDR Designs

DR Rate & Program Design RON

screens

Identify and Address Gaps in Existing

Standard Practice

DR Valuation RON

Develop New Standard Practice for

Valuation


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DR Valuation Phase 2 Objective

• Objective: Develop a valuation methodology that fully and consistently captures the costs and benefits of a wide variety of DR programs types

Interruptible / Curtailable RatesTime of Use (TOU) RatesCritical Peak Pricing (CPP)Real-time PricingDemand Subscription ServiceProgrammable Communicating Thermostats (PCTs)Other dynamic, enabling technologiesEnd-use Cycling; A/C, Pool Pump, and others


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Need for a New Standard Practice• Expanding existing valuation to address DR will provide

significant value to California’s electricity consumers. • The inconsistency among valuation methodologies is

demonstrated by the utility DR filings in California over the last 18 months.

• The CPUC in Decisions D. 04-07-028, D. 05-01-056 and D. 04-12-048 established preliminary avoided cost estimates

• PG&E’s Valuation of CPP, (2005) was developed using both the CPUC AMI business case numbers and its own internal valuation methodology.

• Valuation of Programmable Communicating Thermostats (2005) for the 2006 new building standards

• Both SCE and PG&E have filed avoided generation capacity cost testimony in the respective rate cases.

• In the existing utility generation procurement rules there was a negotiated settlement that established how much DR would be counted to meet a scheduling coordinators planning reserve requirement.


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Vision of New Standard PracticeNew Standard Practice for Dispatchable Resources• Desired characteristics:

• Fully documented and transparent• Consistent valuation across all dispatchable resources • Clearly define differences between non-dispatchable

(DSM) and dispatchable (DR) resources • Full use of publicly available market price data • Not dependent on the use of proprietary data or models

• Process: Use consultation process similar to successful EE avoided costs to develop new valuation standard for dispatchable resources.

• Schedule goal: Complete prior to Phase 3 of CPUC’s avoided cost proceedings beginning in late 2006.


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Phase 3 of CPUC Avoided Cost Proceeding

• Stated Goal of Proceeding• “…address long-run avoided cost forecasts and

calculations and the potential use of the E3 avoided cost methodology to calculate long-run avoided cost for use in valuing other resource options and programs.”

• “…continue to focus on the development of a common methodology, consistent input assumptions and updating procedures to quantify all elements of long-run avoided cost across the various Commission proceedings.”

• Schedule• Schedule to be issued following the proposed

decision on the consolidated QF policy and pricing issues (Hearings begin Jan. 28, 2006, reply briefs due Mar. 17, 2006).

• We expect Phase 3 to begin at the end of 2006.


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Team is Designed for Research Objective

Each member of the E3 Team contributes specific expertise to address complex California electricity market issues:

E3 Team Member

Primary Research Focus

Key California Market Issues

E3, Utilipoint/ Neenan, LBNL

Impact of evolving market structure on cost effective design

• Ancillary Services• 2007 nodal market structure• Capacity market• 2006 Avoided Cost proceedings

HMG, FSC Technical potential and customer acceptance

Evolution of DR pricing to capture• enhanced enabling technologies• enhanced metering technologies• customer acceptance & program enrollment• customer response


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E3 Research Team

* team leader

Team

Ren Orans*

Snuller Price

C.K. Woo

Brian Horii

Jim Williams

Roles

Overall Integration

Rate & Tariff Design

CA Regulatory Context

CA Energy Markets

Energy & Environmental Economics, Inc.

Team

Bernie Neenan*

Donna Pratt

Peter Cappers

Richard Boisvert

Roles

Eastern EnergyMarkets

DR ProgramEvaluation

Dynamic Pricing

Utilitpoint/Neenan Associates

Team

Chuck Goldman*

Galen Barbose

Ryan Wiser

Mark Bollinger

Roles

RTP Rate Design

Western EnergyMarkets

DR ProgramEvaluation

Lawrence Berkeley National Laboratory

Energy Markets and Policy Group

Team

Doug Mahone*

Jon McHugh

Matt Tyler

Heather Larson

Roles

Building Science

Simulations

CA BuildingStandards

Technical Potential

Heschong Mahone Group

Team

Michael Sullivan*

Grayson Heffner

Kent Van Liere

Dan Engel

Chris Ann Dickerson

Josh Bode

Roles

Consumer Research

Participation Rates

Program Marketing

International DRPrograms

Freeman Sullivan & Company

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Approach: Phase 1 Research Findings


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Phase 1 Research Findings

• Current Valuation Framework• Cost Minimization• Other Important Characteristics • Resource Portfolios• Reliability

• Standard Practice• What it Does Do• What it Doesn’t Do

• Existing Avoided Cost Components• Need for New Standard Practice • Summary of Gaps in Standard Practice


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Current Valuation Framework

Objective

• Minimize Cost of Delivered EnergyUnder existing framework, DR has only a cost and a

resource value

• Cost = Cost to utility, society or customer• Define Resource Value of DR = (Cost of Resource

Portfolio without DR) - (Cost of Resource Portfolio with DR)

• Calculate Resource Value of DR = (Avoided Cost of Capacity) x (Avoided Capacity Purchases)


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IRP Using Existing Framework

• New resources include both dispatchable (DR, DG, Hydro, CTs) and non-dispatchable (DSM) resources

• Each resource has 6 characteristics:• cost• cost variance (e.g., fuel cost variability)• cost covariance with each other

resources• quantity if perfectly available• probability of availability• potential impact on reliability

• Goal of IRP: Determine the mix of resources that minimizes costs subject to procurement constraints


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Portfolio Development• Portfolio = combination of new and old resources • IRP compares the performance of different

portfolios according to three metrics:Cost (C) – The total cost of delivered energy needed to

serve peak loadCost variance (V) – The combination of resource-

specific cost variances and covariancesReliability (R) – Probability of meeting peak load in a

given year

• Comparative portfolio valuation requires an analysis in three dimensions

• Can trace a “frontier” or contour among two variables while holding the third constant


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Portfolio Selection

0 Variance

Cost

R = 0.95

R = 0.99

For a fixed reliability target, an LSE chooses a portfolio that minimizes cost subject to an acceptable cost variance.

Portfolio A

Portfolio B

Portfolio C

Portfolio D

Portfolio E

Portfolio F

Cost-Risk contours with fixed reliability


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DR Valuation: Basic Assumptions• DR is one of many dispatchable resources• CPUC adopted avoided costs for EE provide

a good starting point for valuing dispatchable resources

• A new dispatchable resource standard practice must account for:• Changes in costs • Changes in cost variance• Changes in portfolio variance• Changes in reliability


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Types of Avoided Costs

• The avoided costs adopted in California were designed to reflect the value of long term, non-dispatchable conservation programs.

RTP = Real time pricing rates; CPP = Critical peak pricing; DLC = Direct load control; DB = Demand Bidding Program; PCT = Programmable controllable thermostats (Title 24 Building Standards); TOU = Time of use rates; I/C= Interruptible/Curtailable Program

Dispatchable Non-Dispatchable

Short-Term DR (RTP, CPP, DLC, DB, I/C)

PJM Market Rate

Long-Term CT, CCGT, DR (PCT) Energy Efficiency, (TOU)

Resource Matrix


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Existing Avoided Cost Components

• Existing avoided cost methodology for EE adopted by CPUC (R.04-04-003 / R.04-04-025) provide starting point for the following components:• Generation Energy ($/kWh)• Transmission Capacity ($/kW-period/area)• Distribution Capacity ($/kW-period/area)• Marginal Losses at the Generation, Transmission and

Distribution voltage levels by utility service territories• Emissions Avoided Costs ($/MWh)• Multiplier Impact from reducing market prices• Ancillary Services

• Dispatchable resources require additional avoided cost components

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Six Research Gaps

Gap 1: Generation Capacity Value ($/kW-Time Period)

Gap 2: Consumer Surplus ($/Time Period)

Gap 3: Option Value ($/kW-Time Period)

Gap 4: DR Modularity and Value of Information

Gap 5: Value of Lost Load ($/Use)

Gap 6: Portfolio Hedge Value ($/Portfolio)


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Gap 1: Generation Capacity ValueIssue

• A dispatchable DR program is often used only during a few critical hours in a year. What is the value of these programs to the generation system?

Starting Point• Load relief during those hours can offer two direct benefits

• Long-term procurement benefit through less capacity and energy needed to maintain the same reliability target

• Reliability benefits through incremental improvement in reliability and value. Methodology must be careful not to double count the value of capacity and the value of maintaining reliability.


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Gap 2: Consumer Surplus3 Issues:

• 1. General Consumer Surplus• 2. Mitigation of Market Power• 3. Individual Customer Consumer Surplus

Starting Point for the Estimation of General Consumer Surplus:

• AB970 of 2000, Section 7(b)(8)• requires a “Reevaluation of all efficiency cost-effectiveness tests in light of increases of

wholesale electricity costs and natural gas costs to explicitly include the system value of reduced load on reducing market clearing prices and volatility”))

• CPUC D.00-07-017, p.13• “[T]he escalators are determined by looking at the “load reduction value” or “consumer

surplus” relative to the market price and taking a ratio. The escalators are multiplied by the market price - either during peak or off-peak - to arrive at system value.” (ALJ Linda R. Bytof’s 10/25/00 ruling in connection to UDC compliance with D.00-07-017, p.13)


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Bill savings for all customers

General Consumer SurplusPrice ($/MWH)

Hourly demand (MWH)0

Hourly supply

High demand w/oDR

High demand w/DR

Pricedrop

Bill Savings for all customers


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Gap 3: Real Options Analysis

Issue• The existing standard practice is designed to reflect the

benefits of non-dispatchable resources. Dispatchable resources provide an additional option value.

Starting Point• DR as an option to dispatch against energy costs

• Buyers purchase rights to curtailments• Seller (customers) sell curtailment obligation• Buyers exercise options if they are “..in the money.”

• Analogous to utility I/C programs, but• Option value is not avoided costs, but expected value• Option exercise driven by market price or other transparent market

condition • More flexible: supports alternative options that vary by strike price,

number of times exercisable, notice, duration, etc.


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Gap 4: DR Modularity & Value of Information

Issue• DR can be more pliable, nimble, scalable, and targeted to

high value areas than other DR resources.• This additional flexibility helps minimize the costs of

expansion planning costs and is not currently captured in the California standard valuation practice.

Starting Point• Preliminary Value Estimation

• Value of Shorter Lead Time, Value of Information• Value of Shorter Contract Period, Option to ‘Retire’• Value of Local Targeting, Option to ‘Move CT’


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Percent change is the increase in value of a CT

Option ValueLow Value

Base

High Value Description

Value of Information

1% 2% 4%

The value of a shorter lead-time does not provide significant value given our assumptions. The reason is that even if the CT is built a year or two early, it has a low probability of being built more than a few years earlier than needed.

Early Retirement

1% 7% 21%

The value of shorter contract periods is larger and depends on the assumption about the relative value of the plant over time.

Local Targeting

16%43%

82%

Targeting the program to capture local value as well as system value has the greatest increase in potential benefits.

Summary of Option Value Results


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Gap 5: Value of Operating ReliabilityIssue

• DR used as an emergency resource has the ability to reduce the number, scope, and size of rotating black-outs. This gap addresses the value customers receive through improved system reliability.

Starting Point• Evaluate DR’s ability to improve system reliability

• Evaluate DR operation during system emergencies.• Characterize the existing reliability of the system.• Avoid double counting the same capacity for operating reserves and for

emergency load relief.

• Estimate the value of that improved reliability.• Characterize the improvement in social welfare of reduced outages.


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Northeastern Markets Reliability Value Estimation

• “Emergency DR”: load curtailments dispatched during periods when operating reserves are low • Objective: Measure the impact of this DR on the consequences

of forced outages• Avoided outage cost analysis monetizes this benefit• Value = Change EUE * VOLL • Change EUE = Change LOLP * Load at Risk

• Essential features• Estimate the difference in Expected Unserved Energy (EUE)

between scenarios with and without load curtailments• Avoided outage cost calculated as the product of the reduction

in EUE and the Value of Lost Load (VOLL)• Key input variables:

• Change in Loss of Load Probability (LOLP) for each hour of each event

• Percent of load at risk• VOLL


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Gap 6: Portfolio Hedge Value

Issue

•The energy efficiency standard practice valuation approach considers each resource as an alternative to the “avoided cost” of the utilities portfolio. It does not consider cost variance.

•Adding DR to a portfolio can reduce the portfolio’s exposure to high market price scenarios.

0

Portfolio A

Portfolio B

Portfolio C

Expected Cost

Risk


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Portfolio Hedge ValueStarting Point•Several threshold research questions

• Does the existing valuation framework adequately capture DR’s risk mitigating benefits?

• Once option value (GAP 3) is built into the standard practice, is the portfolio hedge value needed?

• As DR adds uncaptured value to the portfolio, what is the best valuation methodology

Approaches to assess risk mitigation include:• Simulation with DR optimization• Simulation without DR optimization• Direct computation


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Example: Efficient Frontier With DR• Using the input assumptions we have made, the cost of the portfolio at a given level of risk is

reduced.• The closed-form solution of the efficient frontier is useful for calculation. However, the

usefulness of the result depends on whether reasonably accurate input data can be developed and incorporated into a complete valuation standard practice that makes sense at the individual program and portfolio levels.

Forward Price ($/MWh) F $39

DR cost c $30

DR MW K 4,000

Expected Demand (MW) D 50,000

Variance (D) D 12,131

Expected Price P 43.19

Variance (P) P 11.7

Correlation (P,D) r 0.42

Correlation (PD,P) 0.93

-

100

200

300

400

500

1,500 1,600 1,700 1,800 1,900 2,000

Expected Cost [m*] ($thousands)

Variance [s*2] ($billions)

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Phase 2 Proposal


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DR Valuation Phase 2 Proposal Summary

Deliverables• A new “standard practice” for the valuation of dispatchable

resources.• Initiate and manage a consultative process with key

stakeholders. • Base the new standard practice for dispatchable resources on

the existing avoided costing approach adopted for energy efficiency

• Each gap in methodology or data will be addressed as a research question.

•Process• The E3 team will be responsible for first drafts, revisions, and

final drafts addressing each research question and the final standard practice description.

• The E3 team will give monthly presentations on the work in progress, with follow-up telephone discussions and working meetings scheduled as needed.


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Task Description and Consultation Process

TRACK 1

Economic Framework &

Analytic Development

Task 1:

Capacity Valuation

Task 2:

Consumer Surplus

Task 3:

Option Value

Task 4:

Planning Flexibility

Task 5:

Portfolio Hedge Value

Task 6:

Value of Lost Load

TRACK 2

Stakeholder Participation &

Dissemination Efforts

Task 7:

Stakeholder

Collaboration

Task 8:

Methodology Incubator

and Calculation Beta

Testing

Task 9:

Workshops & Seminars


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DR Valuation Phase II ScheduleMonth After Award

1 2 3 4 5 6 7 8 9

Task 1Capacity Valuation

Task 2Consumer Surplus Valuation

Task 3Real Option Value

Task 4Planning Flexibility Value

Task 5Portfolio Hedge Value

Task 6Value of Lost Load

Task 7Stakeholder Collaboration

Task 8Methodology Incubator

Task 9Workshops & Seminar

Deliverable (Draft or Final)

Schedule and Deliverables

dr valuation ron-01 phase 2 proposal

Documents

valuation methodologies

dr design

heschong mahone group

utilipoint international

freeman sullivan

internal valuation methodology

proposed valuation approach

utility dr filings