Natural Gas Pipeline Penalty Recovery Issue Paper

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1 Natural Gas Pipeline Penalty Recovery Issue Paper September 16, 2014

2 Table of Contents I. Introduction and Background... 3 II. Scope of Initiative and Plan for Stakeholder Engagement... 4 III. The Approved Policy... 4 Details of Approved Policy and Proposed Implementation... 4 Justification for Policy... 6 Gas Pipeline Reliability Issues... 7 IV. Possible Augmentation to Policy... 8 V. Bid Cost Recovery Modification... 9 VI. Other Stakeholder Initiatives which May Impact Need for Penalty Recovery... 9 VII. ISO Request for Stakeholder Comments VIII. Next Steps CAISO: MIP:sak 2 September 16, 2014

3 I. Introduction and Background In 2012 the ISO conducted a stakeholder initiative dealing with various commitment cost refinements. This initiative included a proposal to allow scheduling coordinators for generators to request the ISO include, under certain limited circumstances, natural gas pipeline penalties (such as those associated with PG&E s operational flow order process) they might receive from natural gas pipelines in the bid cost recovery mechanism. The ISO Board approved the commitment cost refinement policy in May While the ISO implemented several commitment cost refinements in 2013, issues which arose during the tariff development process caused the ISO to delay any filing for FERC approval to allow recovery of natural gas pipeline penalties. The ISO determined that more time was needed in order to conduct additional outreach to intra-state and interstate pipelines. This outreach was needed to ensure that the draft tariff language would differentiate between the non-emergency operational flow orders to which the policy was intended to apply and emergency conditions for which penalty recovery was not intended to apply. The additional outreach provided the ISO the opportunity to more thoroughly understand and address any potential reliability issues the penalty recovery policy might cause pipeline operators. Since the ISO developed its initial policy two years ago and considered implementation issues last year, several changes have occurred in the area of electric/natural gas coordination: Last winter saw periods with extremely high natural gas prices, especially in the eastern US, and this resulted in situations where California pipelines were not seeing the amount of gas delivered into their systems required to meet the expected burns. o This resulted in at least one instance of a generator being curtailed by a gas pipeline for reliability reasons. o The high gas prices, which occurred very quickly and were not reflected in the normal gas price indices used by ISO markets, resulted in an ISO filing at FERC to waive certain ISO tariff rules under such conditions. FERC approved temporary waivers for the winter period of last year. The ISO is proposing permanent changes for the coming winter through the Commitment Cost Enhancement stakeholder process. The high gas prices and stressed or emergency operating conditions on natural gas pipelines have resulted in significantly improved coordination between ISO and gas pipeline operators on system planning and operations. This coordination has resulted in the ISO issuing exceptional dispatches to respond to operational concerns of and situations experienced by the natural gas pipeline operators even under emergency conditions not contemplated by the ISO s original proposal. FERC has issued a NOPR on gas/electric coordination, which suggests changes to how electric and gas systems are coordinated, including modifying the gas day to better align gas and electric markets. SoCalGas filed at the CPUC to implement a tiered operational flow order process, including penalties, similar to that used by PG&E. These changes merit that rather than just implementing the previously approved policy, the ISO consider whether the original policy is still appropriate, should be modified, or possibly expanded. This Issue Paper discusses the issues which led the ISO to develop the original policy, and includes in the CAISO: MIP:sak 3 September 16, 2014

4 discussion gas pipeline reliability issues that became apparent during last year s implementation stakeholder process. Further, since the original commitment cost refinements initiative was conducted two years ago there have been, or will be, additional initiatives dealing with commitment cost and bidding issues in the ISO markets which may address, at least in some manner, the original issues that the natural gas pipeline penalty recovery was supposed to address. The original policy did not extend to penalties resulting from emergency conditions on natural gas pipelines, but the coordinated operations between the ISO and pipelines last winter during emergency conditions may warrant allowing for recovery of any penalties generators might incur for following dispatch instructions during these coordinated operations. During the September 23, 2014 conference call and in comments that are due October 8, 2014 the ISO is requesting that stakeholders provide input on the issues discussed below. II. Scope of Initiative and Plan for Stakeholder Engagement This stakeholder process will address the limited issue of the recovery of natural gas pipeline penalties. This may be related to other issues, such as commitment cost or bidding rules, but the policy for those other issues will be decided in the other stakeholder processes. The proposed schedule for stakeholder engagement for the pipeline penalty recovery is listed below. How this initiative will proceed beyond what is shown in the table will depend on the discussions during the stakeholder call and the comments received from stakeholders. Date September 16, 2014 September 23, 2014 October 8, 2014 Event Issue Paper Posted Stakeholder Call Stakeholder Comments Due III. The Approved Policy The Commitment Cost Refinements 2012 stakeholder initiative proposal was approved by the ISO Board in May The ISO conducted an implementation and tariff drafting stakeholder process during In this section of this Issue Paper the ISO will review this policy and the justification behind it. Details of Approved Policy and Proposed Implementation The policy adopted in 2012 provides scheduling coordinators for generation resources the opportunity to request that the ISO s calculation of bid cost recovery include non-emergency but extra-normal natural gas pipeline balancing penalty costs, such as PG&E s operational flow order penalties, under certain limited circumstances where the generator could not nominate gas and could not recover the penalty through its bid price. Generators were expected to take all possible actions to avoid the penalties, and to include any potential penalty costs in their bids. Additionally, the policy only allowed CAISO: MIP:sak 4 September 16, 2014

5 recovery when the penalties were not associated with emergency reliability orders or curtailment orders. Specifically, scheduling coordinators on behalf of generators could seek to have the ISO include in their bid cost recovery the share of a non-emergency flow order penalty incurred by the resource for a dispatch occurring two hours or less before the final intra-day scheduling nomination for the applicable gas pipeline and the end of the applicable gas pipeline flow day; and that resulted from one or more of the following: 1. Day-Ahead ISO commitment without a day-ahead schedule above minimum load followed by a real-time ISO de-commitment; 2. In the absence of a day-ahead schedule, a real-time ISO commitment to minimum load, without real-time dispatch above minimum load; 3. Real-time dispatch above minimum load whenever the bid submitted on behalf of the resource is mitigated to the default energy bid; or 4. Real-time exceptional dispatch when the exceptional dispatch energy settlement is settled at resource-specific settlement interval locational marginal price or the default energy bid price due to bid mitigation or in the absence of submitted bids (not including any real-time exceptional dispatch of energy from self-scheduled capacity). These situations represent cases where the potential costs of any penalty could not be reflected in the resource s bid, either because the ISO has mitigated the resource s energy bid or the generator did not have an energy bid, or where the ISO based its dispatch on minimum load or start-up costs since these costs cannot be adjusted in real time or in the case of exceptional dispatch as described above. The policy was originally developed in light of Operational Flow Orders included in PG&E s gas tariff. PG&E uses their OFO process to provide shippers with a financial incentive to deliver the gas they intend to burn rather than rely on the pipeline for balancing. There are five levels of OFO with increasingly tight balancing requirements and increasing penalty amounts for failing to meet the balancing requirements. When PG&E forecasts that deliveries of gas into their system might not be enough to keep up the pressure in the pipelines, they call an OFO. The OFO establishes a tolerance level for balancing and a penalty amount for violating the tolerance amount. These amounts are set to a level that provides an appropriate incentive for shippers to deliver gas into the PG&E system to meet their expected burn amounts. The OFO is designed to incent shippers to respond and avoid the need to call an emergency flow order. In addition, if the conditions for inclusion of a natural gas pipeline penalty in bid cost recovery are met, the adopted policy provided that the ISO verify the penalty and provided that the ISO would develop a method to estimate the maximum penalty to provide a check on penalty amounts. The proposed implementation details, including a formula for estimating the maximum allowed penalty, are contained in the Commitment Cost Refinements 2012 Implementation Details, April 25, 2013, The original stakeholder initiative documents and draft tariff language developed last year are available CAISO: MIP:sak 5 September 16, 2014

6 at: tmentcostsrefinement2012.aspx. Justification for Policy This policy was developed to avoid subjecting generators to the possibility of incurring penalties as a result of an ISO dispatch for which they had no opportunity to include in their bids. The potential to seek recovery is allowed only under very limited conditions. The ISO markets are designed so generators manage their gas supplies and reflect constraints in bids submitted to the ISO markets to ensure that they have sufficient gas to meet ISO dispatch instructions. Their bids should ensure that the prices the generators receive for energy from the ISO markets, in conjunction with capacity revenues, are sufficient to cover the costs of generating that energy, including any costs for balancing their gas use and supplies and/or natural gas pipeline penalties. Generators may only seek to include pipeline penalties in the bid cost recovery calculations when they were unable to avoid the penalty and the ISO or the market structure prevents the generator s bid from including the potential penalty. The adopted policy was designed to ensure reliability of both the electric and natural gas systems. Without this policy, generators may be placed in a situation where following ISO dispatch instructions will cause them incur substantial natural gas pipeline penalties which they may not be certain they can recover, even though they have tried to include the potential penalties in their bid. Their only option to avoid the natural gas penalty would be to not follow the ISO s dispatch. The ISO s adopted policy provides an assurance to generators that they will not be forced to absorb natural gas penalty amounts that they were completely unable to avoid or recover. The policy removes a potentially significant disincentive to non-resource Adequacy generators to remain available to the ISO and respond to ISO dispatch instructions. Putting it another way, without the certainty of recovering non-emergency flow order penalties which they were unable to avoid or include in their bids, resources may be incented to avoid the penalties by not being available to the ISO or by failing to follow an ISO dispatch instruction. Thus, the proposed policy assures generators they won t be prevented from recovering in their market prices natural gas pipeline penalties which ISO dispatch forces them to incur. This removes disincentives to the generator to remain available to the ISO by including estimates of potential gas pipeline penalties, or the costs of additional gas procurement to avoid the penalties, in their real time bids. Having all resources available with bids including their natural gas costs will allow the ISO s market mechanisms to efficiently dispatch the gas fired generation. This will enhance the reliability of the electric grid by ensuring that more options are available to the ISO. Because the bids include estimates of additional gas costs or potential pipeline penalties, the ISO s dispatch is accounting for (indirectly through the included pipeline penalties) the impact of increasing a generator s output on the gas pipeline conditions. Efficient ISO electricity market dispatch will tend to improve the reliability of the natural gas pipeline because it uses the potential penalties the generators have included in their bids. The ISO s market dispatch will use the bids incorporating the potential penalties or increased gas costs to mitigate additional stress on the gas pipeline which issued the flow order. ISO real time markets will dispatch up those resources whose bids for real time energy are lower. This would include: CAISO: MIP:sak 6 September 16, 2014

7 Generation on other pipelines without gas pipeline penalties to include in their bids. Generation which has already scheduled gas and may have extra gas available; these resources will include additional gas costs, but these will likely be less than the full penalty. More efficient generators. Because the penalties are per mmbtu; more efficient generators will have a lower penalty per MW, and dispatching them will mean a lower the amount of gas is required. Because the ISO markets dispatch in this manner, the goal of the pipeline when it declares an operational flow order is achieved. The pipeline, when it issues the operational flow order, provides an economic incentive to shippers to deliver to the pipeline gas they expected to burn rather than rely on pipeline balancing. The generators will weigh the cost of procuring additional gas relative to the potential penalty, and assuming the pipeline has set the penalty correctly, enough shippers should be encouraged to deliver extra gas rather than pay the penalty and the pipeline reliability is improved. As described above, when the generators incorporate these costs into their bids, the ISO market optimization will limit the impact on the pipeline s balancing before dispatching generation which would have to pay the penalty the ISO markets will dispatch other generation with cheaper options, such as generation on other pipelines or generation which has sufficient gas already scheduled that ISO dispatch won t cause them to incur any penalties. Gas Pipeline Reliability Issues During the tariff development process for the Commitment Cost Refinements last year, several issues arose which warranted further vetting of the pipeline penalty recovery policy. These include the already mentioned terminology difference between the various pipeline tariffs. There are also differences in the actual operating procedures of various pipelines, and the penalty validation that by necessity will take a very long time and must be a manual process. During the tariff stakeholder process a concern arose that the term operational flow order as used by PG&E (and by SoCalGas/SDG&E in their recently filed proposal) has a different meaning for interstate pipelines. For interstate pipelines, which are FERC jurisdictional, an operational flow order reflects an emergency condition. The intent of the original policy was not to apply penalty recovery during emergency conditions on the pipelines. Indeed, at least one pipeline expressed concern that a policy allowing recovery of penalties during emergency conditions might remove the incentive not to violate the emergency order. In emergency conditions the pipelines need to know that customers will follow the emergency flow orders. The ISO made this distinction very clear as it concerned the intrastate pipelines which provide natural gas to most of the ISO s gas fired generation. However, other stakeholders expressed concern that the different meanings of operational flow orders among the intrastate and interstate pipelines might create reliability issues for interstate pipelines. A related issue is that different pipelines have different types of programs, with different types of penalties that are designed to address situations similar to what the PG&E OFO process addresses. As mentioned, SoCalGas has proposed a similar five level non-emergency operational flow order mechanism, but this may not be in place until Currently, SoCalGas relies on winter balancing rules. These rules have a five day balancing period, which changes to daily balancing when the amount CAISO: MIP:sak 7 September 16, 2014

8 of gas in storage drops below a certain level. A further complication of the existing SoCalGas rules is that rather than specific penalty amounts, customers who fail to balance must buy the gas from SoCalGas at a multiple of the market index price. Such differences in how pipelines attempt to provide enhanced incentives for shippers to deliver the gas they use during periods of expected tightness makes it difficult for the ISO to draft a tariff that treats all generators similarly. IV. Possible Augmentation to Policy As described above, the original policy excluded any penalties associated with emergency operating conditions or curtailments on pipelines. The reason for this exclusion was to ensure that the policy did not provide recovery to a generator which violated an emergency order of a pipeline, so as not to provide even a small incentive for generators to ignore these emergency orders. Over the past two winters the ISO operations group and the operations groups at natural gas pipelines providing service to generators on the ISO grid have refined their coordination activities during emergency situations to help ensure both gas and electric reliability when possible. The actions taken in these situations can lead to generators receiving penalties for violating emergency flow orders or curtailment orders issued by the pipelines even when the gas companies agree that specific generators needed for electric reliability can be served without compromising gas reliability. To ensure there are no disincentives for generators to follow the ISO s operating instructions during these emergencies, the ISO and stakeholders could consider expanding the previously approved policy so generators have the ability to recover natural gas pipeline penalties arising from emergency flow orders or curtailment orders but only when the ISO s dispatch is being coordinated with the pipeline and the pipeline concurs. More than two thirds of electric generation on the ISO grid is natural gas fired. These generators are also among the largest consumers of natural gas on the pipeline systems. When pipelines are experiencing operational issues, gas fired generators often provide the simplest and fastest tool for addressing the situation. By changing the consumption of a single generator the pipeline can achieve relatively large changes in gas usage. However, attempting to do so without coordinating with the ISO can result in the pipeline situation getting worse, as explained above, or compromise electric reliability. When the pipeline curtails specific generators, ideally the pipeline should waive any potential emergency flow order penalties that generators might normally incur. However, when the changes in dispatch occur after a gas curtailment whether through ISO exceptional dispatches or ISO market dispatches, the pipeline may not be able to waive the penalties, either because they do not know which generators are responding through the ISO re-dispatch or because they do not have tariff authority to effect a waiver of the penalties. In these situations, both the ISO and gas pipeline need generators to respond to the coordinated operating instructions in order to ensure the reliability of both systems. Given that some of the emergency flow order penalties can be over $25 / MMCF, generators will have a disincentive to follow the coordinated operating instructions. Allowing the generators to include potential penalties should eliminate this disincentive. CAISO: MIP:sak 8 September 16, 2014

9 The ISO is seeking stakeholder feedback on whether to allow recovery of emergency flow order penalties for dispatches resulting from coordinated operations between the ISO and an affected gas pipeline to maintain both electric and gas system reliability. In response to pipeline conditions the ISO may issue exceptional dispatch instructions to generation that will have the effect of limiting or increasing their gas usage. These resources, if they incurred penalties, may be able to apply for recovery of any emergency flow order penalties. The needed increased output may also come, at least partially, through the automatic market dispatch. In these instances, coordination can be evidenced by the ISO issuing an operating order to follow the market dispatch after coordination with the gas pipeline. Any recovery of penalties for emergency flow orders or curtailments would only be allowed when the ISO and pipeline are coordinating operations and the generator was unable to modify its gas nominations and market revenue was not allowed to include potential penalties. This potential expansion of the adopted policy would apply to all natural gas pipelines, both the California intrastate and interstate pipelines. Unlike the previously adopted policy, which may not apply to interstate pipelines because they do not have non-emergency operational flow order process, all pipelines have emergency (operational) flow orders or curtailments. However, the coordinated operations of the electric system and an interstate pipeline may require the pipeline to modify its tariff. If a pipeline s tariff does not allow the coordinated operations considered here, then this policy will not have any impact for generation receiving natural gas from that pipeline, since any potential penalty recovery will only occur when there are coordinated operations. If adopted, the ISO would work with any pipeline which supplies natural gas to an ISO generator to develop appropriate gas electric coordination based on the pipeline s tariff and operations. V. Bid Cost Recovery Modification Since the original policy was approved by the ISO Board, the mechanism for the recovery of bid costs has been modified. Bid cost recovery now occurs separately for day ahead and real time markets. In light of this, the recovery of any potential penalties through the bid cost recovery mechanism must now specify whether that would be through the real-time or day ahead bid cost recovery processes. Day ahead dispatches will not result in situations where gas pipeline penalties can be recovered, since the generators are expected to be able to adjust their gas nominations to any day ahead dispatch. It is only real time dispatch that would create the conditions for the potential bid cost recovery of natural gas pipeline penalties. Therefore any recovery would only occur in the real time bid cost recovery process. Stakeholders should comment on the appropriateness of this. VI. Other Stakeholder Initiatives which May Impact Need for Penalty Recovery As explained above the Board approved policy and any extension of that policy would only allow the recovery of natural gas pipeline penalties in very limited conditions: when the generator has no ability CAISO: MIP:sak 9 September 16, 2014

10 to adjust its gas nomination to avoid the incurring the penalty and when it was prevented from including the potential penalty costs in its real-time bids, either because the bid is mitigated or dispatch is based on min load costs which cannot be adjusted to include the potential penalty costs. There are several ISO stakeholder initiatives which are, or will, address these restrictions, as well as a FERC NOPR on gas/electric coordination which has proposed modifications to the gas day, including additional opportunities to adjust gas nominations. In the tariff development process for the original policy the ISO asked stakeholders how often they expected to need to use the policy, and the responses indicated that generators did not expect that there would be many situations where penalty recovery would be sought. The changes to markets contemplated in these various initiatives may reduce even further the likelihood of situations where penalty recovery could occur. Currently, most pipelines have four gas nomination cycles. The first is the timely cycle and is the primary scheduling process for the next gas day. There is second day-ahead nomination cycle, and two intra-day opportunities to adjust the gas nominations for the remainder of the gas day. The last of these occurs at 3 pm, and allows the shipper to adjust its nomination for the second half of the current gas day. The FERC NOPR on gas electric coordination has suggested moving the gas day to start earlier, and would also add an extra intra-nomination cycle at 7 pm. If these changes are adopted there would be fewer dispatches from the ISO when the generator would be prevented from adjusting its gas nominations. Further, a 7 pm nomination would allow the generators to see initiation dispatches for the ISO s evening ramp period and thus have an indication of whether their generation is likely to be needed for the remainder of the gas day. The recent Commitment Cost Refinement stakeholder initiative is addressing issues that arose last winter during high natural gas price periods. This initiative is proposing changes in the minimum load and start-up components of bids. The changes are designed to provide more accurate estimates of gas costs when prices of natural gas are rising very quickly, and allow the bids to be up to 125% of the proxy cost. These changes will allow the start-up and minimum load costs to more accurately reflect the natural gas market conditions. The ISO seeks stakeholder comments regarding the degree to which the 125% cap on calculated costs may be sufficient to ensure recovery if the unit is dispatched to minimum load in real time. The ISO will shortly begin another stakeholder process looking more broadly at bidding rules in the ISO markets. One of the issues that will be potentially addressed in this initiative is whether resources that have bid in the day-ahead markets should be allowed to re-bid minimum load in the real-time market, particularly if they are not scheduled in the day-ahead market. Allowing changes in the minimum load bid may allow generators to account for potential penalties if they are committed after their last opportunity to nominate gas and remove the need for special recovery of gas pipeline penalties in these situations. The recovery of pipeline penalties in cases where the dispatch is above minimum load was only considered in situations where the generator didn t submit a bid and was paid at the default energy bid, or had their energy bid mitigated down to the default energy bid (DEB). In these cases the issue is not the recovery of the pipeline penalties, but rather an issue with the local market power mitigation CAISO: MIP:sak 10 September 16, 2014

11 (LMPM) or the default energy bid. If the generator was dispatched based on the default energy bid, which failed to reflect the potential pipeline penalty, then the dispatch is not efficient because it is not based on the actual costs for the generator. The pipeline penalty recovery policy would allow the generator to recover the costs of the penalty and will keep the generator from incurring financial penalties for actions beyond its control, but it does not prevent the market from dispatching the generator inefficiently because it fails to account for the penalty costs. The ISO seeks stakeholder input on this significance of this issue, and if stakeholders see this as a significant issue, how this issue should be addressed. VII. ISO Request for Stakeholder Comments The ISO seeks stakeholder comments on the issues raised in the paper and the extent to which stakeholders see problems with the existing construct. After reviewing the original policy and how conditions have changed since that policy was adopted, there are several directions that the ISO might move. Provided below are some approaches that might be considered to address the issues discussed in this paper. This list is not intended to be exhaustive, and there may be other approaches that could be considered. 1. No change to current tariff: If there is no continuing need for the previously approved policy or for recovery during emergency pipeline flow orders, the simplest path forward would be to leave things as they currently are. 2. Currently approved original policy only: If the justifications for the original policy are still appropriate, and there is no need for recovery during emergency pipeline conditions, the ISO could go forward with the approved original policy. This would not require returning to the Board, but would require a FERC filing to change the tariff. The ISO would develop tariff language structured such that it would not cause reliability problems for interstate pipelines. If you support this option, please comment on how the distinction between the intrastate operational flow order penalties and other emergency conditions, especially on interstate pipelines, can be made in the tariff language. 3. Allow recovery in non-emergency conditions but only when operations are coordinated with the pipeline: A modification of the original policy would be to allow recovery only during nonemergency conditions, but only when the ISO and the pipelines are coordinating operations. This modification would likely require returning to the Board to approve the modification, and then a FERC filing to change the tariff. 4. Expand to emergency flow order penalties when there is coordination: In addition to the original policy, this option includes expanding the recovery options to emergency and curtailment conditions when the ISO and the pipelines were coordinating operations. This would require Board approval of the change, followed by a FERC filing for the tariff change. CAISO: MIP:sak 11 September 16, 2014

12 5. Modify the original policy to apply only with coordination And expand to emergency conditions when there is coordination: As in Case 2, the existing rules pertaining to nonemergency conditions could be modified to only allow recovery if the ISO and pipelines are coordinating operations, but also as in 4 expand to allow recovery of emergency flow order or curtailment penalties when the ISO and pipeline are coordinating operations. 6. Only allow recovery of emergency flow order penalties when there is coordination: This would eliminate the conditions originally approved, and instead only allow recovery of pipeline penalties during emergency conditions when the ISO and pipeline are coordinating operations. Board approval would be required for this option followed by a FERC filing for a tariff change. The ISO requests stakeholders to include in their comments which of these approaches they support and why. Stakeholders are welcome to suggest alternate approaches as well. The ISO also requests stakeholders comment on several other issues: After examining the potential issues, especially the complicated settlement process associated with the adoption of the original policy and assessing the likelihood of eligible situations occurring, does it continue to make sense to implement pipeline penalty recovery? Will the changes being considered in the Commitment Cost Update, Bidding Rules, and other stakeholder initiatives be sufficient to ensure generators that they will be able to recover any potential pipeline penalties by including them in their bids? If not, please provide examples of when recovery may not be ensured, and an estimate of likely these examples will be to occur. Are there other changes to ISO bidding and commitment procedures, or timing of the ISO markets and natural gas pipeline markets, that would eliminate the need for these policies? If you support one of the options which allow recovery of pipeline penalties under certain conditions, please comment on how the ISO can verify and validate the penalties through the settlement system. Please comment on whether the policy will create any potential reliability concerns on any pipelines, or whether it may help to ensure the reliability of the pipelines. VIII. Next Steps The ISO will discuss this Issue Paper with stakeholders during a conference call to be held on September 23, Stakeholders should submit written comments by October 8, 2014 to Questions should be directed to: Stephen Keehn Office: CAISO: MIP:sak 12 September 16, 2014

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