# Presentation: 764520

## DR Valuation RON-01 Phase 2 Proposal 

**January 31, 2006**

## Presentation Overview

**Objectives and Process**
**Approach: Phase 1 Findings**
***Valuation Framework***
***Standard Practice Approach***
***Gaps in Standard Practice***
**Phase 2 Proposal**

## Objectives and Process

## Starting Point

**Broad definition of DR**: Our proposed valuation approach is suitable for evaluating
*Both Price-based (e.g., RTP, CPP and TOU) and Quantity-based (interruptible/ curtailable, cycling/ load control, and demand subscription) programs*
*Programs implemented by utilities, scheduling coordinators, or CAISO*
*Both voluntary and mandatory rates*
**Integration of value and rates**: Our DR Valuation and DR Rate Design research proposals are integrally tied together

## Linking DR Valuation & Rate Design

- Overall objective of Phase 2: Integrate DR Design and DR Valuation to maximize benefits for California energy consumers

- screens

**Identify and Address Gaps in Existing Standard Practice**

**DR Valuation RON**

**Develop New Standard Practice for Valuation**

## DR Valuation Phase 2 Objective

- Objective: Develop a valuation methodology that fully and consistently captures the costs and benefits of a wide variety of DR programs types
- Interruptible / Curtailable Rates
- Time of Use (TOU) Rates
- Critical Peak Pricing (CPP)
- Real-time Pricing
- Demand Subscription Service
- Programmable Communicating Thermostats (PCTs)
- Other dynamic, enabling technologies
- End-use Cycling; A/C, Pool Pump, and others

## Need for a New Standard Practice

- Expanding existing valuation to address DR will provide significant value to California’s electricity consumers.
- The inconsistency among valuation methodologies is demonstrated by the utility DR filings in California over the last 18 months.
*The CPUC in Decisions D. 04-07-028, D. 05-01-056 and D. 04-12-048 established preliminary avoided cost estimates *
*PG&E’s Valuation of CPP, (2005) was developed using both the CPUC AMI business case numbers and its own internal valuation methodology. *
*Valuation of Programmable Communicating Thermostats (2005) for the 2006 new building standards *
*Both SCE and PG&E have filed avoided generation capacity cost testimony in the respective rate cases. *
*In the existing utility generation procurement rules there was a negotiated settlement that established how much DR would be counted to meet a scheduling coordinators planning reserve requirement.  *

## Vision of New Standard Practice

- New Standard Practice for Dispatchable Resources
- Desired characteristics:
- Fully documented and transparent
- Consistent valuation across all dispatchable resources
- Clearly define differences between non-dispatchable (DSM) and dispatchable (DR) resources
- Full use of publicly available market price data
- Not dependent on the use of proprietary data or models
- Process: Use consultation process similar to successful EE avoided costs to develop new valuation standard for dispatchable resources.
- Schedule goal: Complete prior to Phase 3 of CPUC’s avoided cost proceedings beginning in late 2006.

## Phase 3 of CPUC Avoided Cost Proceeding

- Stated Goal of Proceeding
- “...address long-run avoided cost forecasts and calculations and the potential use of the E3 avoided cost methodology to calculate long-run avoided cost for use in valuing other resource options and programs.”
- “...continue to focus on the development of a common methodology, consistent input assumptions and updating procedures to quantify all elements of long-run avoided cost across the various Commission proceedings.”
- Schedule
- Schedule to be issued following the proposed decision on the consolidated QF policy and pricing issues (Hearings begin Jan. 28, 2006, reply briefs due Mar. 17, 2006).
- We expect Phase 3 to begin at the end of 2006.

## Team is Designed for Research Objective

- Each member of the E3 Team contributes specific expertise to address complex California electricity market issues:

| E3 Team Member | Primary Research Focus | Key California Market Issues |
| --- | --- | --- |
| E3, Utilipoint/ Neenan, LBNL | Impact of evolving market structure on cost effective design | Ancillary Services
2007 nodal market structure
Capacity market
2006 Avoided Cost proceedings |
| HMG, FSC | Technical potential and customer acceptance | Evolution of DR pricing to capture
 enhanced enabling technologies
 enhanced metering technologies
 customer acceptance & program enrollment
 customer response |

## E3 Research Team

## Approach: Phase 1 Research Findings

## Phase 1 Research Findings

- Current Valuation Framework
*Cost Minimization*
*Other Important Characteristics *
*Resource Portfolios*
*Reliability**	*
- Standard Practice
*What it Does Do*
*What it Doesn’t Do*
- Existing Avoided Cost Components
- Need for New Standard Practice
- Summary of Gaps in Standard Practice

## Current Valuation Framework

- Objective
*Minimize Cost of Delivered Energy*
- Under existing framework, DR has only a cost and a resource value
*Cost = Cost to utility, society or customer*
*Define Resource Value of DR = (Cost of Resource Portfolio without DR) - (Cost of Resource Portfolio with DR) *
*Calculate Resource Value of DR = (Avoided Cost of Capacity) x (Avoided Capacity Purchases)*

## IRP Using Existing Framework

- New resources include both dispatchable (DR, DG, Hydro, CTs) and non-dispatchable (DSM) resources
- Each resource has 6 characteristics:
*	**cost*
*	**cost variance (e.g., fuel cost variability)*
*	**cost covariance with each other resources*
*	**quantity if perfectly available*
*	**probability of availability*
*potential impact on reliability*
- Goal of IRP: Determine the mix of resources that minimizes costs subject to procurement constraints

## Portfolio Development

- Portfolio = combination of new and old resources
- IRP compares the performance of different portfolios according to three metrics:
**Cost (C)** – The total cost of delivered energy needed to serve peak load
**Cost variance (V)** – The combination of resource-specific cost variances and covariances
**Reliability (R)** – Probability of meeting peak load in a given year
- Comparative portfolio valuation requires an analysis in three dimensions
- Can trace a “frontier” or contour among two variables while holding the third constant

## Portfolio Selection

- 0

**Variance**

**Cost**

**R = 0.95**

**R = 0.99**

- For a fixed reliability target, an LSE chooses a portfolio that minimizes cost subject to an acceptable cost variance.

-  Portfolio A

-  Portfolio B

-  Portfolio C

-  Portfolio D

-  Portfolio E

-  Portfolio F

**Cost-Risk contours with fixed reliability**

## DR Valuation: Basic Assumptions

- DR is one of many dispatchable resources
- CPUC adopted avoided costs for EE provide a good starting point for valuing dispatchable resources
- A new dispatchable resource standard practice must account for:
- Changes in costs
- Changes in cost variance
- Changes in portfolio variance
- Changes in reliability

## Types of Avoided Costs

- The avoided costs adopted in California were designed to reflect the value of long term, non-dispatchable conservation programs.

- 	RTP = Real time pricing rates; CPP = Critical peak pricing; DLC = Direct load control; DB = Demand Bidding Program; PCT = Programmable controllable thermostats (Title 24 Building Standards); TOU = Time of use rates; I/C= Interruptible/Curtailable Program

|  | Dispatchable | Non-Dispatchable |
| --- | --- | --- |
| Short-Term | DR (RTP, CPP, DLC, DB, I/C) | PJM Market Rate |
| Long-Term | CT, CCGT, DR (PCT) | Energy Efficiency, (TOU) |

**Resource Matrix**

## Existing Avoided Cost Components

- Existing avoided cost methodology for EE adopted by CPUC  (R.04-04-003 / R.04-04-025) provide starting point for the following components:
- Generation Energy ($/kWh)
- Transmission Capacity ($/kW-period/area)
- Distribution Capacity ($/kW-period/area)
- Marginal Losses at the Generation, Transmission and Distribution voltage levels by utility service territories
- Emissions Avoided Costs ($/MWh)
- Multiplier Impact from reducing market prices
- Ancillary Services
*Dispatchable resources require additional avoided cost components*

## Six Research Gaps

- Gap 1: Generation Capacity Value  ($/kW-Time Period)
- Gap 2: Consumer Surplus ($/Time Period)
- Gap 3: Option Value ($/kW-Time Period)
- Gap 4: DR Modularity and Value of Information
- Gap 5: Value of Lost Load ($/Use)
- Gap 6: Portfolio Hedge Value ($/Portfolio)

## Gap 1: Generation Capacity Value

_**Issue**_
- A dispatchable DR program is often used only during a few critical hours in a year. What is the value of these programs to the generation system?
_**Starting Point**_
- Load relief during those hours can offer two direct benefits
_*Long-term *__*p*__*rocurement benefit*_* through less capacity and energy needed to maintain the same reliability target*
_*Reliability benefits*_* t**hrough incremental improvement in reliability and value. M**ethodology must be careful not to double count the value of capacity and the value of maintaining reliability**.*

## Gap 2: Consumer Surplus

_**3 Issues:**_
*1.  General Consumer Surplus*
*2.  Mitigation of Market Power*
*3.  Individual Customer Consumer Surplus*
_**Starting Point for the Estimation of General Consumer Surplus:**_
*AB970 of 2000, Section 7(b)(8)*
- requires a “Reevaluation of all efficiency cost-effectiveness tests in light of increases of wholesale electricity costs and natural gas costs to explicitly include the system value of reduced load on reducing market clearing prices and volatility”))
*CPUC D.00-07-017, p.13*
- “[T]he escalators are determined by looking at the “load reduction value” or “consumer surplus” relative to the market price and taking a ratio.  The escalators are multiplied by the market price - either during peak or off-peak - to arrive at system value.” (ALJ Linda R. Bytof’s 10/25/00 ruling in connection to UDC compliance with D.00-07-017, p.13)

## General Consumer Surplus

**all **
**customers**

**General Consumer Surplus**

## Gap 3: Real Options Analysis

_**Issue**_
*The existing standard practice is designed to reflect the benefits of non-dispatchable resources.  Dispatchable resources provide an additional option value.****  ***
_**Starting Point**_
*DR as an option to dispatch against energy costs*
-  Buyers purchase rights to curtailments
-  Seller (customers) sell curtailment obligation
-  Buyers exercise options if they are “..in the money.”
*Analogous to utility I/C programs, but*
- Option value is not avoided costs, but expected value
- Option exercise driven by market price or other transparent market condition
- More flexible: supports alternative options that vary by strike price, number of times exercisable, notice, duration, etc.

## Gap 4: DR Modularity & Value of Information

_**Issue**_
*DR can be more pliable, nimble, scalable, and targeted to high value areas than other DR resources.*
*This additional flexibility helps minimize the costs of expansion planning costs and is not currently captured in the California standard valuation practice.*
_**Starting Point**_
*Preliminary Value Estimation*
- Value of Shorter Lead Time, Value of Information
- Value of Shorter Contract Period, Option to ‘Retire’
- Value of Local Targeting, Option to ‘Move CT’

## Percent change is the increase in value of a CT

| Option Value | Low Value | Base | High Value | Description |
| --- | --- | --- | --- | --- |
| Value of Information | 1% | 2% | 4% | The value of a shorter lead-time does not provide significant value given our assumptions.  The reason is that even if the CT is built a year or two early, it has a low probability of being built more than a few years earlier than needed. |
| Early Retirement | 1% | 7% | 21% | The value of shorter contract periods is larger and depends on the assumption about the relative value of the plant over time.

 |
| Local Targeting | 16% | 43% | 82% | Targeting the program to capture local value as well as system value has the greatest increase in potential benefits.

 |

**Summary of Option Value Results**

## Gap 5: Value of Operating Reliability

_**Issue**_
*DR used as an emergency resource has the ability to reduce the number, scope, and size of rotating black-outs.  This gap addresses the value customers receive through improved system reliability.*
_**Starting Point**_
*Evaluate DR’s ability to improve system reliability*
- Evaluate DR operation during system emergencies.
- Characterize the existing reliability of the system.
- Avoid double counting the same capacity for operating reserves and for emergency load relief.
*Estimate the value of that improved reliability.*
- Characterize the improvement in social welfare of reduced outages.

## Northeastern Markets Reliability Value Estimation

- “Emergency DR”: load curtailments dispatched during periods when operating reserves are low
*Objective: Measure the impact of this DR on the consequences of forced outages*
*Avoided outage cost analysis monetizes this benefit*
*Value = Change EUE * VOLL      *
*Change EUE = Change LOLP * Load at Risk*
- Essential features
*Estimate the difference in Expected Unserved Energy (EUE) between scenarios with and without load curtailments*
*Avoided outage cost calculated as the product of the reduction in EUE and the Value of Lost Load (VOLL)*
- Key input variables:
*Change in Loss of Load Probability (LOLP) for each hour of each event*
*Percent of load at risk*
*VOLL*

## Gap 6: Portfolio Hedge Value

_**Issue**_
*The energy efficiency standard practice valuation approach considers each resource as an alternative to the “avoided cost” of the utilities portfolio. It does not consider cost variance.*
*Adding DR to a portfolio can reduce the portfolio’s exposure to high market price scenarios**.  *

- 0

-  Portfolio A

-  Portfolio B

-  Portfolio C

- Expected Cost

- Risk

## Portfolio Hedge Value

- _Starting Point_
- Several threshold research questions
*Does the existing valuation framework adequately capture DR’s risk mitigating benefits?*
*Once option value (GAP 3) is built into the standard practice, is the portfolio hedge value needed?*
*As DR adds uncaptured value to the portfolio, what is the best valuation methodology*
- Approaches to assess risk mitigation include:
*Simulation with DR optimization*
*Simulation without DR optimization*
*Direct computation*

## Example: Efficient Frontier With DR

- Using the input assumptions we have made, the cost of the portfolio at a given level of risk is reduced.
- The closed-form solution of the efficient frontier is useful for calculation. However, the usefulness of the result depends on whether reasonably accurate input data can be developed and incorporated into a complete valuation standard practice that makes sense at the individual program and portfolio levels.

| Forward Price ($/MWh) | F | $39 |
| --- | --- | --- |
| DR cost | c | $30 |
| DR MW | K | 4,000 |
| Expected Demand (MW) | D | 50,000 |
| Variance (D) | D | 12,131 |
| Expected Price | P | 43.19 |
| Variance (P) | P | 11.7 |
| Correlation (P,D) | r | 0.42 |
| Correlation (PD,P) |  | 0.93 |

## Phase 2 Proposal

## DR Valuation Phase 2 Proposal Summary

**Deliverables**
*A new “standard practice” for the valuation of dispatchable resources.*
*Initiate and manage a consultative process with key stakeholders.  *
*Base the new standard practice for dispatchable resources on the existing avoided costing approach adopted for energy efficiency*
*Each gap in methodology or data will be addressed as a research question. *
**Process**
*The E3 team will be responsible for first drafts, revisions, and final drafts addressing each research question and the final standard practice description.*
*The E3 team will give monthly presentations on the work in progress, with follow-up telephone discussions and working meetings scheduled as needed. *

## Task Description and Consultation Process

## Schedule and Deliverables

**Schedule and Deliverables**