ISEM CRM Decision 3 Contract Auction Design and

I-SEM CRM Decision 3 Contract, Auction Design and Market Power 1

Content • • Contract fix price length Auction frequency and volumes Auction design Market Power 2

Contract fix price length CRM 2 position • Existing plant: 1 year price fix • New plant. “Balanced economic life” basis: – The same for all plant technology types; – Based on ‘balanced economic life’ option, and be no more than ten years with the actual maximum value being to be confirmed in this CRM Decision 3 CRM 3 Decision • Opted for 10 years for new plant given potential auction price volatility, but fix price length kept under review • Storage: considering allowing ten years from start of operation, if meet long stop date • Price volatility factors – Sloped demand curve – Wide applicability of Price-taker Offer Cap – No bid floors 3

Auction Frequency and Volumes: Our Consultation 3 proposals • • T-1 auction [2] to [13] months before start of Capacity Delivery Year T-4 auctions [3½] to [4½] years before start of Capacity Delivery Year Withhold 1. 5% to 5% of capacity requirement for T-1 auctions Flexibility for other auctions as determined by SEM Committee 4

Auction Frequency and Volumes: Key feedback and decisions Feedback Decisions • Some requests for less flexibility around timing of auctions • Flexibility is required to accommodate uncertainty, and timeline around initial auctions • Majority agreed with the proposed approach for the T-1 and T-4 auctions • Some concern at risk if T-4 auction held before intervening year transitional auctions • Proceed with decisions as set out in CRM 3 consultation • 2017/18 Delivery Year auction as soon as reasonably practical • Will consider holding subsequent transitional auctions in sequence before the first T-4 auction, but no commitment 5

Auction Design Framework: Overview Transitional Auctions T-1 Auctions T-4 Auctions Auction Design and Rules • Auction format (Simple sealed bid, multiple round descending clock auction, combinatorial) • Winner determination (including “lumpiness” issue) • Price determination • Information and communication policies • Structure of bids • Tied bids Market power controls • Mandatory bidding • Adjusting the capacity requirement • Prohibition on dominant generators acting as Capacity Aggregators • Sloping demand curve • Controls on price bids (Auction Price Cap, Other Bid Limits) • Information and communication policies 6

Auction Design Decisions: Overview Auction format Decision deferred, pending managing exit consultation Structure of bids Up to 5 P, Q pairs. Inflexible bids allowed Winner determination Price only, no adjustments for contract length Pricing rules Pay-as-clear based on highest inmerit / marginal bid accepted Dealing with lumpiness/discrete bids; Fully in-merit bids accepted, but choose between marginal and outof-merit bids on social welfare 7

Auction format: Options considered • Option 1: Simple sealed-bid, multi-unit auction – Bidders submit sealed offers comprising their supply curves, or Price. Quantity Pair – Auctioneer creates aggregate supply curve from bids and determines winners and clearing price based on merit order • Option 2: Multiple round descending clock auction. As simple sealed bid, but supply curve generated via multiple rounds of biding, with information fed back to bidders between round • Option 3: Combinatorial approach. As simple sealed bid, but – Auctioneer choose package of bidders which satisfies procurement requirement at least cost – With inflexible (lumpy) bids, winners not necessarily selected in merit order 8

Auction formats: Pros and cons Pros Cons Option 1: Simple Sealed Bid Option 2: Multiple round descending clock Lowest potential for market Greater price power abuse discovery and transparency Quickest and simplest for bidders Easiest to solve and monitor Lowest cost Lower price discovery and Greatest potential for transparency during auction market power abuse Sub-optimal solutions to manage exits May tie up bidders for 2 -3 days Option 3: Combinatorial auction format Optimal solutions to lumpiness and transitional constraints Quicker and simpler for bidders than Option 2 Consistent with DS 3 Greater potential for market power abuse than Option 1 Not clear can be delivered for first auction Potential for “unhappy losers” Results less transparent, harder to audit 9

Structure of bid: proposal Price • Up to 5 “PQ” pairs allowed • Inflexible bids allowed Qualified MW = Q MW €Y X Auction Price Cap Can bid up to 10 years if significant financial investment Inflexible bid X (P 2, Q 2, 1, No) X X (P 3, Q 3, 1, No) X 10 X (P 1, Q 1, 1, No) Quantity 10

Winner determination How do you treat bidders wanting different contract lengths: • Option 1: Purely on a price basis, ignoring contract duration • Option 2: Discount rate calculation • Option 3: Multiply each bid amount by (bid’s contract length/maximum possible contract length) • Option 4: Based on expectation of prices in future auctions We consider Option 1 to be the most appropriate for the following reasons: • Auction efficiency and competition: Judged purely on price offered for Capacity Delivery year, this approach will ensure efficient procurement, at least for the first delivery year • Simplicity, practicality and cost: – Clearly the simplest and most transparent; and – Not clear how the relevant adjustments for some other options would be implemented in practice, nobody else has solved 11

Price determination Variants of pricing: • Pay-as-clear (uniform pricing): – Highest accepted bid – Lowest rejected bid • Pay-as-bid Preferred option: Efficient, typically employed in auctions Strongest incentives for truthful bidding, but pays more than necessary Weak incentives for truthful bidding, favours information rich bidders? Also an issue about pricing if you accepted an “out-ofmerit bid” to deal with lumpiness issue 12

Lumpiness • Option 1: Accept the marginal bid in all circumstances • Option 2: Accept or reject the marginal bid based on: – Option 2 a: a net welfare function calculation; or – Option 2 b: some simpler rules based on MW tolerances • Option 3: Can accept out-of-merit bids, based on: – Option 3 a: Least total purchase cost – Option 3 b: Net Consumer Welfare function – Option 3 c: Total social welfare (Net Consumer + Producer Welfare) function. But with proviso that fully in merit bids, must be accepted* Rationale: • • • Accepting out-of-merit bids instead of marginal: • can improve efficiency and benefit consumers • Marginal bid rejected due to its inflexibility declaration Not allowing fully in merit bids to be rejected • Simplicity- reduces number of permutations to evaluate • Fairness- it would be small in-merit bids most at risk Using social welfare: fewer distortions / perverse outcomes *subject to transitional transmission constraint issues 13

Market Power Decisions: Overview Auction Price Cap Yes- value to be determined in Parameters consultation Other Bid Limits • Uniform Price-taker Offer Cap, applies to all generators • Apply for higher CMU specific limit, based on Net Going Forward Costs Bid floors No Sloping demand curve Yes. Principles set out, values to be determined in Parameters consultation Capacity Aggregation No ex ante controls on generators being aggregators Restrictions on plant opting out of T-4 auction No. Allowed to enter T-1 auction for same Delivery Year Secondary market Mandatory centralised platform 14

Other Bid Limits Why applicable to all generators, not just dominant? • Concerned about tacit collusion, not just unilateral market power • Take conservative approach initially until proven competitive outcomes • Considered Two/Three Pivotal Supplier test, but in practice would mean all bidders captured Why uniform, not technology specific? Preference for technology neutrality- outlier technologies can be dealt with on via CMU specific application process What level will Uniform Price-Offer Cap be set at? To be determined in parameters consultation, but should cover Net Going Forward Cost of majority of plant Applications for higher CMU specific bid limit- how will it work? • Application made as part of Qualification process • Must prove CMU Net Going Forward Costs to satisfaction of SEMC, to obtain higher limit 15

Principles for setting demand curve • System security (Reliability) and economic efficiency: – Consistent with at 8 hours LOLE – At minimum, reflect an economically efficient trade-off between price of Reliability Option and value of extra reliability • Competition: Reduce susceptibility of the auction to market power (in conjunction with other market power controls); • Stability (price volatility): – Reduce volatility impact from small variations in market conditions and administrative parameters – Limit the frequency of outcomes at Auction Price Cap. • Practicality: Should perform well under a range of market conditions 16

I-SEM CRM Decision 3 Auction Governance 17

Content • • • Legal and governance framework Disputes Capacity Market Code modification process Role of TSOs and Conflicts of Interests Auction monitor and audit Role of SEM Committee and RAs 18

Legal and governance framework • Reliability Option settlement contained within TSC • Other CRM rules will be set out in Capacity Market Code – Different change procedures- allowing CMC modifications within tight timescales to incorporate the lessons learned from T-1 and T-4 auctions – only parties planning to provide capacity will need to be parties to the CMC. – all generation licence holders will be obliged to become parties to the CMC and to apply for qualification for the capacity auction • TSOs’ licences will require them to enter into and administer Capacity Market Code 19

CMC Content • Eligibility and de-rating rules; • Roles and responsibilities, including that of the TSOs as CRM Delivery Body and Auction Monitor and Auditor; • Auction Qualification; • Operation of the Capacity Market Auction; • Key terms and conditions of the Reliability Option contract (with the exception of settlement terms contained with the TSC); • Obligation on the TSOs to maintain a Capacity Market Register, make data available to support settlement and secondary trading; and • Implementation Agreements • Agreed Procedures • A working draft will be issued in July 20

Disputes • Separate Disputes Resolution Process, to support CMC objectives • CMC Disputes Resolution Board, independent of the TSC Disputes Panel 21

CMC Modification Process 1. 2. 3. 4. 5. 6. 7. 8. 9. • Submission of Modification Proposal within permitted time; • Workshop to discuss proposal and determine priority of implementation (if approved); • Impact Assessment (where appropriate); • Finalisation of legal drafting of Modification Proposal; • Workshop; • Proposed Decision, report from TSOs on systems impact and legal drafting to be submitted to SEM Committee for review and consultation; • Consultation • SEM Committee Decision • Implementation of Change to CMC 22

Managing Conflicts of Interest Mitigation Measure Ringfencing Behavioural Description Spectrum of organisational or structural changes. May be implemented in isolation or in combination with other measures. These relate to Codes of Conduct for staff, incentives etc. Control/Responsibility Regulatory oversight of market design including the energy market, the CRM and DS 3 Auctions. RAs will take the lead on interconnector de-rating factors for the interconnectors Transparency Publication of information in a non -discriminatory manner, independent audit of functions under codes and licences Will continue to develop the measures as part of the ongoing work of the Governance and Licensing workstream – information paper in July 23

Monitoring and Audit • Role of I-SEM CRM monitoring will be split between the Regulatory Authorities and an Auction Monitor • Auction Monitor will be appointed by the SEM Committee to monitor the TSOs as Capacity Delivery Body in their operation of the end-to-end auction process • Detailed terms of reference for the Auction Monitor set out in the CMC • Role of CMC Auditor, distinct from that of the Auction Monitor. Procured separately but simultaneously to allow procurement synergies 24

SEM Committee auction roles/powers • Approving the de-rating methodology set out in the CMC and operated by the TSOs; • Determining the timings of the qualification processes and auctions for each time period; • Approval of key Auction Parameters; • Instructing the TSOs to cancel an auction, if appropriate • Setting the To. R for the Auction Monitor and Auditor, in consultation with stakeholders • Directing changes to CMC • In addition, the Regulatory Authorities will continuously monitor the capacity market (qualification, auctions and the operation of the secondary market) for signs of market abuse 25

I-SEM CRM Decision 3 Residual Issues 26

Strike Price • Include carbon- note correction to formula pointed out by some respondents • Re-affirm use of 15% thermal efficiency, includes appropriate allowance for start up costs • Move to monthly indices to protect RO hedge value to Suppliers, still sufficient incentive to be available • No need to include Gasoil in formula, (HFO / 15% efficiency expected to accommodate all gasoil plant) 27

Socialisation Fund • Supplier Contribution Rate (SCR): SEMO propose the SCR to manage any potential cash flow required to cover shortfalls in socialisation fund. Rate, and rationale, subject to approval by RAs • Suspend and Accrue vs Immediate Additional Charge: Follow respondents suggestion to develop approach consistent with other similar arrangements under ETA and current SEM 28