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UCAP and Performance Periods

April 13, 2018

CWG submission to the AESO working group

Power Advisory LLC 2018. All Rights Reserved.

• The key concerns with the proposed framework are:• 100 hours represent a significant increase in outage risk compared to the energy only framework,

contrary to a key goal of the market transition• 100 hours does not actually diversify delivery risk as the hours cluster and are typically contained within a

small number of events• Increasing the number of hours to 200, for example, does not materially alter the risk profile due to

this clustering• Setting the UCAP in 100 hours and penalizing performance in the same hours effectively double

penalizes providers as there is no incentive for over performance• While the UCAP for classes of assets may be relatively stable, individual generator UCAP varies materially

from year to year creating revenue uncertainty• A true Electric Load Carrying Capability study should yield stable UCAP year to year and the current

methodology does not, which suggests it is not a reliable proxy• There is material misalignment in the definition of the capacity provided by resources and capacity

purchased by loads and as a result the product will not be tradeable

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Key Concerns With Proposed UCAP and Penalty Structure


• Setting UCAP and assessing penalties in 100 hours annually increases revenue uncertainty while providing little benefit

• In the energy only market capacity payments were ‘earned’ during hours in which there was scarcity• Historically, approximately 1,140 hours per year returned 90% of the annual capital costs for a peaking

plant (evaluated at a heat rate of 10)• In its original recommendation paper the AESO stated that the capacity market was required to increase

revenue certainty and reduce risks for investors. The currently proposed UCAP and penalty methodologies do not accomplish this goal.

• A key weakness of the methodology as proposed is that it materially increases the risk associated with forced and scheduled maintenance. This risk is actually less manageable as capacity is a less fungible product than energy, i.e. energy price exposure could be hedged during scheduled maintenance

CWG Proposed solution: The UCAP and availability period for the performance assessment should be based on at least 1,000 hours

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Increased risk and revenue uncertainty


• Rationale:• Both calculations should include enough hours such that they are at a minimum consistent with the

current energy only market• The capacity market was introduced to decrease risk for investors – increasing the number of hours to

1,000 would keep the risk approximately the same as current from a delivery perspective• This better aligns with the weighted energy model for capacity cost allocation which recognizes Alberta

has capacity needs throughout the year and which will likely allocate costs in 5,000-6,000 hours• AESO analysis shows stability of UCAP values by asset class between 100 and 600 hours; increasing the

number of hours should therefore not materially alter the UCAP estimate for the system or asset classes.• Increasing the number of hours reduces risk and should increase the stability of UCAP at the individual

asset level year over year

• Incentives should be added for Availability to reduce the impact of ‘double penalization’• In effect the reduction in UCAP in one year can be recaptured in subsequent years and the ‘penalty’ is not

doubled by a reduction in ‘go forward’ UCAP plus actual penalties in the delivery year

• Test the number of hours chosen against an ELCC estimate for each generator• It is a vital for technical sufficiency to test whether the proxy for capacity is a reasonable estimate of the

true capacity of a resource

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1,000 hours for UCAP and performance assessments


• Historical analysis of the 2010 through 2017 period shows that generators have recovered 90% of their capital costs in an annual average of roughly 1,140 hours.

5

Historical Analysis


• The AESO is now proposing to reduce this amount from 1,140 hours to 100 hours by moving the full value of capacity into 100 hours per year.

• This represents a significant increase in generator risk as a part of the new market rules in any year where capacity revenues are a large portion of overall annual revenues.

• Generators previously only recovered an average of 35% of their capital costs in 100 hours.

• Expected revenues are now much more concentrated in a small number of hours relative to historical experience

• While capacity prices may be less volatile than the prior scarcity pricing mechanism, the proposed design actually increases the risk of capturing the value

6

Historical Analysis


• In the CMD 1.0, the AESO has proposed that the UCAP will be calculated based on average performance in the tightest 100 hours of supply cushion over a five year period.

• In the February working groups, there was debate as to whether the AESO should increase this number to 200 to help lower generator risk.

• The analysis in the appendix shows that a movement from 100 hours to 200 hours does little to spread the risk over an increased number of days.

• Adding a few more tight supply cushion hours tends to extend the events already captured in the 100 hour measurement rather than increasing the number of days that are included in the calculation.

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A material increase in the number of hours is required

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Impact of more hours in diversifying risk

• As the number of hours used to evaluate UCAP goes up, the number of weeks (defined as seven day periods beginning on November 1st each delivery year) increases.

• The increase in doubling the hours is much less than doubling the ‘exposure’ to more weeks in the UCAP calculation

• The curve flattens after about 1,000 hours indicating few new periods are added

• A similar analysis using days instead of weeks shows a somewhat different pattern • There is a significant jump in the number of days evaluated between 500 hours in the UCAP and 1,000 hours in the UCAP

• The graphic illustrates the value of diversity in terms of evaluating a greater number of days to reduce the impact of any one outage period to a reasonable level

• Combined the charts support the proposal of 1,000+ assessment hours


• Alignment with the capacity cost allocation (weighted energy) requires significantly more hours

• The government’s initial policy paper suggested 6 hours of super peak per day, which results in over 2,000 critical super-peak hours per year from the perspective of a load

• Further, even when assigning zero weight to off-peak hours, some costs will be allocated in 5,000-6,000 hours

• 1,000 hours from the generator’s perspective would align more closely with the load perspective, however super peak is eventually defined.

• Alignment between cost allocation and the UCAP calculation results in a much more hedgeable product allowing suppliers and consumers to financially contract for capacity bilaterally

• Cost allocation can be structured to align with the generator incentives wherein the definition of super peak hours can vary by month or season and the hours are specifically chosen to be the hours most likely to contain a supply cushion event and the weights can be reflective of the average likelihood.

9

Alignment of Cost Allocation and UCAP


• The risk of assessing penalties in only 100 hours is unreasonably high. More hours need to be included in the unavailability performance period.

• Further, it is ideal to align the UCAP and unavailability assessment period.• The CWG proposes that at least 1,000 hours should be included in both the UCAP and

performance periods.• Further, not including incentive payments in the unavailability payment adjustment

creates a significant problem.

10

Penalties and UCAP Impact


• The CWG proposes to phase in capacity market penalties• Moving directly from no capacity market to a market with extremely punitive penalties creates

significant investor risk and uncertainty• There is precedent within Alberta for phasing in penalties over time

• The Specified Gas Reporting Regulation came into effect in 2004

• The Specified Gas Emitters Regulation came into effect in 2007

• This shows there was a three year phase in period before the financial consequences of SGER came into effect

• The CWG suggests that the penalty scheme should be defined and established from the outset of the capacity market, however, penalties should only be measured, but not charged, in the early years of the capacity market

• This gives market participants time to understand how the capacity market will work and how the penalties will be calculated before being charged

• The market is currently over supplied which allows the AESO time before needing to send strong incentives through punitive penalties

• It should also be noted that the UCAP methodology creates an inherent penalty by reducing the ability to sell capacity in future years with no opportunity for incentives

• In effect the actual penalty structure is a second layer of penalties that is not needed at market open• The absence of incentives for over delivery exacerbates this concern

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Phasing in Penalties


Appendix• 100 vs. 200 supply cushion hours

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• Analysis shows that moving from 100 to 200 hours generally does not materially decrease risk as a significant number of the incremental hours are added to days that were already included in the UCAP average.

• Analysis also shows that the majority of the tightest hours have historically occurred between May and September.

13

100 vs. 200 supply cushion hours

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