Steve Fernand's comments on the recent ICAP deficiency auction results are
based upon a fundamental misunderstanding of the ICAP market.  This
misunderstanding is summarized in his statement that "Unlike the electric
commodity, there have been no significant changes in the underlying costs
for suppliers of ICAP."  Since last summer there have been very significant
changes in the factors that affect the ICAP markets in New York.

The basic principle of the ICAP market is that it provides the generator (or
external ICAP provider) a mechanism to recover costs that are not adequately
recovered from the energy market.  In return for this revenue the generator
accepts an obligation to bid into the NYISO day-ahead energy market every
day that the generator is not out of service due to either maintenance or
forced outage.

The basic theory on developing a bid into the ICAP market for an internal
generator is that the generator should estimate the total revenue it
requires from the ICAP market to continue operating. This calculation is
based upon its total cost of remaining in business less its expected profits
from the energy market (expected revenues less expected fuel costs).  For
external suppliers the ICAP bid is based upon the opportunity cost of being
obligated to the New York energy market rather than being either obligated
to another market or having no obligations to any market.

Clearly, in each case, the bid into the capacity market is dependent upon
the expectations of the New York energy market.  There have been several
adopted and proposed changes in the New York energy markets that make them
both less desirable than last year and less desirable than the energy
markets surrounding New York.  These include:

The Circuit Breaker/AMP - The Circuit Breaker/AMP creates both a concern
that the day-ahead market prices will be depressed from the levels that
should exist.  The implementation of the circuit breaker raises concerns
that the market prices in New York energy price will be depressed.  The
potential ways in which the DAM prices could be depressed include failure to
incorporate changing unit operating parameters, fuel costs, or emissions
costs.  Additionally, while opportunity costs are a part of an acceptable
bid, there is no methodology to keep the circuit breaker from effectively
removing the opportunity costs for a circuit broken bid.  Finally, the
design of the circuit breaker may result in numerous individual bids by
different market participants being circuit broken when they are not
exercises of market power.  Every time a bid is improperly circuit broken it
affects all sellers because all sellers end up being paid less in the DAM
then they should have received.

In addition to these questions about whether the AMP will improperly depress
prices, there is still uncertainty to how  a generator that has been
improperly mitigated is supposed to be able to be compensated.  This was
part of the original circuit breaker design but as of this point the NYISO
has failed to provide any description of how this process will work.  There
is also uncertainty about the reference prices and the process that
generators will follow in getting changes or exceptions to the reference
prices accepted.  The uncertainty raises the cost of being obligated to the
New York market.

Price Capped Load Bidding - The price capped load bidding mechanism that is
being implemented this summer provides a sophisticated tool to a small
subset of market participants to determine whether they want to purchase at
the DAM market prices.  This provides the possibility that day-ahead market
prices will systematically be depressed relative to the real time market if
this mechanism is abused.  Virtual load bidding has been blocked for the
summer.  If virtual load bidding were implemented it would provide a
potential check on this market manipulating behavior.  The only check
allowed in our market design is the inclusion of opportunity costs in the
generator day-ahead market bids.  As addressed above, the application of the
Circuit Breaker/AMP is likely to impede the generators including opportunity
costs in their bids thereby eliminating the only check on using the price
capped load bids to manipulate the market.

Penalty and Public Disclosure Proposal -  This proposal will penalize market
participants that are mitigated for exceeding the NYISO Market Mitigation
Measures. There have been issues raised related to this proposal regarding
due process and fundamental fairness.  The penalties only apply to
generators and other suppliers.  The penalty is not based upon a
determination that the market participant has exercised market power.
Finally, the ADR process can determine whether mitigation was properly
applied by the NYISO but cannot determine whether the penalty that was
applied was appropriate.

Each of the above measures has resulted in a potential reduction in energy
market revenues and added significant uncertainty to the New York market.
The above price control measures are not in place in the surrounding
markets.  Each of these makes the New York market less desirable than its
neighbors and raises the price of being obligated to the New York market.
Interestingly, the Penalty and Public Disclosure Proposal was approved by
the NYISO Management Committee between the ICAP Monthly auction and the ICAP
Deficiency auction.

The above are not the only price control proposals that have been made for
the NYISO energy market.  Most notably, there have been proposals for $150
price caps in the energy market and retroactive price authority.
Fortunately, both of these ill-considered proposals were ultimately
withdrawn.  However, the mere fact that they were proposed inflicts
uncertainty on the energy market and therefore increases the expected prices
in the ICAP market.

Two final points need to be clarified regarding Mr. Fernand's argument that
the results of the auction indicate a problem.  First, he lists the change
in ICAP market clearing prices between last year and this year as indicating
there is a problem in the ICAP markets.  When generators bid into last
summer's auction they had not yet experienced summer operation under the
NYISO markets. There also had not been the broad range of price control
measures proposed and adopted for this summer.  Compared to last summer,
ICAP bids for this summer would have incorporated better understanding of
the expected profits in the energy market as well the expected impacts of
the price control measures.  Second, he also uses the results of this
summer's strip/monthly auction and the deficiency auction as an indication
of there being problems in the ICAP market.  Because the entire ICAP
requirement is not cleared in a single auction, the prices that are bid into
the earlier auctions are essentially an ICAP providers estimate of its
opportunity cost of selling in the earlier auction rather than selling in a
later auction.  This requires the ICAP providers to guess the likely bids of
the marginal ICAP providers.  The results of this years auctions merely
indicate that those who sold in the early auctions apparently did not do a
very good job of guessing the lost revenue associated with selling in the
earlier auctions.

Mr. Fernand's provides a set of proposed measures for addressing the ICAP
issue.  If any of them are worthy of be considered then they should be aired
through the committee process.  Nonetheless, one of the proposals should be
killed at the outset.  Because being an ICAP provider to New York includes
an obligation to bid into the energy market, no ICAP owners should ever be
"automatically bid into the Deficiency Auction" or any other auction.  Mr.
Fernand's suggests that that the automatic bidding requirement be relieved
if a Long ICAP Owner exclude itself.  The act of choosing not to bid into
the ICAP auction is in itself an indication that the ICAP provider has
chosen to exclude itself.

Mark Younger
Vice President
Slater Consulting
69 Werking Road
East Greenbush, NY  12061
518-286-1937 ph
518-286-1941 fax


-----Original Message-----
From: kkranz@nyiso.com [mailto:kkranz@nyiso.com]
Sent: Tuesday, May 08, 2001 2:49 PM
To: marketrelations@nyiso.com
Subject: NYISO - MC - Document from Stephen Fernands to MC Members

 Dear Management Committee Members.

The attached document  is being forwarded to you at the request of Stephen
Fernands of New Energy Inc.

Regards,

Kristen Kranz
518-356-6186


(See attached file: Stephen Fernands to MC re ICAP.PDF)

 - Stephen Fernands to MC re ICAP.PDF