DECEMBER 02, 2015

Where Did The Descending Clock Format Come From?

Markets Committee Presentation

Mark Karl VICE PRESIDENT, MARKET DEVELOPMENT

ISO-NE PUBLIC Background on the DCA Format in FCM

• Purpose of this presentation is to briefly trace the source and reasons for using the Descending Clock Auction (DCA) in the Forward Capacity Market (FCM). • Discussions on auction format for capacity markets in New England go back to the late 1990s. • ISO-NE did not propose a DCA format in its Locational Installed Capacity (LICAP) proposal. • Load parties, including regulators, were the major proponents of using a DCA format and a forward auction, but they did not originate the idea. • The source of the DCA format can be traced to a recommendation from a Final Report prepared by National Economic Research Associates (NERA) in 2003/2004 titled: – Central Resource Adequacy Markets for PJM, NY-ISO and NE-ISO (the CRAM Report) http://www.nera.com/content/dam/nera/publications/archive1/CRAM_Report_Feb_2004.pdf

ISO-NE PUBLIC 2 The CRAM Report

• NERA was retained by ISO-NE, New York-ISO, and the PJM ISO to conduct a comprehensive analysis of the centralized resource adequacy market model that was developed and proposed by the interregional Resource Adequacy Model Group.

• This occurred in the 2002 timeframe and was a separate interregional effort conducted in parallel with the SMD/ICAP development process. • The goal was to establish a centralized interregional capacity market model that would provide sufficient economic incentives for, and indeed to assure, resource adequacy. • The model recommended in the CRAM report had the ISOs: determine the resource need in advance of a planning period, hold a central procurement through an auction, pay the auction clearing price to all resource providers and recover the cost from load during the planning period. • NERA was specifically requested to compare Pay-as-Bid to Descending Clock and Reverse formats.

ISO-NE PUBLIC 3 NERA’s Assumptions • Providing information to bidders who face uncertainty makes them bid more confidently. • Providing information to bidders reduces the risk of the winner’s curse. • If the views that bidders have of the value of capacity are ‘affiliated,’ then an open auction format performs better (the ‘’). • Using an open auction format promotes the selection of the most efficient provider. • In a sealed bid format, entrants can use uncertainty to their advantage in the face of strong incumbents. • In a closed uniform price auction, there are well-known ways for bidders to coordinate. • In a closed uniform price auction with smooth supply functions and reasonable assumptions on information, a wide range of prices can occur. • The price resulting from pay-as-bid auction can be unpredictable. • In an open auction format, if there are multiple bidders and the value of capacity is uncertain, coordination between bidders becomes very difficult.

ISO-NE PUBLIC 4 NERA’s Recommendation

• Under Section 5 of CRAM, specifically Section 5.2, NERA explains why they recommend using a DCA format in a forward procurement market. The salient features they considered:

1. Common Value Uncertainty and Affiliation of Values: Resource providers face common sources of uncertainty regarding the future.

2. An Entry-Smoothing Problem: A mechanism is needed to identify who is committed to enter the market to address too much or too little entry.

3. Asymmetry of Bidders: The goal is for the auction to identify the most efficient providers.

4. Completing the Market System: The creation of a capacity market that operates a long time in advance will increase efficiency by allowing new trades to occur.

ISO-NE PUBLIC 5 The LICAP Adventure

• The JCAG/CRAM process ran from early 2001 through 2004. • The SMD implemented in March 2003 used capacity market design based on the NYISO market.

• The principle differences between the ISONE and NYISO markets were that ISONE used a pool-wide non-locational design and did not include a demand curve. At the time, the DC was a new feature and was being litigated. • Since ISONE and NYISO are directly interconnected, a common market design was desirable. • The NERA design was not completed until February 2004, well after implementation of SMD. • In response to protests, on April 25, 2003 FERC issued the “Devon Order” ER03-563, requiring implementation of a locational capacity design by June 1, 2004. • Throughout 2003 and into 2004 ISO and NEPOOL considered options for a locational design.

• Although the NERA design was nearly complete, at that time the decision was made to continue with a monthly New York based design.

ISO-NE PUBLIC 6 So Who put the DCA in the FCM?

• Following a June 2004 Order, the LICAP proposal was addressed in hearings before an Administrative Law Judge. Twenty-four days of hearings were held from February 23, 2005 until March 31, 2005. An Initial Decision was issued on June 15, 2005. • Following the issuance of the Initial Decision, the Commission granted a request by numerous parties for oral arguments on alternatives to LICAP.

• During oral arguments in opposition to LICAP the FERC Commissioners challenged opponents to offer a viable alternative to LICAP. • On September 13, 2005, parties representing TO’s, load and end users, including the public utility regulatory commissions for all six states, filed the New England Resource Adequacy Model (NERAM) and the New England Locational Resource Adequacy Model (NELRM) as alternatives to LICAP.

ISO-NE PUBLIC 7 So Who put the DCA in the FCM? (Continued)

• That alternative was the NERA CRAM design and proposed a forward resource auction to procure capacity, with a descending clock auction held several years in advance of an installed capacity commitment period. • On October 21, 2005 the Commission granted the request of multiple parties for appointment of a Settlement Judge. • All of the features of the proposed alternatives, including the DCA format, were incorporated into the Settlement Agreement at the request of parties representing load, end users, transmission owners and the state regulators. • The FCM was designed and built around a DCA format from the beginning, since it was based on the NERA CRAM design which included the DCA as a feature of the design.

ISO-NE PUBLIC 8 Summary

• NERA offered specific reasons for putting the DCA into the FCM. • ISO-NE did not originally advocate for the DCA format, but was requested to consider it.

• ISO ultimately supported its adoption because it was thoughtfully constructed based on economic principals detailed in the CRAM study and recommended by NERA. • The final market design incorporates a clearing engine, in addition to the DCA, to deal with optimization of lumpy offers and other special tariff rules. The auction price is based on the Tariff-specified pricing rules. • The principals outlined by NERA in slide 5, as well as practical experience gained over the conduct of past nine , would need to be addressed if any new auction format were to be considered.

ISO-NE PUBLIC 9