New Market Structures:

1. New Market Structures: THE TEXAS ALTERNATIVE Robert W. Gee President THE GEE STRATEGIES GROUP APEC COAL TRADE AND INVESTMENT LIBERALISATION AND FACILITATION (TILF) WORKSHOP Kuala Lumpur, Malaysia March 8, 2002

2. Overview • How the Texas electricity market will be fundamentally restructured • Operational Basics of “Texas Electric Choice” • Purpose of Market Power Mitigation Measures • Role of the ERCOT Independent System Operator for wholesale market • Future Challenges: Sufficient Generation and Transmission Capacity THE GEE STRATEGIES GROUP

3. Texas Is Unique • 85 percent of market not subject to federal wholesale jurisdiction within Electric Reliability Council of Texas • Texas restructuring plan extends to wholesale market reforms • Areas outside of 85 percent are still subject to new law but application being deferred or under consideration for deferral THE GEE STRATEGIES GROUP

4. Electric Power Regions of the U.S and Canada THE GEE STRATEGIES GROUP

5. No Rush to Judgment in the Lone Star State • Not under economic pressure for reform • State took several years to weigh options and alternatives • Had benefit of witnessing experience in other countries (U.K.) and other states (California, Pennsylvania) THE GEE STRATEGIES GROUP

6. Texas 3rd highest average annual residential bill of $1,047 per customer. Texas 27nd highest average residential rate of 7.55 cents per kilowatt-hour. 50 State Average Residential Electric Bills & Rates -1999 THE GEE STRATEGIES GROUP

7. Basics of “Texas Electric Choice” • Statewide customer choice began January 1, 2002 • Integrated utilities split into separate businesses • Base rates frozen until 2002 • “Price to Beat”: 6% rate reduction in 2002 for residential and small commercial customers • Customers have access to renewable energy, energy efficiency programs, and distributed generation • Municipal and cooperative utilities given choice to opt in or out of competition THE GEE STRATEGIES GROUP

8. Integrated Utility Generation Generation Ancillary Services Competitive Transmission & Distribution • Transmission & Distribution • Wires • Non-bypassable Fee • Nuclear Decommissioning • Administer DSM • Metering • Retail Services • Metering • Billing • Customer Service • Energy Service Regulated Retail Services Metering Billing Customer Service Energy Services All regulated Competitive “Unbundling” Utilities: Before and After under Texas Retail Choice THE GEE STRATEGIES GROUP

9. Fundamental Structural Market Reforms • Each utility must separate into a: • Power Generation Company (PGC) • Transmission and Distribution Utility (TDU) • Retail Electric Provider (REP) • The REP will be the entity with the primary contact with customers and will purchase energy and T&D service on their behalf THE GEE STRATEGIES GROUP

10. The New Market Structure THE GEE STRATEGIES GROUP

11. How Does It Work? • All REPs & PGCs have equal access to the transmission & distribution grid • Retail customers contact REPs for service • REPs & PGCs contract for power to serve retail customers • TDU bills REP for customers’ use of the grid • REP sends bill to retail customer • Aggregators can also bargain with REPs on customers’ behalf • Customers have option to change suppliers • Residential & small commercial customers (below 1 MW of peak demand) who do not change still get 6% rate reduction THE GEE STRATEGIES GROUP

12. Key Features of Retail Market • Uniform terms and conditions for delivery service • Published tariffs for delivery service • Switching, billing, and other information exchanged electronically through uniform rules • Utilities do not provide competitive services THE GEE STRATEGIES GROUP

13. How Information and Power Flows THE GEE STRATEGIES GROUP

14. Preventing Market Power: Ownership Restrictions on Generation • Law limits generation ownership of single company to 20 percent in power region • Code of conduct for transactions between affiliates • Requires divestiture by utility-affiliated power generation company w/ greater than 400 Mw of capacity of at least 15 percent of its capacity during the first five years of retail competition, or until utility-affiliated company loses 40 percent of residential and small commercial business. THE GEE STRATEGIES GROUP

15. Price to Beat – The Competitors’ Edge • Default rate offered by utility- affiliated REP at 6% discount for residential and small commercial customers • Affiliated REP must charge PTB until it loses 40% of PTB customers or January 2005, whichever first • In non-ERCOT areas, PTB must be maintained for 5 years • PTB can be adjusted for changes in market price of natural gas and purchased energy • No PTB for industrial and large commercial customers-- Open competition permitted • Difference between PTB and market price to serve represents “headroom” for non-affiliated REPs THE GEE STRATEGIES GROUP

16. The “Price to Beat” – Illustration THE GEE STRATEGIES GROUP

17. The Pilot Program • Began August 1, 2001 • Limited to 5 percent of utility’s customers or load • Large commercial customer response • Over 100,000 residential customers participating • Currently, 28 REPs certified to do business THE GEE STRATEGIES GROUP

18. Essential Elements of a Workably Competitive Wholesale Market • Neutral organization responsible for: • Access to transmission system • Reliability • Settle wholesale accounts • Manage customer switching • Policy promoting equitable interconnection process for new generation capacity • Mechanism for regional transmission planning • Role of Electric Reliability Council of Texas Independent System Operator (ISO) THE GEE STRATEGIES GROUP

19. The ERCOT ISO: Market Principles • Bilateral energy market; No Oversight of “Pool” or Power Exchange • Maintains reliability and provides access, but has minimal role in markets • ERCOT creates markets for balancing energy and ancillary services • Ancillary services can be self-provided (matching output to load and contingency reserves) • ERCOT will oversee congestion management by zones THE GEE STRATEGIES GROUP

20. How Bilateral Trades Occur THE GEE STRATEGIES GROUP

21. Can Texas Avoid the Fate of California? • Will Texas have sufficient generating capacity? • Will Texas have sufficient transmission capacity? • Texas officials say yes with proper planning & oversight THE GEE STRATEGIES GROUP

22. Dallas Ellis County El Paso Austin San Houston Antonio Harris County 27 Plants completed since 1995--9,343 MW Corpus Christi 27 Plants under construction--13,991 MW 31 Plants announced or planned New Electric Generating Plants in Texas THE GEE STRATEGIES GROUP

23. ERCOT Reserve Margins THE GEE STRATEGIES GROUP

24. ERCOT Installed and Planned Capacity – 2001 THE GEE STRATEGIES GROUP

25. Paris North HVDC East HVDC DFW North North East West South South Houston Ship Channel CPL NORTH CPL SOUTH Corpus Christi Laredo RGV Transmission Constraints in ERCOT THE GEE STRATEGIES GROUP

26. 1 Paris North HVDC East HVDC 15 12 DFW 8 5 10 13 14 4 8 18 7 19 23 11 22 20 21 9 16 3 Houston Ship Channel Under Construction Pending at PUC 17 Corpus Christi Recommended by ERCOT 6 2 Laredo Under Consideration at ERCOT 17 Transmission Projects in Texas THE GEE STRATEGIES GROUP

27. Conclusion • Texas is taking a gamble that it has the “right stuff” others lacked • Unique factors may give it the edge • Time will tell whether they got it right THE GEE STRATEGIES GROUP

28. For More Information Contact: Robert W. Gee President THE GEE STRATEGIES GROUP 7609 Brittany Parc Court Falls Church,VA 22043 Tel: 703.593.0116 Fax: 703.698.2033 Email: racbud@ix.netcom.com Special Thanks to Commissioner Brett Perlman, Public Utility Commission of Texas for assistance in providing graphics THE GEE STRATEGIES GROUP