Price Formation Education 4: Shortage Pricing and Operating Reserve Demand Curve

Price Formation Education 4: Shortage Pricing and Operating Reserve Demand Curve Patricio Rocha Garrido Lisa Morelli Laura Walter

Disclaimer This is not a committee meeting. This session is for educational purposes only, to help introduce and clarify different aspects of price formation. The material presented is not necessarily representative of any proposal PJM has or will present in the future. 2

Purpose of this Session The purpose of this session is to develop a common understanding of : The role Shortage Pricing plays in the energy and reserve markets PJM s current implementation of shortage pricing, including the use of the Operating Reserve Demand Curve How PJM s shortage pricing implementation and Operating Reserve Demand Curve compares to that of other ISOs 3

Agenda Recap of Sessions 1, 2 and 3 What is Shortage Pricing and why do we need it? PJM s Shortage Pricing implementation Evolution of PJM s Operating Reserve Demand Curves Shortage Pricing and Operating Reserve Demand Curves in other ISOs/RTOs 4

Recap of Session 1 Session 1 Economic Dispatch Basics Videos are available here PJM.com > Committees & Groups > Stakeholder Meetings > Price Formation Education Sessions 5

Recap of Session 2 Session 2 Alternative Pricing Frameworks Videos are available here PJM.com > Committees & Groups > Stakeholder Meetings > Price Formation Education Sessions 6

Recap of Session 3 Session 3 Reserve Markets Day-Ahead Scheduling Reserve Reserve Services Each service carries a reserve requirement Primary Reserve Videos are available here PJM.com > Committees & Groups > Stakeholder Meetings > Price Formation Education Sessions 30 Minute Reserves Cleared in Day-Ahead Tier 1 Resources Synchronized Reserve Tier 2 Resources Non- Synchronized Reserve (NSR) NSR Resources Cleared and maintained in real time Reserve Products Each product has a clearing price 7

Recap of Session 3: Reserve Zones One Reserve Zone (RTO) Includes Mid-Atlantic Dominion (MAD) sub-zone due to potential reserve deliverability issues RTO Reserve Zone RTO Non-MAD Mid-Atlantic Dominion Sub-Zone (MAD) Most Limiting Interface Mid- Atlantic Dominion (MAD) Sub-Zone 8

WHAT IS SHORTAGE PRICING AND WHY DO WE NEED IT? 9

What Is Shortage Pricing? In PJM, Shortage Pricing refers to the market rules that govern how energy and reserve prices are calculated when there is not enough supply on the system to meet demand and reserve requirements. Its aim is to provide clear, transparent pricing signals to the market to indicate the current operating state of the system. Includes prices that escalate with tightening conditions to help mitigate emergency conditions by incenting at will supply. It is implemented in most ISOs/RTOs, although implementation is not uniform. 10

Shortage Pricing s Role in Energy Market Design Effective shortage pricing reduces the missing money problem Rewards resources that supply energy and other essential grid services during emergency conditions These resources collect additional revenues that go directly towards offsetting going-forward costs As a result, shortage pricing mechanisms reduce reliance on the capacity market revenues to attract efficient resource investments 11

Why Shortage Conditions Occur Why would we encounter shortage conditions even though we ve met the capacity adequacy requirements? Capacity adequacy is based on forecast assumptions that may not hold on any particular day or in any particular year. For instance: Extreme weather conditions beyond those used to determine capacity requirements Higher than average generator outages Greater than expected economic activity and consequent peak load growth Unexpected transmission outages that lead to more localized shortage 12

PJM S SHORTAGE PRICING IMPLEMENTATION 13

Shortage Pricing Triggers Shortage Pricing will be triggered under either of the following conditions: The amount of available reserves dips below the reserve requirement Available Synchronized Reserve MW < Synchronized Reserve Requirement Available Primary Reserve MW < Primary Reserve Requirement Voltage reduction action or manual load shed action is initiated Shortage pricing is triggered locationally by reserve zone Reserve shortage or emergency procedures in MAD reserve zone does not trigger shortage pricing in RTO reserve zone 14

Shortage Pricing Triggers Shortage Pricing is triggered via PJM s real-time security constrained economic dispatch (RT SCED) application Produces prices consistent with the 10 minute look-ahead dispatch solution As of May 2017, declaration of shortage pricing no longer requires that the shortage condition be forecasted for 45 minutes or more before shortage pricing can be triggered Transient shortage implementation (FERC Order 825) 15

Termination of Shortage Pricing Once triggered, Shortage Pricing will remain in effect until sufficient reserves are available to meet the reserve requirements Shortage Pricing can not be terminated if any of the following remain in effect in the affected reserve zone Voltage reduction Manual load shed 16

Transparency into Shortage Conditions Market participants have several indications when the system is approaching reserve shortage: Reserve prices will approach the reserve penalty factor (pre-determined shortage price) Operational warnings on Emergency Procedures page leading up to the declaration of emergency actions Shortage Pricing Indicators on: Markets and Operations page on pjm.com Dispatched Reserves page in Data Viewer 17

Frequency of Shortage Conditions Date Shortage Locations Shortage Products Total Number of Intervals Reason for Shortage January 6, 2014 MAD & RTO Primary and Synchronized Reserves 12 Voltage Reduction Action for RTO January 7, 2014 MAD & RTO Primary and Synchronized Reserves 59 Reserve shortage September 21, 2017* RTO Synchronized Reserves 2 Reserve shortage MAD & RTO Primary Reserves 19 Reserve shortage *Only short the Extended Reserve Requirement (Step 2 of ORDC) 18

Pricing Reserve Shortages The Real-Time reserve markets are cleared using Operating Reserve Demand Curves (ORDCs) When the reserve requirement cannot be met, the reserve shortage is priced using the penalty factor from the ORDC The penalty factor sets a price for being unable to meet the reserve requirement It sends a signal to market participants that as the reserve market clearing price reaches the penalty factor, reserve shortage may occur 19

What Does the Penalty Factor Represent? The penalty factor price of an ORDC can be thought of as a resource with infinite reserve capability at the penalty factor price. Penalty factors are in use in most dispatch software today to ensure the dispatch problem is solvable under reserve shortage conditions. 20

A Simple Step Function ORDC Reserve shortage = 5 MW 5 MW shortage is committed on the demand curve pseudo-resource Demand curve would also be used to serve the next MW of reserves (marginal MW) It therefore sets the clearing price at the demand curve Penalty Factor price 21

The ORDC The ORDC: Sets the reserve requirement for market clearing purposes Puts a defined limit on the cost willing to be incurred to substitute reserves for energy Acts as a cap on the market clearing price to clearly indicate reserves shortages The ORDC only impacts the reserve markets, energy dispatch and LMP when the reserve requirement cannot be met at a price below the penalty factor price 22

ORDC Impacts If the cost for a resource to provide reserves exceeds the penalty factor, it will not be committed for reserves PJM Operations would still assign reserves out-of-market if available and the cost of those reserves would be recovered in uplift or Balancing Operating Reserve charges The penalty factor must be set high enough so that shortage being signaled is due to running out of reserves rather than going short for economic reasons. 23

Current ORDC Step 1 of Demand Curve Represents the Reliability Requirement, which is generally the output of the largest online unit Penalty factor for being short Step 1 is $850/MWh Step 2 of Demand Curve Adds 190 MW to the Reliability Requirement Also includes an Optional Adder MW that can be used to capture additional reserves that are scheduled for reliability reasons Penalty factor for being short Step 2 is $300/MWh 24

Pricing Energy During a Reserve Shortage During a reserve shortage, the price of energy will continue to represent the cost of serving the next MW of load 25 MW Load 25 MW Reserve Req. 26 MW Load 25 MW Reserve Req. When the system is short reserves, this cost includes the cost of converting a MW of reserve into energy In other words, the energy price is the offer cost of energy, plus the penalty of going short one more MW of reserve The Locational Marginal Price (LMP), as well as the reserve market clearing price, will include the reserve penalty factor 25 MW Reserve 25 MW Energy Convert to Energy Cost = Offer Cost + Penalty Factor 24 MW Reserve 26 MW Energy 25

Locational Shortage Impacts on LMP The Reserve Penalty Factor is not an adder to the energy component of LMP The location of the shortage condition and the location of the load reference determine which component(s) of LMP the penalty factor is reflected in. Location of Shortage Energy Price Penalty Factor May Be Reflected In Congestion Price Marginal Loss Price MAD Only RTO Only RTO and MAD 26

Escalation of Prices Approaching Shortage A stepped demand curve does not equate to a step change in reserve or energy prices as the system reaches reserve shortage when conditions gradually tighten As the supply of reserves tightens, PJM re-dispatches units in order to maintain adequate reserves The opportunity cost of the marginal unit for reserves will be what sets that reserve clearing price. The cost of re-dispatch becomes greater and greater as system conditions tighten. The effect of this is a rational increase in the reserve clearing price up to the point at which it no longer becomes cost effective and we are willing to, or must, go short that reserve product 27

Example Show how the ORDC works to raise prices as the market goes into a reserve shortage Repeat same example, but with increasingly larger loads to show how prices change Simplified example with three generators and an example one-step operating reserve demand curve for a generic reserve product Generic reserve product does not require the unit be on-line to provide reserve for this example Energy demand is not price-sensitive 28

Example Information 400 MW 400 MW Total Capacity Reserve Capability 80 MW 300 MW 100 MW 120 MW Generator A Generator B Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 29

Real-time Dispatch Objective Minimize the bid production cost of energy and reserve subject to the demand constraint and reserve constraint For this example, the optimal energy and reserve assignments are found while using the following assumptions: Joint, simultaneous co-optimization of energy and reserve Energy bids as presented above Reserve bids are zero Reserve prices are non-zero when generators are backed down from providing energy to maintain reserves (opportunity cost) or when short of the reserve requirement (penalty factor) Demand is perfectly inelastic and does not change based on LMP Amount of available capacity does not change based on LMP During scarcity, the opportunity cost of providing reserves gets reflected in the energy price 30

Adequate Supply 490 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 300 MW 100 MW 400 MW 400 MW 30 MW Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 120 MW 120 MW 80 MW 300 MW Generator A 190 MW Generator B Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output Energy price = $80 Reserve price = $0 31

Adequate Supply 630 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 300 MW 100 MW 400 MW 400 MW 30 MW Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 120 MW 120 MW 80 MW 300 MW Generator A 330 MW Generator B Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output Energy price = $80 Reserve price = $0 32

Adequate Supply 720 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW 100 MW Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 400 MW 400 MW 30 MW 120 MW 120 MW 300 MW Generator A 370 MW Generator B Energy Offer $50/MWh $80/MWh 50 MW Generator C $100/MWh + $2/MWh Output = $200/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $200 $200 - $80 = $120 $120 Energy price price Energy offer Reserve Price 33

Getting Close to Shortage 870 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW 100 MW Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 400 MW 400 MW 30 MW 120 MW 120 MW 300 MW Generator A 370 MW Generator B 200 MW Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output = $500/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $500 - $80 = $420 Energy Energy Reserve price offer Price 34

Getting Close to Shortage 920 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW 100 MW Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 400 MW 400 MW 30 MW 120 MW 120 MW 300 MW Generator A 370 MW Generator B 250 MW Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output = $600/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $600 - $80 = $520 Energy Energy Reserve price offer Price 35

Reserve Shortage = 50 MW, Energy Demand = 1,000 MW Total Capacity Reserve Requirement = 150 MW Penalty Factor for being short reserve = $850 Reserve Capability Assigned Energy Assigned Reserve 300 MW 100 MW 400 MW 400 MW 120 MW 100 MW 80 MW 300 MW Generator A 370 MW Generator B 300 MW Generator C Energy Offer $50/MWh $80/MWh Reserve price is equal to the penalty factor of $850 Energy Price is equal to the cost of delivering one more unit of energy to the system $100/MWh + $2/MWh Output = $700/MWh $700 + $850 = $1,550 Unit C cost Penalty Factor* Energy price *Serving next MW of energy incurs cost of going short 1 more MW reserve 36

Price ($/MWh) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Energy Price Reserve Price Price Escalation 0 100 300 490 550 630 680 720 760 800 810 870 920 960 1,000 Load (MW) 37

Price Escalation During Transient Shortage A stepped demand curve can equate to a step change in reserve or energy prices if the system reaches reserve shortage suddenly (transient shortage) Transient shortages are often shorter-lived and prices can drop as quickly as they escalated A second, lower step on the ORDC helps smooth the step change in prices that can result from transient shortages 38

Impact of Multiple Simultaneous Reserve Shortages The ORDC represents the max willingness to pay to meet the reserve requirement for a single product in a single location Four separate ORDCs exist to model reserves for each product/location combination When there are multiple reserve products with substitution, the ability of one product to meet the requirement for another increases the willingness to pay for the multipurpose reserve products Prices become additive 39

Refresher: Reserve Substitution MAD Synch Reserves MW can be used to meet MAD PR requirement or RTO SR requirement Product Substitution SR Price >= NSR Price MAD Primary Reserves MW can be used to meet RTO PR requirement MAD Price >= RTO Price Locational Substitution Locational Substitution MAD Price >= RTO Price RTO Synch Reserves MW can be used to meet RTO PR requirement SR Price >= NSR Price Product Substitution RTO Primary Reserves 40

Effect of Reserve Product Substitution on Reserve and Energy Prices If short Primary Reserve, the Primary Reserve penalty factor is generally incorporated into both reserve prices and the energy price Price Non-Synchronized Reserve Synchronized Reserve Energy Price = = = Calculation Primary Reserve penalty factor Marginal cost of Synchronized Reserve + Primary Reserve penalty factor Marginal cost of energy + the Primary Reserve penalty factor* * Assumes next MW of energy comes from converting reserves to energy 41

Effect of Reserve Product Substitution on Reserve and Energy Prices If short both Primary Reserve and Synchronized Reserve, Price Non-Synchronized Reserve = Calculation Primary Reserve penalty factor Synchronized Reserve Energy Price = = Synchronized Reserve penalty factor + Primary Reserve penalty factor Marginal cost of energy + Synchronized Reserve penalty factor + Primary Reserve penalty factor* * Assumes next MW of energy comes from converting reserves to energy 42

Impact of Multiple Simultaneous Reserve Shortages When there is a nested region within another, like MAD within RTO, the prices may be additive by location depending on system conditions Additive in MAD when: Imports limit the ability to deliver reserves from the remainder of RTO to MAD The MAD and RTO requirements are simultaneously short 43

Limitations on Additivity of Shortages From a pricing perspective, the most extreme shortage condition that could occur would be a shortage of Synchronized Reserve and Primary Reserve in both RTO and MAD Violation of all four reserve requirements 4 * Penalty Factor As part of the initial implementation of shortage pricing, an administrative rule was implemented to allow, at maximum, two simultaneous shortages to affect energy and reserve prices (2 * Penalty Factor) Assuage concerns about implementation of demand curves and co-optimization of energy and reserves Prior to the implementation of shortage pricing in 2012, historical experience was that there had never been more than two simultaneous reserve requirement violations at any one time During the Polar Vortex in 2014, PJM experienced a shortage of all four reserve requirements 44

Energy Price Caps Prior to factoring in congestion and losses, the energy component of LMP will be capped at the energy offer cap + 2 * Penalty Factor from the first step on the ORDC $2,000 + 2 * $850 = $3,700 maximum energy component Total LMPs can still rise above this level when factoring in locational congestion and loss prices 45

Reserve Price Caps The Synch Reserve Market Clearing Price is capped at 2 * Penalty Factor ($1,700) The Non-Synch Reserve Market Clearing Price is capped at the Penalty Factor ($850) The above price caps are applicable regardless of The existence of a shortage condition The existence of additive locational shortage Administrative constraint that may understate the reliability contribution of some reserve types Example, the MAD Synch Reserve Clearing Price is still capped at 2 * Penalty Factor even if reserve shortages exist for all four reserve requirements, despite MAD Synch Reserve being able to satisfy all four requirements 46

EVOLUTION OF PJM S OPERATING RESERVE DEMAND CURVES 47

Evolution of PJM s ORDC Oct. 2012 Initial Shortage Pricing implementation Penalty factors escalated from $250 to $850 over 2.5 year period $850 penalty factor became effective June 2015 May 2017 Transient Shortage Pricing RTSCED can declare shortage and price off the demand curve without notification from ITSCED July 2017 Added permanent second step of the demand curve to reflect 190 MW plus any reserves for conservative operations Intended to moderate effects of transient shortage pricing before 5 minute settlements is implemented Nov. 2014 MRC approved adding a temporary second step to the ORDC at a penalty factor of $300 Intended to prevent conservative operator actions from suppressing reserve prices 48

Future Evolution of the ORDC The shape of the ORDCs, and the associated penalty factors, as well as other aspects of PJM s shortage pricing implementation, are based on dated assumptions How shortage is triggered Historical costs of reserve resources Severity of historical shortages The ORDC will be revisited as part of the Energy Price Formation Senior Task Force (EPFSTF) 49

SHORTAGE PRICING AND ORDC IN OTHER ISOS 50

CAISO Shortage Pricing Requirement Shortage Amount Value ($/MWh) Regulation-Up Any 200 Spinning Any 100 Non-Spinning 0 MW 70 MW 500 70 MW 210 MW 600 More than 210 MW 700 51

ISO New England Shortage Pricing Requirement Sub-Category Value ($/MWh) 10-Minute Spinning 50 10-Minute Non-Spinning 1,500 30-Minute Operating Minimum Requirement 1,000 Replacement Reserves 250 Local 30-Minute Operating 250 52

MISO Shortage Pricing Requirement Region Shortage Amount Value ($/MWh) Regulation All Any Max(100, peaker commitment cost for 1 hour) Spinning MISO 0 10% of requirement 65 Total Operating Reserves Reserve Zone More than 10% of requirement 98 0 10% of requirement 65 More than 10% of requirement 98 MISO 0 4% of requirement 200 Reserve Zone 4% 96% of requirement 1,100 3,400 More than 96% of requirement 3,400 0 20% of requirement 200 20% 90% of requirement 1,100 More than 90% of requirement 3,400 53

NYISO Shortage Pricing Requirement Region Shortage Amount Value ($/MWh) Regulation NYCA 0 MW 25 MW 25 25 MW 80 MW 400 More than 80 MW 775 10-Minute Spinning NYCA Any 775 All Other 25 10-Minute Total NYCA Any 750 EAST Any 775 All Other Any 25 30-Minute Operating NYCA 0 MW 300 MW 25 300 MW 655 MW 100 655 MW 955 MW 200 More than 955 MW 750 SENY Any 500 All Other Any 25 54

Other ISO/RTO Shortage Pricing While there are differences in the types of products available in PJM and the other ISO/RTOs reviewed so far, all of them share some common features: Products have a certain MW requirement with associated penalty factors These requirements and penalty factors are combined to derive vertical (or stepwise) ORDCs with prices capped at the penalty factors ERCOT is different because its ORDCs are downward-sloping and prices are capped at the Value of Lost Load (VOLL) 55

ERCOT Shortage Pricing Key concepts Value of Lost Load (VOLL): value (in dollars) that a 1 MW reserve increment has in preventing a 1 MW shedding of load Loss of Load Probability (LOLP): in general, probability that, at a time t, available capacity minus load is less than 0 MW (or a minimum contingency MW value) Implementation Not via co-optimization of energy and reserves; price adder based on a side calculation System-wide ORDC 56

ERCOT Shortage Pricing Price = Loss of Load Probability (Reserves) * Value of Lost Load 57

ERCOT Shortage Pricing VOLL approved by ERCOT board Currently at $9,000 per MWh VOLL is shifted down by the System Lambda System Lambda is the energy component of the LMP X, the minimum contingency level, currently at 2,000 MW LOLP is not calculated at the 0 MW threshold but at the minimum contingency level (X) 58

ERCOT Shortage Pricing LOLP is calculated for multiple reserve levels (R) What is the probability that real time reserves fall below X if the hour-ahead reserves are R? When R is less than or equal to X LOLP is assumed to be 1 When R is greater than X LOLP is calculated using historical hour-ahead reserves error 59

ERCOT Shortage Pricing Reserve Error = Hour Ahead Reserves Real Time Reserves - Assumed to be normally distributed The mean and the standard deviation of the normal distributions are calculated using historical reserve errors Historical data split into 24 groups 4 seasons (3 months each) 6 time-of-day blocks (4 hours each) 60

ERCOT Shortage Pricing Hour Start End Mean Standard Deviation Winter 1 2 269.06 1,164.99 3 6 612.42 1,156.65 7 10 467.36 1,356.29 11 14 121.67 1,307.81 15 18 298.80 1,201.24 19 22 297.52 1,072.00 23 24 269.06 1,164.99 Spring 1 2 170.31 1,191.98 3 6 685.67 1,113.29 7 10 806.67 1,225.47 11 14 223.99 1,205.81 15 18 121.83 1,179.34 19 22 170.99 1,183.51 23 24 170.31 1,191.98 Hour Start End Mean Standard Deviation Summer 1 2 369.81 1,254.63 3 6 886.86 1,163.84 7 10 990.57 1,264.22 11 14 407.38 1,152.39 15 18 23.05 1,187.46 19 22-146.12 1,164.75 23 24 369.81 1,254.63 Fall 1 2-7.25 1,079.97 3 6 557.94 996.40 7 10 665.21 1,114.53 11 14 298.82 1,182.08 15 18 74.96 1,100.35 19 22 223.58 1,149.43 23 24-7.25 1,079.97 Current Mean and Standard Deviations used by ERCOT for Winter 17/18, Spring 18, Summer 18 and Fall 18 and corresponding time-of-day blocks Source: http://www.ercot.com/ mktinfo/rtm 61

ERCOT Shortage Pricing For example, let s focus on Summer Season, 15-18 Time-of-day block Mean = 23.5 MW Standard Deviation = 1,187.46 MW 62

ERCOT Shortage Pricing R R-X LOLP(R-X) 0-2,000 1 500-1,500 1 1,000-1,000 1 1,500-500 1 2,000 0 1 2,500 500 0.3441 3,000 1,000 0.2054 3,500 1,500 0.1069 4,000 2,000 0.0480 4,500 2,500 0.0185 5,000 3,000 0.0061 5,500 3,500 0.0017 6,000 4,000 0.0004 6,500 4,500 0.0001 7,000 5,000 0.0000 The LOLP for reserve (R) values ranging from 0 MW to 7,000 MW with X equal to 2,000 MW can be calculated using the normal distribution in the previous slide. 63

Price ($/MWh) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 ERCOT Shortage Pricing Non-Spinning Reserve ORDC - Summer, 15-18 Time-of-day Block LOLP * 0.5 * (VOLL System Lambda) VOLL = $9,000/MWh System Lambda = $0/MWh 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 Reserves (MW) 64

Price ($/MWh) 900 800 700 600 500 400 300 200 100 0 10-min Spinning PJM 10-min Spinning NYCA 10-min Spinning MISO 10-min Spinning ISO-NE 10-min Spinning CAISO Summary ORDCs in PJM and other RTO/ISOs (excluding ERCOT) 0 200 400 600 800 1,000 1,200 1,400 Note: To facilitate comparison of the ORDC shape, the requirement for 10-min reserves has been made equal to 1,190 MW for all RTO/ISOs, except ERCOT. Reserves (MW) 65

Price ($/MWh) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Summary 0 1,000 2,000 3,000 4,000 5,000 6,000 Note: To facilitate comparison of the ORDC shape, the requirement for 10-min reserves has been made equal to 1,190 MW for all RTO/ISOs, except ERCOT. ORDCs in PJM and other RTO/ISOs (including ERCOT) 10-min Spinning PJM 10-min Spinning NYCA 10-min Spinning MISO 10-min Spinning ISO-NE 10-min Spinning CAISO 30-min Responsive Online Reserve ERCOT ERCOT Reserves (MW) 66

Summary Cascaded Shortage Price ($/MWh) 4,000 Cascading Shortage Prices for Selected Products in PJM and other RTO/ISOs (excluding ERCOT) 3,500 CAISO ISO-NE 3,000 PJM MISO 2,500 NYISO 2,000 1,500 1,000 500 0 30 Min. Total - 1 30 Min. Total - 2 30 Min. Total - 3 30 Min. Total - 4 10 Min. Total - 1 10 Min. Total - 2 10 Min. Total - 3 10 Min. Sync - 1 10 Min. Sync - 2 67

Email Additional Questions? Price_formation@pjm.com or Priceformation@pjm.com 68

APPENDIX Two Step Operating Reserve Demand Curve Example 69

Two-Step Demand Curve Example Show how a two-step ORDC works to raise prices as market goes into a reserve shortage Repeat same example as before, but with a two-step demand curve and increased reserve requirement 70

Example of two-step ORDC 400 MW 400 MW Total Capacity Reserve Capability 80 MW 300 MW 100 MW 120 MW Generator A Generator B Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MWh Output Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 71

Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Adequate Supply 490 MW Energy Demand Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 400 MW 400 MW 100 MW 80 MW 120 MW 120 MW 300 MW Generator A 190 MW Generator B Generator C Energy Offer $50/MWh $80/MWh $100/MWh + $2/MW Output Energy price = $80 Reserve price = $0 72

Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Adequate Supply 630 MW Energy Demand Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 400 MW 400 MW 80 MW 100 MW 120 MW 120 MW 300 MW Generator A 320 MW Generator B Energy Offer $50/MWh $80/MWh 10 MW Generator C $100/MWh + $2/MWh Output = $120/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $120 - $80 = $40 Energy Energy Reserve price offer Price 73

Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Adequate Supply 720 MW Energy Demand Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 400 MW 400 MW 80 MW 100 MW 120 MW 120 MW 300 MW Generator A 320 MW Generator B Energy Offer $50/MWh $80/MWh 100 MW Generator C $100/MWh + $2/MWh Output = $300/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $300 - $80 = $220 Energy Energy Reserve price offer Price 74

On the Verge of Shortage 760 MW Energy Demand Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 400 MW 400 MW 80 MW 100 MW 120 MW 120 MW 300 MW Generator A 320 MW Generator B Energy Offer $50/MWh $80/MWh 140 MW Generator C $100/MWh + $2/MWh Output = $380/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve $380 - $80 = $300 Energy Energy Reserve price offer Price 75

Pricing along the Demand Curve Point of equilibrium at 760 MW of load: opportunity cost of reserves = penalty factor As load increases, if serving the next MW of load would raise the opportunity cost of the marginal resource for reserves above $300, the cost minimizing solution is to commit fewer reserves and incur the cost of the reserve shortage ($300). This leads to committing fewer and fewer reserves until no portion of the second step of the demand curve can be served for less than $300. At that point, reserves will only be procured to meet the 150 MW requirement on the 1 st step of the demand curve. The price of this will increase from $300 up to $850 until there are no reserves available at a cost less than $850. 76

Reserve Shortage = 40 MW, Energy Demand = 800 MW Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 100 MW 400 MW 400 MW 40 MW 120 MW 120 MW 300 MW Generator A 360 MW Generator B 140 MW Generator C Energy Offer $50/MWh $80/MWh Short 40 MW of reserve. Since the opportunity cost of meeting the last 10 MW of the reserve requirement is greater than $300, the system is not redispatched to meet the full requirement. Reserve price is equal to the associated penalty factor of $300 for this level of shortage $100/MWh + $2/MWh Output = $380/MWh $80 + $300 = $380 Unit B Penalty Energy cost Factor* price *Serving next MW of energy incurs cost of going short 1 more MW reserve 77

Reserve Shortage = 50 MW, Energy Demand = 811 MW Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 100 MW 400 MW 400 MW 30 MW 120 MW 120 MW 300 MW Generator A 370 MW Generator B 141 MW Generator C Energy Offer $50/MWh $80/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve Short 50 MW of reserve. Since the reserve price is greater than $300, the system is not redispatched to meet the last 50 MW of the reserve req. 78 $100/MWh + $2/MWh Output = $382/MWh $382 - $80 = $302 Energy Energy Reserve price* offer Price *Serving next MW of energy does NOT incur an additional MW of reserve shortage, so penalty factor is not included in energy price

Reserve Shortage = 50 MW, Energy Demand = 920 MW Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 100 MW 400 MW 400 MW 30 MW 120 MW 120 MW 300 MW Generator A 370 MW Generator B 250 MW Generator C Energy Offer $50/MWh $80/MWh Reserve price equals the opportunity cost to B for being backed down to provide reserve Short 50 MW of reserve. Since the reserve price is greater than $300, the system is not redispatched to meet the last 50 MW of the reserve req. $100/MWh + $2/MWh Output = $600/MWh $600 - $80 = $520 Energy price Energy offer Reserve Price 79

Reserve Shortage = 100 MW, Energy Demand = 1,000 MW Total Capacity Reserve Capability Assigned Energy Assigned Reserve 80 MW 300 MW Reserve Requirement Penalty Factor for being short reserve = 200 MW = $850 for 150 MW = $300 for 50 MW 400 MW 400 MW 100 MW 120 MW 100 MW 300 MW Generator A 400 MW Generator B Energy Offer $50/MWh $80/MWh Reserve price is equal to the associated penalty factor of $850 for this level of shortage Energy Price is equal to the cost of delivering one more unit of energy to the system 300 MW Generator C $100/MWh + $2/MWh Output = $700/MWh $700 + $850 = $1,550 Unit C Penalty Energy cost Factor* price *Serving next MW of energy incurs cost of going short 1 more MW reserve 80

Price ($/MWh) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Single Step Reserve Price Two Step Reserve Price Energy Price Comparison 0 100 300 490 550 630 680 720 760 800 810 870 920 960 1,000 Load (MW) www.pjm.com 81

Price ($/MWh) 900 800 700 600 500 400 300 200 100 0 Single Step Reserve Price Two Step Reserve Price Reserve Price Comparison 0 100 300 490 550 630 680 720 760 800 810 870 920 960 1,000 Load (MW) www.pjm.com 82