London Economics International LLCLondon Economics International LLC

Dr. Serkan BahDr. Serkan Bahçeciçeci

Contact: Contact: serkanserkan@londoneconomics.com@londoneconomics.com

A Comparative Analysis of Actual LMPs A Comparative Analysis of Actual LMPs and Estimated SRMCs in the PJM Marketand Estimated SRMCs in the PJM Market

prepared forprepared for

Assessing Restructured Electricity Markets: An Assessing Restructured Electricity Markets: An APPA SymposiumAPPA Symposium

Washington, DCWashington, DCFebruary 5, 2007February 5, 2007

2

Plan of presentationPlan of presentation

IntroductionIntroduction

Basics – prices, timeframe, marketBasics – prices, timeframe, market

Results of the StudyResults of the Study

SRMC Modeling MethodologySRMC Modeling Methodology

3

Focus on applied economics with quantitatively rigorous analysis to policy and regulatory issues in the sector

Evolved as a result of the infrastructure restructuring in the UK – now headquartered in US, a global economic, financial, and strategic advisory professional services firm specializing in energy and infrastructure

LEI has a number of complementary and cross-disciplinary practice areas:

Regulatory economics and market design Asset valuation, price forecasting and market analysis Expert testimony and litigation consulting Strategy advisory

LEI’s advisory experiences are complemented by a unique set of tools include network-based simulation models, cost-benefit frameworks, models of strategic bidding behavior, and real options analysis

Clients in energy industry include financial institutions, law firms, market institutions, utilities and IPPs

LEI has an extensive regulatory advisory backgroundLEI has an extensive regulatory advisory background

4

Our assignment is to assess the relationship Our assignment is to assess the relationship between energy prices and marginal costs of between energy prices and marginal costs of productionproduction

Aim to provide insight to the efficiency of market mechanismAim to provide insight to the efficiency of market mechanism Selected timeframe is from Selected timeframe is from January 2003 to July 2006January 2003 to July 2006 PJM ClassicPJM Classic only (PJM as of January 2003) only (PJM as of January 2003) Collate actual historical LMPs Collate actual historical LMPs

Aggregates of the load zone LMPs – Day Ahead Energy Aggregates of the load zone LMPs – Day Ahead Energy MarketMarket

Simulate the market-clearing price that would have resulted if Simulate the market-clearing price that would have resulted if generators bid their short-run marginal costs (SRMC) generators bid their short-run marginal costs (SRMC)

Compare actual LMPs to simulated SRMC-based pricesCompare actual LMPs to simulated SRMC-based prices Re-created a Re-created a price-cost markup indexprice-cost markup index for a sample of for a sample of

discrete, hourly trading intervals over the timeframe based discrete, hourly trading intervals over the timeframe based on simulated marginal-cost based biddingon simulated marginal-cost based bidding

5

Plan of presentationPlan of presentation

IntroductionIntroduction

Basics – prices, timeframe, marketBasics – prices, timeframe, market

Results of the studyResults of the study

SRMC Modeling MethodologySRMC Modeling Methodology

6

We have focused on the Day-Ahead LMPs in the We have focused on the Day-Ahead LMPs in the PJM market, as that is one of longest-lived nodal PJM market, as that is one of longest-lived nodal markets in the USmarkets in the US

Day-ahead LMPs are financially binding and typically cover 60% of the system load in PJM (2005 average)

Day-ahead and real time LMPs are actually converging In PJM, LMP is composed of generation marginal cost +

transmission congestion costs (other markets have also included cost of marginal losses, which PJM is also introducing)

LMPs are equal, when transmission system is unconstrained (ignoring loss component)

LMPs vary by location, when transmission system is constrained LMP is based on how energy flows – not contract paths

generators get paid at generation bus LMP load zone LMPs used for load settlement

In order to encompass many actual conditions, our modeling focused on ‘LMP areas’ rather than individual nodes

7

Selected timeframe is long enough to analyze trends Selected timeframe is long enough to analyze trends and the selected sample is intended to be representative and the selected sample is intended to be representative of each year of each year We sampled days (rather than We sampled days (rather than

hours) to capture fluctuations hours) to capture fluctuations within days within days

The sample size is 55%The sample size is 55% 200 days for each full year200 days for each full year 120 days for 2006120 days for 2006

Sampling is done using Sampling is done using Latin Latin hypercube sampling methodhypercube sampling method, , that allows multiple categories that allows multiple categories and makes sure each category and makes sure each category is equally represented in the is equally represented in the samplesample

monthsmonths days of the weekdays of the week load level load level daily load variationdaily load variation

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Dai

ly A

vera

ge L

oad

(MW

)

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Dai

ly A

vera

ge L

oad

(MW

)

2005 daily load –365 days

2005 selected sample –

200 days

8

PJM Classic has 10 transmission zones, based PJM Classic has 10 transmission zones, based on the service territories of the electric on the service territories of the electric distribution companiesdistribution companies

9

Primary Fuel Type ofMajor Generating Assets

Map also shows state and county

borders and location of the 10

load zones

While coal is concentrated in the west, Eastern While coal is concentrated in the west, Eastern PJM is dominated by gas-fired resourcesPJM is dominated by gas-fired resources

Source: Energy Velocity

10

… … and population density (proxy for load) is and population density (proxy for load) is higher in the east compared to the westhigher in the east compared to the west

11

Map is showing:Map is showing:

Transmission lines Transmission lines greater than 200 kVgreater than 200 kV

Generation units Generation units greater than 100 MWgreater than 100 MW

Transmission Transmission interfaces recreated interfaces recreated from PJM document from PJM document titled “titled “GIS Applied to GIS Applied to PJM Transmission PJM Transmission SystemSystem”, October 18, ”, October 18, 2005. 2005.

Network topology depends on transmission Network topology depends on transmission interfaces, which are not perfectly aligned with interfaces, which are not perfectly aligned with the boundaries of the load zonesthe boundaries of the load zones

Western Interface

Central Interface

Eastern Interface

Source: Energy Velocity

12

Our five region topology is consistent with the Our five region topology is consistent with the differences in zonal LMPsdifferences in zonal LMPs

DPL

AECO JCPL PSEG PECO

BG&E PEPCO METED (31%)

METED (69%) PPL PENELEC

Central Interface

Eastern Interface

Western Interface

13

LMPs are consistently lower in the western LMPs are consistently lower in the western zones during the study timeframezones during the study timeframe

Source: PJM

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

$/M

Wh

P M B E D 12 per. Mov. Avg. (M)

14

Plan of presentationPlan of presentation

IntroductionIntroduction

Basics – prices, timeframe, marketBasics – prices, timeframe, market

Results of the StudyResults of the Study

SRMC Modeling MethodologySRMC Modeling Methodology

15

Short run marginal cost includes fuel costs, Short run marginal cost includes fuel costs, environmental costs and variable O&M costs environmental costs and variable O&M costs

Environmental costs cover SO2 and NOx allowancesEnvironmental costs cover SO2 and NOx allowances Variable O&M costs include Variable O&M costs include

operations supervisionoperations supervision coolants and water coolants and water

expenditures;expenditures; pumped storage expensespumped storage expenses equipment expensesequipment expenses steam expenses from other steam expenses from other

sourcessources expenses of transferred expenses of transferred

steamsteam electric expenseselectric expenses

miscellaneous steam power miscellaneous steam power expensesexpenses

maintenance supervision maintenance supervision and engineeringand engineering

structures maintenancestructures maintenance boiler maintenanceboiler maintenance maintenance of reservoirsmaintenance of reservoirs maintenance of electric plantmaintenance of electric plant miscellaneous maintenancemiscellaneous maintenance

16

Fuel is the biggest component in SRMC Fuel is the biggest component in SRMC calculationscalculations

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

Nuclear Coal CCGT Gas fired peaker

$/M

Wh

Environmental costs

Fuel Costs

Variable O&M Costs

17

Average monthly fuel costs have rising trends Average monthly fuel costs have rising trends through the timeframethrough the timeframe

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

$/M

MB

tu Light Oil

Heavy Oil

Coal

NG

18

Price-cost markup index is unit free, allowing Price-cost markup index is unit free, allowing comparisons across regions and timecomparisons across regions and time

Price-cost markup (in dollar terms) is informative but cannot be Price-cost markup (in dollar terms) is informative but cannot be used for binary comparisonsused for binary comparisons

Price-cost markup index (markup over price) is used by PJM as Price-cost markup index (markup over price) is used by PJM as well as other ISOs, and measures the percentage of the price-well as other ISOs, and measures the percentage of the price-cost markup of the actual LMP cost markup of the actual LMP

( )

Actual LMP SRMC Modeled LMP

Actual LMP

19

We simulated the market using POOLMod, our We simulated the market using POOLMod, our proprietary proprietary market simulation market simulation software software

For each hour we used actual historical For each hour we used actual historical loadload transmission flowstransmission flows imports and exports imports and exports

Daily fuel prices are used for thermal plantsDaily fuel prices are used for thermal plants For gas and oil fired units the closest NG or oil hub (spot) price is For gas and oil fired units the closest NG or oil hub (spot) price is

usedused Coal prices take long-term contracts and transportation costs into Coal prices take long-term contracts and transportation costs into

account account The availability of each thermal plant is determined using EPA’s The availability of each thermal plant is determined using EPA’s

CEMS database and other sources CEMS database and other sources CEMS cover more than 90% of the nameplate capacityCEMS cover more than 90% of the nameplate capacity

For hydro plants we used monthly production data as submitted For hydro plants we used monthly production data as submitted in EIA Form 906in EIA Form 906

20

POOLMod simulates the actual market conditions to POOLMod simulates the actual market conditions to calculate SRMC-based market clearing pricescalculate SRMC-based market clearing prices

Stage 1 - Commitment

Is plant available?

Stage 2 - Dispatch

No

Not committed for dispatch

Review technical capabilities of

units

Schedule hydro based on optimal

duration of operation

Competitive bidding assumed

Stage 1 - Commitment

Is plant available?

Stage 2 - Dispatch

No

Not committed for dispatch

Review technical capabilities of

units

Schedule hydro based on optimal

duration of operation

Competitive bidding assumed

Stage 1 - Commitment

Is plant available?

Stage 2 - Dispatch

No

Not committed for dispatch

Review technical capabilities of

units

Schedule hydro based on optimal

duration of operation

Competitive bidding assumed

Stage 1 - Commitment (daily)

Is plant available?

Stage 2 - Dispatch (hourly)

Yes

No

Not committed for dispatch

Review technical capabilities of units and offers

Schedule hydro based on optimal

duration of operation

Resources dispatched based on offer price subject

to transmission limits, as well as plant-specific technical constraints

SRMCbidding assumed

LMPs set equal to the bid of the most

expensive dispatched resource

Demand duration curve plus

reserves for a typical day

(MW

)(M

W)

(MW

)

Hourly demand(M

W)

21

Plan of presentationPlan of presentation

IntroductionIntroduction

Basics – prices, timeframe, marketBasics – prices, timeframe, market

Results of the StudyResults of the Study

SRMC Modeling MethodologySRMC Modeling Methodology

22

Monthly averages of price-cost markup indices Monthly averages of price-cost markup indices show variation across regionsshow variation across regions

20% +

15% - 20%

10% - 15%

5% - 10%

0% - 5%P

MB

ED

0

5

10

15

20

25

Peak markup index, %

23

… … and through timeand through time

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak

Off-Peak

2 per. Mov. Avg.(Peak)2 per. Mov. Avg.(Off-Peak)

Load-weighted monthly peak and off-peak price-cost markup indices

Ma

rku

p in

de

x, %

24

Monthly price-cost markup indices and monthly Monthly price-cost markup indices and monthly averages of regional load are not correlatedaverages of regional load are not correlated

-5%

0%

5%

10%

15%

20%

25%

30%

0 5,000 10,000 15,000 20,000 25,000 30,000Regional load (MW)

Pri

ce-c

ost

ma

rku

p in

de

x (%

)

P - Peak P - Off-peak M - Peak M - Off-peak B - PeakB - Off-peak E - Peak E - Off-peak D - Peak D - Off-peak

25

Region P (Penelec) has relatively higher markup Region P (Penelec) has relatively higher markup indices compared to the other regionsindices compared to the other regions

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Overall Markup index

Peak Markup index

Off-Peak Markup index

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak periods-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Off-peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

All periods

26

Region E (AECO, JCPL, PECO, PSEG) had high Region E (AECO, JCPL, PECO, PSEG) had high markups through 2004 to 2005markups through 2004 to 2005

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Overall Markup index

Peak Markup index

Off-Peak Markup index

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak periods-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Off-peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

All periods

27

Region M (PPL and portion of METED) has many Region M (PPL and portion of METED) has many statistically insignificant off-peak indicesstatistically insignificant off-peak indices

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Overall Markup index

Peak Markup index

Off-Peak Markup index

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak periods-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Off-peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

All periods

28

Region B (BGE, PEPCO and remaining METED) Region B (BGE, PEPCO and remaining METED) has a smaller difference between peak and off-has a smaller difference between peak and off-peak indicespeak indices

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Overall Markup index

Peak Markup index

Off-Peak Markup index

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Off-peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

All periods

29

Region D (Delmarva peninsula) has the highest Region D (Delmarva peninsula) has the highest markup index values in late 2004markup index values in late 2004

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Overall Markup index

Peak Markup index

Off-Peak Markupindex

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Off-peak periods

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Jan-

03

Mar

-03

May

-03

Jul-0

3

Sep-0

3

Nov-0

3

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

All periods