MMU Comments on Analysis Group Findings Regarding the FCM Lock-In Provision

Transcription

1 MMU Comments on Analysis Group Findings Regarding the FCM Lock-In Provision Pallas LeeVanSchaick NYISO Market Monitoring Unit Potomac Economics Installed Capacity Working Group February 25, 2015

2 Introduction Analysis Group ( AG ) performed a comprehensive assessment of differences between forward and spot capacity markets. The assessment provides many valuable insights about a broad range of issues. Many factors were explicitly modeled in simulation analyses. AG has been providing periodic updates on its capacity market assessment. MMU has had opportunity to review draft materials during the process. This presentation provides the MMU s comments on several issues identified by AG related to the Lock-in provision

3 AG Report Findings Related to a Lock-In Primary benefit from a Lock-In: Reduces market risk lowers financing costs for new entrant (which lowers Net CONE for Demand Curve Proxy Plants) However, AG identifies at least three significant concerns: 1) Lower financial risk achieved through transfer of risk from merchant generation to load (slide 65) 2) Discriminates against existing generation Risk of premature retirement (slide 40) 3) incentives for resources to submit offers above true costs lock-in may exacerbate incentive by increasing reward of an above-cost new resource offer new resource offers may time entry decisions to maximize lock-in prices (slide 40) The remaining slides discuss how a lock-in provision would affect financing costs and potential strategic conduct

4 Financing Cost Impact from Lock-In: Introduction AG Report assumptions: Cost of Debt falls 125 bps (Rating increases from BB to BBB) Cost of Equity falls 139 bps (Levered beta falls by 0.20) MMU performed additional analysis of financing costs: Cost of Debt: 125 bps reduction applicable for first 7 years Rated as other merchant gens over last 13 years Cost of Equity: Composite of revenue streams assuming: Locked-in capacity payments have business risk of a regulated utility (DC Reset: CoE = 8.93%, D/E = 55/45*) E&AS and other capacity payments have business risk of a merchant gen (DC Reset: CoE = 12.50%, D/E = 50/50) Unlevered cost of equity is calculated from CoE and D/E for each type of business

5 Annual Discounted Revenue (as Percent of Total) Share of Discounted Revenues Exposed to Market Risk Financing Cost Impact from Lock-In: Analysis of Market Risk 10% 9% 8% 7% 6% Discounted Revenue for NYC-Frame 7 Energy & Ancillary Services Other Capacity Locked-In Capacity Over Project Life 18% 40% 42% Real WACC v. Market Risk G-J CC Zone K Frame 7 NYC CC G-J Frame 7 NYCA Frame 7 NYC Frame 7 Merchant 100% 90% 80% 70% 60% 5% 4% 3% 2% 1% Regulated Utility 50% 40% 30% 20% 10% 0% Year of Operation - 5-0% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% Real WACC

6 Financing Cost Impact from Lock-In: Analysis of Market Risk Results The table summarizes 20-year levelized parameter assumptions for the Frame 7 technology used by AG and MMU: Parameter: NYC Other NYC Other NYC ZoneK G-J NYCA Nominal Cost of Equity 12.50% -1.39% -0.82% -0.40% -0.74% -0.80% Nominal Cost of Debt Demand Curve AG MMU 7% -1.25% -0.79% Real After-tax WACC 6.24% 6.37% -1.01% -1.05% -0.61% -0.42% -0.59% -0.62% Lev Carrying Charges 12.43% 12.06% -1.15% -1.16% -0.70% -0.46% -0.66% -0.69% Financing benefits would be even smaller for CC units given: Longer amortization period (25+ years); and Greater projected cash flow from energy & ancillary services. The MMU s lower estimates of the financing cost effects reduces estimated effects on the overall cost to loads by 40 percent

7 Incentives for Strategic Offers by New Entrants: Introduction AG identified suppliers have incentive to offer > Net CONE Purpose: set clearing price > demand curve Offer strategy balances: Potential gain from setting a higher clearing price and locking in the higher price Potential loss from not being selected Exacerbated by factors that increase upside potential for gain: Larger new resource size Larger potential price increase Larger portfolio size Larger gain from price increase Lock-in provision Multiplies potential gain by 7-7 -

8 Incentives for Strategic Offers by New Entrants: Illustrative Example New Offer at Net CONE P $120 Clearing Price/Quantity $125 Offer at Net CONE 10 GW 10.4 GW Demand Curve slope: $15/kW-year per 100 MW Q

9 Incentives for Strategic Offers by New Entrants: Illustrative Example Offer Above Net CONE P $185 $155 Clearing P/Q if New Unit Does Not Clear Profit-Maximizing Offer New resource offer clears if: blue triangle > green triangle Clearing P/Q if New Unit Clears 10 GW 10.4 GW Demand Curve slope: $15/kW-year per 100 MW Q

10 Incentives for Strategic Offers by New Entrants: Discussion & Conclusion Potential new generator: 400 MW, Net CONE = $120/kW-yr Profit from offering at net CONE: $14 million (~$35/kW) above Net CONE Potential profit from strategy to set higher clearing price: Overly aggressive offer Profit: $0, Cost to loads: +42% Profit-maximizing offer Profit: $98 million (~$245/kW) above Net CONE, Cost to loads: +24% The potential upside is large compared to the potential downside because of the 7-year price lock-in (assuming average price does not rise in Years 2 7). Costs to loads from strategic offers may fully offset the benefits to loads from lower financing costs

11 Conclusions The AG Report provides useful insights regarding the NYISO potentially moving to an FCM framework. We agree with AG s conclusion that such a change is not advisable. Short-term cost reductions to load associated with lower financing rates are likely lower than estimated in the report. Strategic offer incentives would further reduce such savings. The lock-in will also likely create a stream of subsidy payments to new units that would tend to rise after 2020 as new resources enter. The costs of these payments has not been estimated. We believe these factors, together with the potential for FCM to accelerate retirements, would likely raise costs to load over the longer-term