GETTING

the

BEST DEAL

for
Electric Utility Customers

A Concise Guidebook
for the Design, Implementation
and Monitoring of Competitive
Power Supply Solicitations

Prepared For:
Electric Power Supply Association
1401 New York Avenue, NW, 11th Floor
Washington, D.C. 20005
Telephone: (202) 628-8200
Fax: (202) 628-8260
Web site: www.epsa.org

Prepared By:
Boston Pacific Company, Inc.
1100 New York Avenue, NW, Suite 490 East
Washington, D.C. 20005
Telephone: (202) 296-5520
Fax: (202) 296-5531
Web site: www.bostonpacific.com

Copyright 2004 Electric Power Supply Association

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Electric Power Supply Association

TABLE of Contents
FOREWORD BY EPSA ...............................................................................................................................................................iv
FOREWORD BY BOSTON PACIFIC COMPANY, INC. ......................................................................................iv
EXECUTIVE SUMMARY..............................................................................................................................................................v
I. INTRODUCTION: THE IMPORTANCE OF AND ROLE FOR COMPETITIVE SOLICITATIONS
A. A Tool For Modernizing State Prudence Review ..........................................................................2
B. Allaying Concerns About Affiliate Bias ................................................................................................3
C. Overview Of This Report ..............................................................................................................................4
II. ENSURING A CREDIBLE SOLICITATION
A. Collaborative Process.....................................................................................................................................5
B. Independent, Third-Party Monitor ...........................................................................................................7
III. CHOOSING A SOLICITATION FORMAT AND PRODUCT TYPES
A. Requests for Proposals (RFPs).................................................................................................................9
B. Price-Only Auctions .......................................................................................................................................11
IV. FAIR AND ACCURATE BID EVALUATIONS
A. Comparability ....................................................................................................................................................13
B. Transmission Assessments .....................................................................................................................14
C. Cost-Plus Offers ..............................................................................................................................................15
D. Unequal Lives....................................................................................................................................................16
E. Creditworthiness Concerns .....................................................................................................................17
F. Balance Sheet Penalty .................................................................................................................................18
V. CONCLUSION
APPENDICES
A. Example of an RFP for Unit Contingent Power
B. Example of a Price-Only Auction (New Jersey Basic Generation Services Auction)
C. Hypothetical Example of the Balance Sheet Penalty

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iii

FOREWORD by EPSA
The Electric Power Supply Association (EPSA) is the national trade association
representing competitive power suppliers, including generators and marketers.
These suppliers, who account for nearly 40 percent of the installed generating capacity in the United States, provide reliable and competitively priced
electricity from environmentally responsible facilities serving global power
markets. EPSA seeks to bring the benefits of competition to all power
customers. EPSA supports the continued formation of regional transmission
organizations (RTOs), including essential features such as independent
administration of the transmission system, real-time and day-ahead energy
markets, and capacity markets. In addition, but not as a substitute for RTO
markets, EPSA believes that all parties, and customers in particular, benefit
from competitive solicitations for longer-term power purchases that are
designed to be fair, accurate, and transparent. As such, it is useful to establish
guidelines for the proper conduct of competitive solicitations, particularly in
areas where RTOs have yet to be formed. This reference document is intended
to assist policy-makers in establishing guidelines to ensure that competitive
solicitations provide the best possible deal for electricity consumers.

FOREWORD by Boston Pacific Company, Inc.

Boston Pacific Company, Inc. is an energy consulting and investment
services firm. Our clients include competitive power suppliers, electric utilities, electric and gas marketers, gas pipeline companies, trade associations,
government agencies, public service commissions and energy consumers.
This guidebook is based on our experience working in engagements on
competitive solicitations conducted in primarily non-RTO areas, and in
RTO areas, as well. It reflects the lessons we learned from these engagements, and is intended to help all participants in the competitive solicitation
process get the process right. Getting the process right means ensuring that
the competitive solicitation, from start to finish, is a credible process that
results in the best possible deal for electric utility customers in terms of price,
risk, reliability and environmental performance.

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Electric Power Supply Association

EXECUTIVE Summary
Although federal regulators have rightfully focused much of their effort in
recent years on properly structuring shorter-term spot markets for energy
and capacity under the auspices of independent regional transmission
organizations (RTOs), the design of longer-term bilateral markets is equally
important. Longer-term markets, in which power is procured on a multimonth, yearly, or multi-year basis, could and in some
regions do satisfy 85 percent to 90 percent of
power needs. Along with shorter-term mar-

Consumers benefit

kets, these markets provide the necessary

price signals for development of new

when suppliers take advan-

resources. And, because they involve

tage of these opportunities by

longer-term commitments to sell

building new infrastructure,

power, they provide a significant

which both intensifies

opportunity to justify major capital

investments in power plants and related

competition and increases

infrastructure. Consumers benefit when

suppliers take advantage of these opportunities

reliability.

by building new infrastructure, which both intensifies

competition and increases reliability.
To many, the design of longer-term markets is synonymous with the design
of competitive solicitations, which range from price-only auctions to more
extensive requests for proposals (RFPs) that evaluate bids with respect to a
long list of price and non-price criteria.1 This guidebook is based on lessons
learned from hands-on experience with competitive solicitations. It is meant
to be a useful resource for all those charged with designing, implementing
and/or monitoring these solicitations.
First and foremost, the goal of competitive solicitations is to evaluate a full
range of resources in the wholesale marketplace to obtain the best possible
deal for electric utility customers. In this specific sense, competitive solicitations, when conducted in a fair, accurate and transparent manner, are an
important tool at both the state and federal levels for determining the

Short-term markets such as day-ahead and real-time spot markets also use bid-based competitive solicitation formats; however, the focus of the guidebook is on longer-term competitive
solicitations.

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prudence of utility power purchase and investment decisions and allaying

concerns about affiliate bias.
It is essential that the solicitation be credible to all parties, including electric
customers, regulators, the utility buyer, and suppliers. The primary means
of ensuring credibility are the use of (a) a collaborative process that adopts consensus-based
solicitation rules upfront and (b) an inde-

The purpose of the

independent monitor is to

pendent, third-party monitor. The

collaborative process includes specific

provide assurances to all those opportunities for significant input

involved in the solicitation that from all participants early on, thereby
the process was fair, transparent and accurate.

streamlining the overall solicitation

design, especially in contrast to full
litigation. An independent, third-party

monitor can help facilitate the collaborative

process and oversee the solicitation itself.
The purpose of the independent monitor is to provide assurances to all
those involved in the solicitation that the process was fair, transparent
and accurate.
Once measures are in place to assure a credible solicitation, the format and
product types to be solicited must be decided. Price-only auctions are best
for markets in which there are standardized products, meaning that all
aspects of the non-price bid evaluation can be
settled beforehand. This, of course, adds greatly
to transparency since only a single factor (price)
determines who wins the solicitation. Price-only
RFPs also are issued for standard products such as a
share of full requirements service or blocks of power
(e.g., 100 MW of firm power for 16 hours a day on all
weekdays). Many RFPs, however, involve evaluations of
(and allow variations in) a full range of price and nonprice factors. Asset-backed or unit-contingent power is
one example of a product solicited through these more complicated RFPs.
Generally, auctions and RFPs conducted in the context of a well-functioning
RTO can take much less time to start and run more smoothly than those in
non-RTO areas.

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Electric Power Supply Association

Within a competitive solicitation, there are at least six key issues that need
to be addressed to fairly and accurately evaluate bids:
the principle of comparability means that all proposals should meet
the same requirements and be evaluated under the same standards;
transmission assessments for bidders during a solicitation should
include an opportunity for any bidder to receive a timely and fair
estimate of what it would take to become a network resource;
when assessing cost-plus offers, the evaluation should explicitly
take into account the greater risk that these offers impose on
customers as compared to pay-for-performance bids;
financial theory supports using the annuity method when comparing
offers of unequal lives, and this should be at least one approach
used during any bid evaluation;
creditworthiness is a legitimate concern; however, collateral
requirements must be set comparably and fairly for all parties, and
contractual alternatives to collateral must be considered; and,
in determining whether to assess a balance sheet penalty, regulators
should take the perspective of the utility customer, ask for evidence
that a balance sheet effect actually occurred, and if the penalty is
assessed, then ensure it is accurately calculated.

Ideally, all six of these issues should be settled

during the collaborative process, along with
all of the other solicitation rules and

All decisions for the

conditions, before the solicitation

solicitation should be guided

takes place. Doing so minimizes the

by one goal: to obtain the best

potential for objections later on in

the solicitation. Most important,

possible deal for customers

settling these issues provides clarity

by credibly evaluating the

to all stakeholders about the criteria

full range of resource

that will be used to evaluate the bids.

alternatives offered.
Regardless of the solicitation format used,
the product types solicited, or the approach to
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vii

evaluation chosen, all decisions for the solicitation should be guided by one
goal: to obtain the best possible deal for customers by credibly evaluating
the full range of resource alternatives offered in the wholesale power market.

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Electric Power Supply Association

INTRODUCTION

of and Role for

I. INTRODUCTION: The Importance
Competitive Solicitations
In recent years, the focus on designing shorter-term power markets has
overshadowed the importance of properly structuring longer-term markets.
Longer-term power markets, in which power
is procured on a multi-month to multi-

Because a significant

year basis, are crucial to providing the

necessary price signals for suppliers

amount of power can be

to develop new resources to meet a

substantial portion of our future

procured for lengthy periods of

power needs. Because a significant

time, mistakes in the design of

amount of power can be procured

longer-term markets can be

for lengthy periods of time, mistakes

costly to utility customers.

in the design of longer-term markets

can be costly to utility customers.

For example, a long-term procurement decision that had substantial consequences in terms of cost, risk, and environmental performance was the
construction of nuclear and other large baseload power plants during the 1970s
and 1980s. The Federal Energy Regulatory Commission (FERC) reported that,
expensive large baseload plants for which there was
little or no demand, came onto the market or were in the
process of being constructed. Accordingly, between 1970
and 1985, average residential electricity prices more than
tripled in nominal terms, and increased by 25 percent after
adjusting for general inflation. Moreover, average electricity prices for industrial customers more than quadrupled in
nominal terms over the same period and increased 86 percent after adjusting for inflation.2
Again, the potential for significant, adverse consequences from poorly made
procurement decisions make it especially important that long-term markets
be properly designed. To many, the design of longer-term markets is synonymous with the design of competitive solicitations, which range from
price-only auctions to more extensive requests for proposals (RFPs) that

FERC Order 888 at p. 14.

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evaluate bids with respect to a long list of price and non-price criteria. This
guidebook is based on lessons learned from hands-on experience and is
meant to be a useful resource for all those charged with designing, implementing, and monitoring competitive solicitations.

A Tool For Modernizing State Prudence Review

By requiring utilities to demonstrate the prudence

of their investment and procurement decisions,
state regulatory commissions attempt to ensure that
their energy consumers get the best possible deal on
electricity in terms of price, risk, reliability, and
environmental performance. The heart of prudence
has always been a reasonable decision-making process
in which all alternatives are evaluated side-by-side with
information known and knowable at the time of the decision. This definition of prudence is reflected in a ruling in Gulf States Utilities Company v.
Louisiana Public Service Commission by the Louisiana Supreme Court,
which states that:
Although there is no single formulation sufficient to express
constitutional, statutory, or judicially derived standards for
determining how much of a utilitys investment in a particular plant should be included within its rate base, one of the
principles used by ratemaking bodies and courts to make
such a determination is the prudent investment standard
That is, the utility must demonstrate that it went through a
reasonable decision-making process to arrive at a course of
action and, given the facts as they were or should have been
known at the time, responded in a reasonable manner. Re
Cambridge Electric Light Co., 86 P.U.R. 4th 574 (Mass.
D.P.U. 1983) the focus in a prudence inquiry is not
whether a decision produced a favorable or unfavorable
result, but rather, whether the process leading to the decision
was a logical one, and whether the utility company reasonably relied on information and planning techniques known
or knowable at the time. Metzenbaum v. Columbia Gas
Transmission Corp., Opinion No. 25, 4 FERC 161,277.

Electric Power Supply Association

An electric utility can use competitive solicitations to demonstrate prudence

by showing that it used a reasonable decision-making process, meaning that
it fairly evaluated the full range of alternatives. Indeed, in todays market,
because so many alternatives are proposed by credible parties other than
the regulated utility, and include more than just large-scale conventional
power plants, competitive solicitations are essential to ensure that the utility
has evaluated the full range of both utility and non-utility alternatives. In
addition, many of these alternatives are from suppliers who, in contrast to
traditional utility cost-plus offers, are willing to guarantee the customer
benefits that they promise in their proposals, so the evaluation must take
this customer risk-protection into account.
Using competitive solicitations to demonstrate prudence also can provide
regulatory certainty to the utility. For example, if the solicitation meets certain
standards, the state commission could establish a rebuttable presumption that
the process results in a prudent investment or procurement decision; in any
subsequent proceeding, the rebuttable presumption would shift the burden
of proof away from the utility to intervenors. With this in place, the
commission could generally review the solicitation process in a much shorter
time. This determination of prudence would remove the risk that the utility
would not be able to recover costs that were incurred as a result of the
contracts signed through the competitive solicitation.
Regulatory certainty also is enhanced for competitive power suppliers in
two ways. First, a quick review period minimizes the market risks to suppliers
of keeping bids open for extended periods of time. Second, a determination
of prudence obviates the need for a regulatory out clause in the Power
Purchase Agreement (PPA).

Allaying Concerns About Affiliate Bias

At the Federal Energy Regulatory Commission, a properly designed competitive solicitation can play a central role in allaying concerns about affiliate
bias. In Boston Edison Company Re: Edgar Electric Energy Company 55
FERC f 61,382 (1991), FERC set forth three non-exclusive ways a utility
could demonstrate the lack of affiliate abuse. One way is to offer evidence
of direct head-to-head competition, which means the utility uses some

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form of competition solicitation.3 If a utility chooses this route, then the

commission seeks assurance that (1) the solicitation process did not favor
the affiliate; (2) the analysis of the bids or responses did not favor the affiliate; and, (3) the affiliate was chosen based on a reasonable combination of
price and non-price factors. Moreover, if an affiliate is chosen and is not the
least-cost option, the applicant must explain why that selection was made.4
The concern here is primarily with affiliate abusewhen a utility unduly
favors its affiliates offer over other offers to the detriment of consumers. The
Edgar precedent is useful because it establishes a threshold standard that a
utility must meet when conducting competitive solicitations to demonstrate a
lack of affiliate abuse. Getting longer-term market design right by conducting a
fair, transparent and accurate competitive solicitation is essential to meeting
FERCs Edgar standard.

Overview Of This Report

Clearly, competitive solicitations can play a central role in evaluating

resource alternatives so as to get the best possible deal for utility customers.
At the state level, they can assist in modernizing the prudence review standard,
and at the federal level, they meet the requirements of the Edgar standard
for demonstrating the lack of affiliate abuse. But, what are the essential
elements of a competitive solicitation? Section II (Ensuring a Credible
Solicitation) examines the key elements that ensure the solicitation process
is fair and credible, which include the use of the collaborative process and
an independent, third-party monitor. Section III (Choosing a Solicitation
Format and Product Type) describes different solicitation formats and product types. Section IV (Fair and Accurate Bid Evaluations) reviews important
evaluative factors used in a competitive solicitation. The conclusion, Section
V, emphasizes that accurate, credible, and transparent competitive solicitations
ensure that customers get the best possible deal on electricity in terms of
price, risk, reliability and environmental performance. Finally, three
appendices delve deeper into technical details.

See Boston Edison Company Re: Edgar Electric Energy Company 55 FERC f 61,382 (1991)
(Edgar).
4
Id.
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Electric Power Supply Association

A CREDIBLE SOLICITATION

II. ENSURING a Credible Solicitation

Above all else, competitive solicitations must be credible to all. This can be
achieved primarily through the use of (1) a collaborative process and (2) an
independent, third-party monitor. The loss of credibility due to affiliate
abuse or other deficiencies in the procurement process tends to chill the
market because competitive suppliers will not submit proposals if there is
a perception that the proposals will not be evaluated objectively.5

Collaborative Process

One approach to establishing credibility in the solicitation is called the

collaborative process. The intent is that a full consensus can be achieved
during a collaborative process on most issues with respect to the solicitation,
such as the amount and type of power to be procured and the evaluation
criteria to be used. This process has three key steps: (a) the local utility
submits proposed approaches to all aspects of the solicitation, including the
definition of product types and bid evaluation criteria; (b) a series of multiday, commission-facilitated collaborative meetings are held that allow for
significant stakeholder input on the utility proposals; and, (c) the state
commission promptly resolves outstanding issues that are not resolved
within a specified time frame.
To illustrate the use of a collaborative process for an RFP, here are eight
recommended steps:
1. The state commission chooses a monitor (ideally an independent,
third-party monitor) to facilitate the collaborative process or work
in conjunction with the commission staff to facilitate the process;
2. The utility submits its forecasted resource requirements to the
collaborative process;
3. A multi-day collaborative meeting allows for an open discussion
with the goal of gaining consensus on those resource requirements
among market participants, commission staff and the utility. These

Preparation of legitimate bids for long-term supplies typically cost $50,000-$75,000 to prepare,
and competitive suppliers take these costs into consideration when deciding whether to bid.

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estimates are key to defining the amount of power and types of

products to solicit;
4. If consensus is reached, the resource requirement phase is over. If
consensus is not reached, the independent, third-party monitor or
staff would submit a report to the commission with recommendations on unresolved resource requirement issues. Other participants
in the collaborative process also may file comments. The commission
promptly resolves outstanding issues;
5. Next, the utility submits a draft solicitation package to the
collaborative process;
6. The draft solicitation package provides the basis for another
multi-day meeting in the collaborative process. These collaborative
meetings would address issues such as bidder qualifications, the
terms of a Model PPA if one is used, bid evaluation techniques
and criteria, etc.;
7. If consensus is reached, the RFP design phase is over. If not, the
independent, third-party monitor and/or commission staff reports
to the commission with recommendations and the commission
again settles any unresolved issues. Other participants also file
comments, and the state commission promptly resolves outstanding
issues; and,
8. The RFP is issued. While the local utility still is responsible for
choosing the winning bids, the independent monitor has full access
to all communication between the utility and bidders (most notably
with the utility affiliate) through all phases of bid evaluation.
A process that incorporates stakeholder input can go a long way in building
credibility. For a competitive solicitation in Arizona that addressed future
needs for Arizona Public Service Company and Tucson Electric Power, the
Independent Monitor wrote:
in order for the Solicitation to attract wide participation,
the process had to be accepted by participants as fair, open,
and transparent. To achieve this, prospective bidders and
interested persons who agreed to keep certain information
confidential had the opportunity to review supporting data
and draft documents in advance of the RFP... Many bidders
and other interested persons provided comments to the util-

Electric Power Supply Association

ities, the Independent Monitor, or the Staff regarding the

completeness or quality of the information provided. . .
Bidders conferences were held so that all interested parties
had the opportunity to ask questions directly of the utilities
as well as to identify deficiencies in the Solicitation documents or supporting data.6
State commissions and utilities might be concerned that using a collaborative approach

A process that incorpo-

will encourage litigation and thus delay the

rates stakeholder input

solicitation itself. However, limiting the

time for and the types of objections allowed
in the collaborative process can mitigate these

can go a long way in

building credibility.

concerns. For example, in a recent Florida Public

Service Commission (FPSC) order adopting changes to the
rules governing utilities procurement of new resources, the FPSC limited
the amount of time RFP participants had to file objections, and limited the
types of objections to specific allegations of violations of the rule.7 Within
30 days of filing the objection, the FPSC would determine whether a rule
violation occurred. Commenting on these changes, the FPSC stated that,
[w]e believe these changes will ensure that the objection process does not
cause unnecessary delays to the RFP process. These changes should also
provide greater clarity and certainty early on in the RFP process, and
should help streamline and reduce the number of similar objections in the
need determination process.8

Independent, Third-Party Monitor

In addition to facilitating the collaborative process, an independent, thirdparty monitor also can add credibility by overseeing the entire solicitation
process to ensure that there is no bias. For example, the monitor may perform
an independent evaluation of the bids and monitor the communication
between the utility and its affiliate.

Independent Monitors Final Report on Track B Solicitation to the Arizona Corporation

Commission, Accion Group (May 27, 2003) at pgs. 6-7.
Order Adopting Changes to the Proposed Amendments of Rule 25-22.082, Florida
Administrative Code in Docket No. 020398-EQ (January 27, 2003) at p. 6.
Id.

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The benefit of an independent monitor is that the commission, staff, market

participants and customers will have an extra pair of experienced eyes
watching over the solicitation process. The monitor will know the mistakes
that can be made and will possess the technical expertise to delve into the
details of the utilitys evaluation to determine any biases. Bidders gain peace
of mind knowing that a fair and impartial entity is reviewing the details of
the solicitation.
The decision on whether to use an independent monitor is driven primarily
by three factors: (1) the desire to assist state regulatory commission staff
with logistical and technical assistance; (2) whether a utility affiliate or the
utilitys self-build option participates in the solicitation; and (3) an assessment of the need to enhance confidence among stakeholders that the
solicitation is credible.
For example, an Arizona Corporation Commission staff report on the
process to be used for a competitive solicitation addressed two of the above
points. Specifically, the report stated, [t]o assist the Staff and to assure all
parties to the Solicitation for power supplies that the process employed is
conducted in a transparent, effective, efficient and equitable manner, an
Independent Monitor will be appointed by the Staff of the Commission to
oversee the conduct of the Solicitation.9
Of course, if an independent, third-party monitor is hired, it serves to complement, not replace, the state commissions staff. For example, in Arizona,
a consultant was hired to work as part of a team with the commission staff,
and in Maryland, a technical consultant was selected to assist in the bid
evaluation phase of the solicitation.
Furthermore, an independent, third-party monitor would not supplant the
utilitys decision-making ability in the negotiation and signing of contracts
the utility still makes the decision on what resources to select. This is of
particular concern for some utilities that fear that an independent third
party or even commission staff would encroach on the utilitys responsibility
to determine the appropriateness of resource alternatives. Separately, commissions may be concerned over the costs of hiring an independent monitor.
One way to defray these cost concerns is by assessing a non-refundable fee
per bidder.
9

Staff Report on Track B: Competitive Solicitation in Docket Nos. E-00000A-02-0051 et. al.,
(October 25, 2002) at p. 9.

Electric Power Supply Association

CHOOSING A FORMAT

III. CHOOSING A SOLICITATION Format and

Product Types
Formats vary along a spectrum from price-only bid evaluations to bid evaluations based on a long list of price and non-price factors. Once measures
are in place to ensure a credible solicitation, the format and product types
to be solicited must be decided. The right solicitation format is primarily
dictated by the type of product being solicited. For example, price-only
auctions and RFPs are best for markets in which there are standardized
products, meaning that all non-price factors can be settled beforehand.
This, of course, adds greatly to transparency since only a single factor
(price) determines who wins the solicitation. Many RFPs, however, involve
evaluations of (and allow variations in) a full range of price and non-price
factors. Asset-backed or unit-contingent power is a good example of a
product solicited through such an RFP.

Requests for Proposals (RFPs)

In many non-RTO areas, RFPs are often used

to solicit unit-contingent power supply
(i.e., the services of a specific power

The primary benefit of a

plant). RFPs allow bidders to submit

unit-contingent RFP is that it

proposals that include a variety of

capacity sizes, start dates, term

enables competitive suppliers to

provide generation under the

lengths, and pricing structures.10 For

instance, with respect to term

same terms and conditions that

lengths, a utility may want to solicit a

the utility would apply to its

mix of five-, ten- and fifteen-year con-

owned generation.

tracts to match its evolving needs and

spread its market risk over time.

The primary benefit of a unit-contingent RFP is that it enables competitive

suppliers to provide generation under the same terms and conditions that
the utility would apply to its owned generation. This best allows for a head-

10

In addition, RFPs allow demand-side management programs and renewable resources to

compete as long as they offer comparable terms.

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to-head comparison between a utility built power plant and one built by a
competitive power supplier. Note, too, that competitive power suppliers
who are marketers can provide unit-contingent power. Consumers benefit
because the competition drives the utility and competitors to offer better,
tangible deals in terms of lower price, lower risk, higher reliability and
superior environmental performance. An added benefit is that suppliers can
bid generation that is not yet on-line so that the number of competitors and
the intensity of competition are increased.
A downside to unit-contingent RFPs is that they increase the difficulty of
comparing proposals due to the differences in the bidders offers. This may
potentially lead to less transparent comparisons by allowing the evaluating
party more discretion in the methods used to compare different aspects such
as term lengths, availability guarantees, capacity sizes and timing. More discretion means more opportunity for bias. However, the lack of transparency
can be mitigated during the collaborative process by deciding on the criteria
and evaluation methodology to be used in the RFP beforehand and by
employing an independent, third-party monitor. For a more detailed
description of an RFP for unit-contingent power, see Appendix A.
However, RFPs also can be used to solicit standardized products (in addition to unit-contingent power) and can do so in a very transparent manner.
For example, Marylands four investor-owned electric utilities (Allegheny
Power, Baltimore Gas and Electric Co., Delmarva Power & Light Co., and
Potomac Electric Power Co.) issued a price-only RFP to meet their standard
offer service (SOS) obligations. The RFP requested proposals from suppliers
to provide shares of full requirements wholesale supply service as defined
by the PJM RTO.11
The RFP process and the model contract to be used was the result of a
lengthy settlement effort involving the Maryland Public Service Commission
(MPSC), the utilities and market participants. Key aspects of the RFP
process and the RFP itself include: (a) the use of a technical consultant by
the MPSC, who in conjunction with the MPSC Staff, monitors the entire
RFP process from the flow of information to the actual evaluation procedures;
(b) resolution of all non-price factors and contract terms prior to the solici-

11

Full requirements wholesale supply service consists of capacity, energy, ancillary services and
transmission losses.

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Electric Power Supply Association

tation via a collaborative effort; and, (c) the transparent evaluation of all
bids based on a single discounted average price.
At the conclusion of the process, the technical consultant prepares a final
report for the MPSC, which details the process and assures the MPSC that
customers received the best possible deal.

Price-Only Auctions

In price-only auctions, the winners are chosen

solely on the basis of price (i.e., all non-price
factors are settled beforehand). Another distinctive feature is that an auction employs
multiple rounds of price bids. While there
are various types of price-only auctions,
the descending clock auction has gained
credibility because it was the method
used to procure roughly 18,000 MW of default service for customers in
New Jersey. In a descending clock auction, an auctioneer announces prices
in descending order until a price is reached at which the supply power
offered is just sufficient to meet load.12
It is important to note that there can be price-only RFPs, too. For example,
the 2004 Maryland Standard Offer Service RFP settled all non-price terms
such as product types and credit standards. Suppliers will submit price-only
offers for the provision of a share of full requirements service for specific
customer types and contract lengths.
The primary difference between a price-only auction and a price-only RFP
is the way prices are set. In the descending clock auction, the auctioneer

12

An example of a different type of auction is the New York Independent System Operator
(NYISO) new Installed Capacity (ICAP) auction system, also known as the ICAP demand
curve. The auction determines the amount and price of ICAP each load-serving entity (LSE)
must obtain for the following month. The NYISO auction system uses a downward sloping
demand curve, which reflects the decreasing value of additional supply of capacity. The
demand curve is administratively determined by the NYISO and is based on the cost of new
entry and the decreasing value of installed capacity above the various locational ICAP
requirements within the NYISO. For example, the demand price is set equal to the annualized cost of a new peaking unit at a capacity of 118 percent of peak load in each of the
three areas: Long Island, New York City and the rest of New York State.

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runs through multiple rounds of price bidding, but in the end, all winning
bids are paid a uniform price. In the price-only RFP described in the previous
section, bidders submit a price offer and winners are paid the price of each
bid (i.e., non-uniform prices are paid).
Some benefits of price-only auctions and RFPs include: (a) the transparency
of a price-only bid because all the non-price terms have been predetermined;
(b) the limitation on the utilities exposure to market risk by awarding
the supplier a percentage share of the utilities load rather than a fixed
megawatt supply; and, (c) the limitation on the suppliers exposure to
keeping bids open the turnaround time can be as short as a few days
before commission approval. Possible downsides to auctions include: (a)
a generally short-term length of purchase (i.e., one to two years for the
awarded contracts) and (b) that price-only bids mean that there is no
opportunity for suppliers to offer a lower price with less strict nonprice requirements.
More information on the aforementioned descending clock auction for
Basic Generation Service in New Jersey can be found in Appendix B.

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BID EVALUATION PROCESS

IV. FAIR AND ACCURATE Bid Evaluations

This section examines six key issues involved in fairly and accurately evaluating bids: (1) the principle of comparability for all bidders; (2) transmission
assessments of bidders; (3) cost-plus offers versus pay-for-performance bids;
(4) comparing bids with unequal lives; (5) creditworthiness concerns; and,
(6) balance sheet penalties. The important point in this section is that these
issues should be openly settled during the collaborative process before the
start of the solicitation. Generally, these issues become more contentious
when evaluating bids in non-RTO areas. For instance, issues such as
transmission assessments are contentious in non-RTO areas because there
are no independent transmission authorities to make an objective assessment
of the need for and cost of transmission upgrades.

Comparability

The golden rule of comparability (treat others

as you treat yourself) means that all
bidders should meet the same

The golden rule of

requirements and be evaluated

comparability means that

under the same standards so that

no single bidder has an unfair
advantage over another bidder.
Two quick examples demon-

all bidders should meet the same

requirements and be evaluated under

strate this point. The first

the same standards so that no single

example involves a Firm

bidder has an unfair advantage

Liquidated Damages (Firm LD)

over another bidder.

product, which requires the supplier

to either provide power at the agreed-to

price or pay any higher costs for replacement

power. If a utility affiliate offers a Firm LD energy product in which the
affiliates bid is backed up by the utilitys own generation reserves, then that
utility should offer the same reserve service to all the non-affiliated competitors under the same price and non-price terms. To do otherwise would confer
upon the affiliate an unfair advantage in the solicitation.

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The second example in which comparability is particularly pertinent is

when a utilitys self-build option is on a cost-plus basis. Cost-plus means the
offer is not a fixed-price bid and the utility or its affiliate is able to come
before the commission in the future to pass through costs such as unanticipated capital expenditures or major maintenance costs. In this instance, the
utility or its affiliate can offer a lower price bid, knowing that it can come
back before the commission to request recovery for unanticipated costs.
This would confer an unfair advantage to the utility or its affiliate as compared to a fixed or fixed formula offer from a competitive power supplier,
which must bid higher to account for added risk. The evaluation, as will be
explained later, must take into account this difference in consumer risk.

Transmission Assessments

Assuring the reliability of a bidders supply is a legitimate and important

goal for a competitive solicitation in terms of both generation (physically
being available) and transmission (physically being able to deliver). However,
one key concern during bid evaluations is how to fairly and accurately assess
the deliverability of a bidders power. For example, a bidder rightly may be
required to be a network resource to be eligible to bid. If so, the solicitation
process should include an opportunity for any bidder to receive a timely and
fair estimate of whatever system upgrades or other transmission-related costs
that the bidder would incur to serve as a network resource.
Oftentimes, in the absence of RTOs, there are complaints of biased transmission assessments that inflate the amount of transmission-related costs
necessary to ensure that electricity from a specific resource is deliverable.
Further, there is the central question of who pays for upgrades. Outside
well-functioning RTOs, there are sometimes allegations that the upgrades in
question are in fact network upgrades and should be rolled in to rates not
borne by bidders. Obviously, these issues are much easier to address in a
well-functioning RTO area. In all instances, however, the most important
principle is that all bidders should be treated comparably.
A different but related complaint is that, if transmission constraints are
found for the moment with respect to certain bids, those bids might be
rejected for the entire term of the proposal, which could be up to 25 years.

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Electric Power Supply Association

As already noted, deliverability of power should be an important factor in

evaluating bids, but there are ways to evaluate this factor without rejecting
bids for the entire term. From the customers perspective, if the cost of
upgrades to relieve the constraint is included in the price of a bid and the
bid is still the lowest price bid, then a contract should be signed with that
supplier on the date deliverability is available; interim service can be procured
from other suppliers, including the utility affiliate.

Cost-Plus Offers

The concern here is how to properly evaluate the

higher risk that cost-plus offers impose on
customers as compared to fixed-price offers. In a
cost-plus offer, the bidder does not guarantee the
customer benefits asserted in that bid. In contrast,
bidders offering a pay-for-performance PPA are
willing to guarantee the customer benefits asserted
in their proposals.
This concept of cost-plus versus fixed-price offers can be best demonstrated
through the analogy of a customer taking bids to get his or her house built.
One builder comes to the customers and says, I think I can build the house
you want for about $250,000, and I think I can build it with the features
you want. However, I will not sign a contract that guarantees the price nor
what features the house will have, but you will pay all costs I incur, pay me
a profit on top of that, and accept the house as built. This is the cost-plus
builder. Another builder says, I will build the house you want for
$250,000, and I will guarantee that price as well as the features of the
house by signing a contract. If it is not what you wanted, you do not have
to take it. This is the pay-for-performance builder. It would seem implausible
that a customer would ever choose the cost-plus offer over a readily available pay-for-performance contract. The added risk of cost-plus is too much
to bear.
If a solicitation in the electricity business does allow cost-plus offers to be
submitted during a solicitation, the added risk to customers must be
addressed. One approach is to limit the payments the cost-plus seller

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receives to the estimates provided by the seller in its offer during the
solicitation. For example, if the seller offers the utility a cost-plus formula,
but estimates (for comparison of bids) that the capacity payment will be
roughly $95/kW-yr (again not guaranteed), then the commission should
limit all payments to the supplier to $95/kW-yr over the full term of the
contract. This would help protect customers by forcing cost-plus offers to
have a more realistic appraisal of the costs that will actually be incurred.
Another approach is to apply a risk premium to the cost-plus offer in the
evaluation of bids. The risk premium could be based on historical experience on cost pass-throughs with similar technologies. For example, if cost
pass-throughs raised rate base by 20 percent in the past, the capacity related
price in the cost-plus bid would be raised by 20 percent for purposes of
bid evaluation.

Unequal Lives

How should a utility choose between a lower priced

offer to supply power for 10 years (say at $40/MWh)
and a higher priced offer for 20 years (say at
$50/MWh)? Clearly, for the first 10 years, the
$40/MWh offer wins easily. The issue is how the two
offers compare in the second 10 years. What should
be assumed about what replaces the 10-year offer?
One approach that allows for more transparency is the use of the annuity13
method, and while it need not be the only method used, it should be among
the methods used when comparing offers of unequal lives. Indeed, financial
theory dictates the use of the annuity method to compare options that have
unequal lives. That is, the two proposals should be compared on the basis
of their annuities. The annuity of the 10-year offer would be calculated
over 10 years and that of the 20-year offer would be calculated over 20
years. The proposal with the lower annuity is the better choice.14

An annuity is an equal annual payment over the life of the investment that has the same
present value as the actual, unequal annual costs of the investment.
14
This method is recommended by financial textbooks for evaluating investments or purchases
of unequal lives because it is incorrect to directly compare the net present value of projects
that have unequal lives.
13

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Again, it is important to note that with any approach, assumptions must be

made about what happens when the shorter-term proposal expires. With
the annuity approach it is presumed that the initial offer is repeatable. This
means that the gap between the 10- and 20-year options would be filled by
assuming that the 10-year option would be repeated over time. An alternative is to allow the utility to assert the price and terms of the power supply
in the years between the two offers. For example, a utility may fill in the
second 10 years of the shorter-term offer with the assumed cost to build a
new power plant a decade later. The primary appeal of the annuity method
(as compared to the fill-in method) is that it lets the bid speak for itself.
This greatly enhances the credibility of the solicitation process because it
does not allow any bias to occur by letting the utility (a competitor) speak
for that bidder.
In addition, making assumptions about the costs that a bidder would be willing
to offer in the remaining years is challenging, given the many opportunities for
technological advancement (e.g., a hydrogen-based fuel economy and decentralized generation). In other words, a utility may have an opportunity to purchase
power in years 11 through 20 from a different supplier that may use more
advanced, cheaper and environmentally friendly technology. Technological
change makes the fill-in method fraught with uncertainty.

Creditworthiness Concerns

State commissions are rightfully concerned about

how power suppliers will contractually fulfill
their obligations to utility customers. This

State commissions

concern manifests itself during competitive

are rightfully concerned

solicitations in the types of creditworthiness requirements imposed on bidders.

Ideally, market participants would
address ways to mitigate these concerns

about how power suppliers

will contractually fulfill their

during the collaborative process. The goal

obligations to utility

is to openly discuss and agree upon these

customers.

issues so that all parties know and understand

their obligations.

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Both the nature of the risk being addressed and the full range of ways to
mitigate that risk should be discussed. For example, consider the risk that a
specific power plant will be available to run when a supplier is in financial
distress. To address this risk, participants in the collaboration could discuss a
model PPA that could include certain terms and conditions to protect
customers such as measures that could physically give customers comfort
by knowing that they can have access to the power plant in the event of
trouble or default.
Additional requirements for both asset-backed and financial (non-asset
backed) offers that can provide additional comfort include provisions for
the supplier to pay for the replacement cost of power. At the outset, it must
be confirmed that all bidders utility and non-utility alike face this
requirement. This is important, since traditional cost-plus rates do not
include the requirement to pay for replacement costs. A requirement to pay
for replacement will require an assessment of the bidders financial status
and may trigger collateral requirements. Again, comparable standards must
be applied to all bidders. The amount of collateral required may be tied to
(a) the buyers replacement cost exposure and (b) the suppliers financial
status in terms of bond rating and net worth. Collateral requirements can
be typically met by either (1) cash, (2) a parent guarantee, and/or (3) a letter of credit. These requirements, individually or as a combination, can be
used to mitigate risks to the customers.

Balance Sheet Penalty

A few state commissions have allowed their utilities

to reflect in the bid evaluation process a possible
adverse effect on the utilities balance sheets from
signing a PPA with a third party. The motivation for
this comes from financial ratings agencies such as
Standard & Poors (S&P), who assert that the capacity
payments in a PPA are to some extent, in some circumstances, the equivalent of debt. The argument for
reflecting this in bid evaluations is that, with this added debt equivalent, the
utility will have to add more equity to its balance sheet. Since equity costs
more than debt, there is a cost to signing the PPA and that cost should be
used as a penalty against non-utility bids.

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Electric Power Supply Association

Two questions then arise during the competitive solicitation process. First,
should the utility assess a balance sheet penalty to the third-party suppliers
when evaluating proposals? Second, if it is assessed, how should it be
calculated? The second question is answered in detail in Appendix C,
Hypothetical Example of the Calculation of the Balance Sheet Penalty. If a
penalty is imposed, it should be calculated fairly and accurately because it could
potentially add millions of dollars to the total cost of non-affiliate proposals
and bias the results of the competitive solicitation in favor of the utility.
As to whether the balance sheet penalty should be assessed, each market
participant may have its own viewpoint. However, the state commission
should take the viewpoint of the utilitys customers. Taking their viewpoint
is important because they, and not the utility stockholders and debt
investors, are the ones that will be paying for the power and for any
penalties applied.
From the customers perspective, if the penalty is imposed, they would ask
the commission why, if the utility or the affiliate loses in the competition to
supply power because its power is higher cost and/or higher risk, should the
commission reward the utility by increasing the amount of equity return it
receives? Stated more bluntly, as a reward for not offering the best deal to
customers, the utility is asking the commission to approve an increase in
rates so that its equity investors can earn more return on equity.
Also, from the customer viewpoint, the commission should ask what level
of debt obligation customers would prefer. If the utility had two options,
either (a) build a plant that requires $150 million in debt investment or (b)
enter into a PPA with a non-affiliated supplier with capacity payments that
have a present value of $150 million, which would the customer choose? To
put a fine point on this, just think of the consequences of the worst case
the power plant simply fails to work after it is brought into commercial
operation. With the pay-for-performance PPA, the customer owes nothing,
because if there is no performance, there is no payment. In sharp contrast,
with the utilitys self-build or lease option, directly or indirectly, the customer
is on the hook for $150 million. Again, the customer clearly would choose
the pay-for-performance option.

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State commissions must see that S&P looks at this with the exclusive
perspective of that of the debt investor, not the customer perspective. S&Ps
intent is to alert the debt investor to the possible off-balance sheet obligations
of a company that could compete for payment with loan repayment at
times of financial distress for the utility. Rather than just passively going
along, utilities can work with S&P to understand the terms and conditions
of the PPA and that if determined to be prudent, the PPA payments will be
made and do not compete with debt repayment. This may sway S&P to
determine that no debt equivalent should be calculated.

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Electric Power Supply Association

CONCLUSION

V.

CONCLUSION

Regardless of the solicitation format used, the product types solicited, or

the approach to evaluation chosen, all decisions for the solicitation should
be guided by one goal: to obtain the best possible deal for customers by
credibly evaluating the full range of resource alternatives offered in the
wholesale power market. If designed properly,
competitive solicitations can be used to
determine the prudence of resource

Properly designed

procurement decisions and demonstrate the lack of affiliate abuse.

competitive solicitations can

However, in order for the results

result in an outcome in which

to be credible, the competitive

consumers are assured of

solicitation should be fair and

receiving the least-cost power

transparent. Such credibility can be

achieved via the use of a collaborative

available from the best mix

process and/or an independent, thirdparty monitor. Ideally, the collaborative

of resources.

process settles as many issues as possible before

the solicitation proceeds so that all involved have a clear
understanding of what the solicitation entails. In the end,
customers, utilities and state commissions want to buy power that is reliable
and affordable, and competitive power suppliers want to sell their power.
Properly designed competitive solicitations can result in an outcome in
which consumers are assured of receiving the least-cost power available
from the best mix of resources.

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APPENDIX A

EXAMPLE of an RFP for Unit Contingent Power

(MEANT TO ILLUSTRATE THE ISSUES FACED; IT IS NOT OFFERED
AS A TEMPLATE FOR RFP DESIGN)
The purpose of this exhibit is to give an example of the methods that could
be used to develop an open and fair competitive solicitation through the use
of a request for proposals (RFPs) for unit-contingent power. This exhibit is
based on a document distributed for an actual collaborative process in
which it served to guide the discussion for this type of solicitation and
product. It is believed to list the measures needed to obtain the best deal for
customers in terms of price, risk, reliability and environmental performance.
All the specific features would be tailored to the actual customer needs in a
specific area of the country.

PRODUCTS
If the RFP solicits unit-contingent asset-backed offers, then the product
should include capacity and energy. Potential bidders would include unit
sales and system sales.
Asset-backed unit-contingent offers allow customers to receive
the benefits of dispatchable generation similar to the utilities
own generation.
System sales include bids that identify a system or portfolio of assets.
This does not require that a bidder have ownership of the asset(s);
instead it requires that a bidder show proof that it has control of
the asset(s), and that the asset(s) is deliverable.

RESOURCES
All types of resources (i.e., generation, distributed generation, demand-side
management, renewables, portfolio bids, etc.) are allowed to submit bids
provided that their bid identifies an asset(s).
Bidders must demonstrate that they are able to provide the product
that is being solicited (i.e., demand-side bids will be accepted if they
can demonstrate that they are effective alternatives to peaking capacity).

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Electric Power Supply Association

 For portfolio bids, if a seller offered a bid that identified a portfolio

of assets, the seller must prove that each asset is deliverable to the
utility. Then, when the energy is required to be scheduled by the
utility (this is likely to occur 24 hours in advance of delivery, but
the utility would have some discretion in this regard), the bidder
would identify the precise asset(s) that will be used.

CODES OF CONDUCT / AFFILLIATE RULES

If an affiliate of the utility bids, then it will be evaluated under the
same rules as any other bidder and must be held to its bid if it wins.
The commission should impose a zero tolerance standard. That
is, if any significant misconduct occurs before or during the solicitation by the utility or the affiliate that results in an unfair advantage
toward an affiliate, then all affiliates should be banned from
the solicitation.

LENGTH OF CONTRACTS
The RFP should solicit a range of contract terms to develop a diversified
portfolio and protect customers.
The utility will file with the commission its portfolio-term preferences
for approval (e.g. the utility prefers 60 percent of the RFP capacity
procured under 10-year terms, 20 percent under 5-year terms, 10
percent under 3-year terms, and 10 percent under a 1-year term).
This preference will be made public as part of the collaborative
RFP process.
The commission should promote customer risk protection by
establishing an incentive system for load serving entities to better
manage price and volatility risk.

STRUCTURE OF PRICE BID

All bids submitted in the RFP shall include the following features to ensure
that (a) the customers will receive reliable products and services and (b) the
suppliers are accurately compensated for those products and services.

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1. Capacity Price: This will ensure that the resource is available to

supply capacity and energy.
Stated in $/kW-year for each year of the contract term; or,
initial-year stated and then indexed to inflation.
The capacity price must be tied to an availability guarantee.
2. Availability Guarantee: This will ensure that the customers are
protected against poor performance.
The capacity price would be paid in full if, and only if, the
facility was available for service 95 percent of the time, on
average, over the previous 12 months. If it was available for
less than 95 percent of the time, capacity payments would be
reduced proportionally, and the seller would be responsible for
the replacement cost of power. If the performance fell below
50 percent availability, no capacity payment would be made.
If availability was above 95 percent, then the supplier would
receive a proportional bonus for each percentage point above
95 percent.
A guaranteed megawatt output will be stated.
3. Energy Price: Compensates the supplier for providing energy to
the customers.
The energy price will either be a fixed price ($/MWh) stated
for each year; or,
Stated as a guaranteed heat rate and a fuel price tied to some
publicly available fuel price index.
Gas tolling offers are acceptable and, in this case, a guaranteed
heat rate must be offered.
For portfolio bids or system sales, the bidder would have a
single fixed energy price or heat rate for all the assets.
4. Fixed Operation & Maintenance (FO&M) Cost
An explicit fixed cost in terms of $/kW-year for each year of
the contract length, or an initial-year price indexed to inflation.
FO&M also will be tied to the availability guarantee.

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Electric Power Supply Association

5. Variable Operation & Maintenance (VO&M) Cost

VO&M will be a fixed price in terms of $/MWh stated for
each year or an initial-year price indexed to inflation.
Start Price: The cost in $/start can be fixed or tied to a
publicly available index.

MODEL PPA
The RFP should include a model PPA to be used as a template for bids. This
PPA will detail all the required and/or preferred price and non-price terms.
The goal is to streamline the bid evaluation process by settling most contract
issues upfront. The following items are some specific features that should be
included in the model PPA to ensure that bids can be compared equally.
1. Dispatchability: Each generation asset is dispatchable based on its
energy price plus VO&M plus transmission losses. Each bid must
submit the necessary parameters for dispatch such as:
Minimum load level,
Ramp rates,
Minimum run times, and,
Start-up times.
2. No Regulatory-Out Clause
The RFP itself will be the prudence review, and, therefore there
is no need for an ongoing prudence review of the contract.
Since there is no risk of a disallowance, there is no need for a
regulatory-out clause.
3. Force Majeure will be defined using the industry standards for
events out of the control of the parties.
4. Security Deposit
Construction Period Security Deposit shall be in the form of a
letter of credit (or an acceptable substitute) for $30,000/MW
and be applicable from the date that the winning bidder(s)
signs the PPAs until the in-service date of the asset.
Operation Period Security Deposit shall be in the form of a
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letter of credit (or an acceptable substitute) for $30,000/MW

and be applicable for the entire term of the contract.
Additional security in the form of a second lien (secondary
mortgage) on the asset(s) also could be imposed as recourse
when a default occurs.
5. Construction Milestones
If a bidders asset is not on-line, it must contractually guarantee
to meet milestones, such as the completion of permitting,
financial close and equipment delivery.
6. Liquidated Damages
A bidder is liable for the replacement cost of power in the
event of (a) early contract termination, (b) under-performance,
or (c) failure to meet in-service date.
The Construction or Operation Period Security Deposits are
the source of payment and set the limit for replacement costs.
7. Creditworthiness: Prospective bidders may submit bids only if
they meet one of the following creditworthiness standards:
Bond rating of the company is investment grade;
The asset to be bid has been financed;
The asset has an investment grade guarantor; or,
Both Construction and Operation Period Security Deposits are
increased to $100,000/MW.

BID EVALUATION IN THE RFP

If an affiliate of the utility participates in the solicitation, an independent
monitor could be selected and hired by the commission to work alongside
the commission staff to ensure fair treatment for all bids. The independent
monitor should be deeply involved in the details of the evaluation process
(i.e., ensuring that the details do not favor one participant over another).
The bid evaluation will be in two stages. The first will consist solely of an
assessment of generation costs, and the second will take into account possible
transmission system upgrade costs.

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Electric Power Supply Association

Stage One: Generation Cost Assessment

1. The initial generation cost bid evaluation will be done across a
range of uniform capacity factors. The monitor, selected by the
Commission, will specify the uniform capacity factors to be used
(e.g., 10 percent, 20 percent, and so on) and each bid will yield a
price at each capacity factor (a screening curve).
2. In addition to specifying the uniform capacity factors, the independent monitor will specify all other assumptions for evaluation
such as natural gas prices or other fuel costs, and inflation.
3. With the uniform capacity factor evaluation, the costs will be represented as an annuity cost per MWh. The steps are as follows:
The annual costs for each price component (capacity, energy,
VO&M, FO&M and starts) will be projected over the proposed
term of the offer, at each of the uniform capacity factors.
The present value of these projected costs will be determined
using the utilitys after-tax weighted cost of capital as the
discount rate.
To compare the contracts with unequal lives (i.e. a three-year
contract as compared to a five-year contract) the bid evaluation
should follow the annuity method. To be clear, if a 3-year offer
is made, a 3-year annuity would be calculated. If a 5-year offer
is made, a 5-year annuity would be calculated.
To adjust for unequal bid sizes, the annuities would be
divided by the MWh of the bid, as dictated by each uniform
capacity factor.
The monitor will rank the annuities per MWh and choose the
lowest-cost bids sufficient to meet the megawatt level solicited.
4. If the monitor is satisfied with the uniform capacity factor evaluation, it need not go further in the generation cost evaluation. If,
however, the monitor wants an additional analysis, it is entirely
appropriate to add a production simulation based-bid evaluation.
Capacity factors for each bid would be determined through
production simulation.

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 Bid comparison would be done on the basis of the cumulative

present value of the revenue requirement adjusted for differences
in contract term and project size.

Stage Two: Transmission System Upgrades Cost Assessment

1. The winning bidders, based on generation costs, as a group, will
be called the Minimum Supply Cost Portfolio (MSCP).
2. Transmission modeling will be used to determine the system
upgrade costs, if any, associated with the MSCP. System upgrades
will be made to assure reliability criteria are met.
3. The determination of system upgrade costs must be performed in
a comparable manner for all bidders.
4. The cost of the MSCP is now reassessed taking into consideration
transmission system upgrade costs. If the MSCP is judged to still
be the lowest cost to customers, then the MSCP is the winning
portfolio.
5. If the MSCP is clearly not the lowest cost portfolio, another portfolio of generation bids will be created. This will be called the
Second-Best Supply Cost Portfolio (SBSCP). The SBSCP will
include higher-cost generation bids that are expected to require
lower transmission system upgrades. Transmission modeling will
be used to determine the system upgrade costs of the SBSCP.
6. The costs of the MSCP and SBSCP now would be compared with
the transmission costs included. The annuity cost of transmission
upgrades would be added to the annuity cost of the generation
bids. The lower cost portfolio would win.

LOAD-POCKET LOCATION
A separate analysis for load-pocket location for generation is required to
determine if, and only if, system reliability requires load-pocket location for
physical needs regardless of transmission capability.
If a load pocket is a result of insufficient transmission capability,
it is an economic decision captured in the transmission cost
analysis detailed above. That is, if the cost of (a) generation
outside the load pocket plus the cost of required system

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Electric Power Supply Association

upgrades is more expensive than (b) the cost of in-pocket

generation, then in-pocket generation will win the RFP without
any locational preference. There is no need for a location
preference if the reason for the load pocket is insufficient
transmission capability.
The utility may allow bidders to co-locate facilities with the
utility, as possible, on its existing load pocket sites.
If the utility mothballs or retires in-pocket units, it will include
in the RFP a price at which out-of-pocket bidders may call on
these units when transmission constraints are binding.

OTHER ISSUES
Although many non-price factors are made comparable by the
Model PPA, the value of non-price factors in bid evaluation
must be made clear in the RFP evaluation process beforehand.
For example, some value can be assigned to having completed
construction or being in an advanced stage of construction.
Confidentiality: All bids are confidential. The PPAs from winning bids may be made public upon contract signature.
Dispute Resolution: Each bidder may be entitled to a post-bid
meeting with the Bid Evaluation Team if it is omitted from the
short-list, or it is not a winner after being on the short-list. If a
grievance remains, losing bidders (a) will agree to arbitration
on matters concerning the evaluation of its bid or (b) can
appeal to the commission for serious breaches of procedure
only. The entire RFP must be re-opened if procedural breaches
are found to benefit the utility or its affiliate.
Bid Fee: A non-refundable $8,000 fee per bidder (covering up
to three bid alternatives) will be assessed to defray the cost of
the independent monitor.

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APPENDIX B

EXAMPLE of a Price-Only Auction

(NEW JERSEY BASIC GENERATION SERVICES AUCTION)
The purpose of this exhibit is to give the commission an example of the
methods to be used in developing an open and fair competitive solicitation
through the use of an auction format. The example described is from New
Jerseys Basic Generation Service (BGS) Auction.

NEW JERSEYS BASIC GENERATION SERVICE AUCTION

In February 2003, New Jerseys Electric Distribution Companies (EDC)
successfully utilized a declining block auction to supply BGS.1 It should be
noted that this auction was performed under the structure of the PJM
Interconnection and thus under an open and level playing field for participants. With that in mind, this description of the New Jersey Auction is
included to aid in the understanding of this form of competitive solicitation.
The states four incumbent EDCs: Public Service Electric and Gas Co.
(PSE&G), Jersey Central Power & Light Co. (JCP&L), ACECI/Conectiv
Power Delivery (Conectiv), and Rockland Electric Co. (RECO) held a
descending clock auction to bid out their BGS load. Roughly 18,100 MW
was solicited for two products. The first product, Fixed Price (FP) service,
for small to mid-size customers, pays suppliers a fixed price (in cents-kWh)
to cover their costs (suppliers must use this price to cover capacity, energy,
ancillary service and transmission costs). The peak capacity solicited for this
product totaled approximately 15,500 MW. The second product, Hourly
Electric Price (HEP) service, for large customers, pays suppliers a capacity
payment ($/MW-day) which is determined in the auction and an energy
payment determined by the PJM zonal real-time hourly market. In addition,
suppliers are paid the pre-specified ancillary service rate and transmission
rates according to PJMs Open Access Transmission Tariff (OATT). The
capacity solicited for this product totaled approximately 2,600 MW.

More information is available at http://www.bgs-auction.com.

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Electric Power Supply Association

DESCENDING CLOCK AUCTION DETAILS

According to the auction rules, each EDCs peak BGS load is divided into
roughly (a) 100 MW tranches for the FP product and (b) 25 MW tranches
for HEP product.2 An auctioneer runs the solicitation by stating the initial
price of each EDCs tranche, then the suppliers bid for the number of
tranches they would like to serve. If the total number of tranches bid by the
suppliers is greater then the number of tranches desired by the EDC, the
auctioneer would hold another round of auctions and tick down or lower
the price. This continues until the number of tranches offered by suppliers
equals the number of tranches desired by the EDC.
The winning bidders are awarded a fixed percentage of the EDCs load
based on the number of tranches won. For example JCP&L wanted to offer
30 tranches (roughly 30100 MW blocks) for their 10-month FP product. If
a bidder won five tranches it would provide full service requirements for
one sixth (5/30 tranches) of JCP&Ls BGS load in all hours. In short, suppliers
are not guaranteed a fixed number of megawatts, but rather a right to serve
a fixed percentage load.
A winning supplier provides full-requirements service. That is, the provider
is responsible for fulfilling all the requirements of a PJM Load Serving
Entity (LSE) including capacity, energy, ancillary services and transmission,
and any other service as may be required by PJM. A supplier may win one
or more tranches for one or more EDCs and for one or more terms.

TERM LENGTH
The length on contract terms in the auction is short term. The FP auction
awarded two-thirds of the tranches to 10-month contracts and one-third to
34-month contracts. The HEP auction awarded contracts for 10 months
of service.

Each tranche (or block of power) is actually slightly less than 100 MW for FP to make the
number of tranches a whole number. E.g. JCP&Ls peak load is 2,973 MW, but in order to
have 30 equal size tranches the megawatts must be reduced to 99.1 MW per tranche. (99.1
MW x 30 tranches = 2,973 MW)

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CONTRACT
Once the auction is closed, the prices are final. There are no negotiations
and suppliers are required to sign a predetermined contract. While the auction
price is final, the price actually realized by suppliers varies by season. Built
into the auction are seasonal factors (greater than one for summer, less than
one for winter) that are multiplied by the auction price to take into account
seasonal variability. The factors vary by EDC for the summer from 1.11 to
1.24 and for the winter from .92 to .96. For example, PSE&Gs 10-month
FP closing auction price was 5.386 cents/kWh. Its summer factor is 1.1423,
therefore the price charged during the summer months is 6.152 cents/kWh.

RESTRICTIONS
Each bidder must post a letter of credit or bid bond of
$500,000 per tranche for the FP service (translates into roughly
$5/kW) and $125,000 per tranche for the HEP product for the
number of tranches offered in the first round of bids.
Depending upon creditworthiness, an additional security
deposit could be required.
Each EDC submits a load cap on the number of tranches any
one bidder is allowed to serve. The goal is to prevent any one
bidder from influencing the auction and overexposing the EDC
to a single supplier.
There are minimum and maximum statewide starting prices.
The EDCs agreed upon two prices to give the auctioneer a
range of values to begin the solicitation.

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Electric Power Supply Association

APPENDIX C

HYPOTHETICAL Example of the Balance Sheet Penalty

While we do not recommend the use of the balance sheet penalty in the
evaluation of bids, if it is used in some context, there are several steps
involved in calculating the balance sheet penalty. First, the utility calculates
the present value of the capacity payments as defined in the PPA using the
utilitys after-tax weighted average cost of capital as the discount rate.3
Next, the utility assesses the risk level associated with the PPA and multiplies
the risk percentage times the present value to get the imputed debt. The
next calculation is the required equity needed to keep the debt-to-equity
ratio consistent with the utilitys original balance sheet, prior to the execution
of the PPA. The utility then imputes a pre-tax interest payment (based on
the utilitys equity return) necessary to support the imputed debt.
To illustrate, Table One presents a hypothetical example of the calculations.
First, the present value of the capacity payments for our hypothetical PPA is
$150 million.
Second, the utility asserts that 12 percent of that present value of capacity
payments is the equivalent of debt. This leads the utility to add $18 million
of what is imaginary debt to its balance sheet to reflect this debt equivalent;
with the addition of imaginary debt, we will refer to this as the utilitys
hypothetical balance sheet.
Third, because the addition of this imaginary debt means that the utility
will have a higher debt-to-equity ratio, the utility asserts that it will have to
add equity to restore the debt-to-equity ratio it would have had prior to
signing the contract. The utility declares that it wants debt to be 40 percent
of its total capitalization. If the utility wants to regain its 40 percent debt
share, it must add $27 million of equity to its balance sheet. Thus, it will
add a total of $45 million to its hypothetical balance sheet with $18 million
(40 percent) coming from imaginary debt and $27 million (60 percent)
coming from equity.

The assumed discount rate is 11 percent and it is not forced to be equal to the cost of capital
for the hypothetical equity-debt swap.

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33

Fourth, if $27 million in equity must be added, then the utility claims that
customers must pay the pre-tax return on equity for that added equity investment. The utility asserts that the pre-tax return is about 18.5 percent (an
after-tax rate of 12 percent grossed up for income taxes of 35 percent). In the
first year, the added return on equity would be $4.98 million ($27 million
multiplied by .185). The utility calculates this added return on equity for each
year of the PPA; the dollar amount of return declines each year because the
amount of equity is shown to decline each year due to depreciation.
Fifth, before the penalty is applied, the utility deducts from the penalty the
cost of debt, since in reality the utility is asking to simply swap equity for
debt. (Actual total capitalization does not change, since the PPA causes only
imaginary debt.) Thus, the net cost is the equity return less the debt return
that would have been paid.
Sixth, the utility calculates the present value of these added annual returns
on equity after deducting the cost of debt. This present value of annual
equity returns after deducting the cost of debt is the balance sheet equalization penalty that the utility assesses against the competitive power suppliers.
Assuming a 20-year straight-line depreciation, our example would lead to a
$20.4 million penalty. That is, the utility would treat the $20.4 million
penalty as if it were a cost of signing the PPA, thus giving the utilitys own
power plants an artificial cost advantage. In this example, that advantage
amounts to artificially increasing the competitors capacity cost by 13.6
percent on a present value basis ($20.3 million divided by $150 million).

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Electric Power Supply Association

TABLE ONE: Balance Sheet Equalization Penalty Example

NPV of Total Capacity Payments:

$150,000,000

Risk Factor:

12%

Imputed Debt:

$18,000,000

Required Equity (60% Equity Target):

$27,000,000

Amortization Factor:

$1,350,000

Discount Rate:

11.00%

Depreciation Life:

20

Pre-Tax Return on Equity:

18.46%

Yn

Equity
Amount
(a)

Return at
18.46%
(b)

Debt
Payment at
6% ( c )

$27,000,000

$4,984,615

$1,620,000

$3,364,615

$25,650,000

$4,735,385

$1,539,000

$3,196,385

$24,300,000

$4,486,154

$1,458,000

$3,028,154

$22,950,000

$4,236,923

$1,377,000

$2,859,923

$21,600,000

$3,987,692

$1,296,000

$2,691,692

$20,250,000

$3,738,462

$1,215,000

$2,523,462

$18,900,000

$3,489,231

$1,134,000

$2,355,231

$17,550,000

$3,240,000

$1,053,000

$2,187,000

(b)-(c)

$16,200,000

$2,990,769

$972,000

$2,018,769

10

$14,850,000

$2,741,538

$891,000

$1,850,538

11

$13,500,000

$2,492,308

$810,000

$1,682,308

12

$12,150,000

$2,243,077

$729,000

$1,514,077

13

$10,800,000

$1,993,846

$648,000

$1,345,846

14

$9,450,000

$1,744,615

$567,000

$1,177,615

15

$8,100,000

$1,495,385

$486,000

$1,009,385

16

$6,750,000

$1,246,154

$405,000

$841,154

17

$5,400,000

$996,923

$324,000

$672,923

18

$4,050,000

$747,692

$243,000

$504,692

19

$2,700,000

$498,462

$162,000

$336,462

20

$1,350,000

$249,231

$81,000

$168,231

21
NPV

www.epsa.org

$0

$0

$0

$0

$163,972,298

$30,271,809

$9,838,338

$20,433,471

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Electric Power Supply Association

1401 New York Avenue, NW, 11th Floor
Washington, D.C. 20005
Telephone: (202) 628-8200
Fax: (202) 628-8260
www.epsa.org
January 2004