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Credit Exposure

Credit Working Group Background Information Credit Aspects of Mass Transition Update – February 3, 2006. Credit Exposure – 3 primary components Outstanding Invoices Uninvoiced, historical activity Expected forward liability

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Credit Exposure

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  1. Credit Working GroupBackground InformationCredit Aspects of Mass TransitionUpdate – February 3, 2006

  2. Credit Exposure – 3 primary components Outstanding Invoices Uninvoiced, historical activity Expected forward liability A great deal of work has been done in the past year to reduce credit exposure in all areas above Additional work is needed (and in process) Credit Exposure

  3. Credit Exposure – 3 primary components Outstanding Invoices Uninvoiced, historical activity Expected forward liability Credit exposure

  4. This credit exposure is well defined Known and measured Currently, there can be up to 3 invoices outstanding Collateral is held for outstanding invoices PRR 638 is proposed to reduce this exposure Impact on EAL / collateral is automatic Credit exposure – Outstanding invoices

  5. PRR 638 sponsored by COPS Proposes to change payment due date from 16 calendar days after invoice date to 5 business days after invoice date (usually a Thurs) Expected to go to the BOD this month (Feb 2006) Normally would implement Mar 1 (if passed) COPS will ask that implementation be delayed to April 1 so as to not overlap implementation of PRR 568 Collateral requirements will automatically adjust since EAL includes “outstanding unpaid transactions” Currently there can be up to 3 outstanding invoices When fully implemented, there will be 1 outstanding invoice PRR 638 - Summary

  6. During the transition period, there will be two weeks when two invoices are due (one on Monday and one on Thursday) During PRR 638 implementation, After week 1, each QSE will have only two invoices outstanding After week 2, each QSE will have only one invoice outstanding All else being equal, A QSE’s EAL will decrease as the number of outstanding invoices decrease (by the amount of the invoice) After week 1, EAL will reflect only two outstanding invoices After week 2, EAL will reflect only one outstanding invoice A QSE may request a refund of their posted credit. The refund may be wired to the QSE or held by ERCOT to apply toward the next invoice(s) due. Going forward, QSE’s EAL will include only one invoice outstanding. PRR 638 Impact on Collateral during Transition Period

  7. Credit Exposure – 3 primary components Outstanding Invoices Uninvoiced, historical activity Expected forward liability Credit exposure

  8. Currently, at any point in time there can by 21 – 24 days of uninvoiced historical exposure Example: Invoice dated Feb 2 billed for operating days Jan 6 – 12 Operating days Jan 12 through Feb 6 (next payment date) are uninvoiced, historical exposure This credit exposure is difficult to measure First, we capture this exposure under the “40 day” portion of the EAL (weekly) Second, we use the NLRI to test the adequacy of the collateral held (daily) Catches changes in scheduling activity, etc PRR 568 has been approved to reduce this exposure Credit exposure – Uninvoiced, historical activity

  9. PRR 568 sponsored by COPS Reduces settlement date from 17 days after operating day to 10 days after operating day COPS and ERCOT staff did an extensive review of the implications of these changes Higher level of estimated data on invoices Implementation will be phased-in PRR 568 will reduce credit exposure by 7 days Note: Reduced credit exposure does not automatically translate to reduced collateral. A PRR would need to be processed. CWG will evaluate the overall credit risk in the market first. PRR 568 - Summary

  10. Beginning in Feb, invoices will include 8 settlement statements rather than 7 settlement statements It will take 7 weeks to complete the transition Transition should be complete by the end of March Collateral is based on an average daily transaction amount over two invoices ERCOT credit staff will adjust to allow for 15 or 16 days to get to the correct average daily transaction amount PRR 568 Impact on Collateral during Implementation

  11. Credit Exposure – 3 primary components Outstanding Invoices Uninvoiced, historical activity Expected forward liability Credit exposure

  12. Primary focus of Feb 3rd meeting Address “exit” scenarios LSE no longer represented by a QSE QSE There is currently unmitigated credit exposure in the market in this area Even with current mitigation plans, there is still expected to be unmitigated credit exposure Credit exposure – Expected forward liability

  13. Credit exposure related to a troubled entity generally centers around that entity’s use of the Balancing Energy Service (BES) A troubled entity that has been “cut off” for credit reasons from its bilateral energy providers still serve its end users By default, energy requirements come from the BES, creating liability for remaining market participants if that entity defaults Credit exposure related to a QSE or LSE exists as long as end users are associated with that entity Energy continues to flow to end users Credit exposure – Expected forward liability

  14. Credit exposure can only be eliminated by moving end users to another entity (e.g. the Mass Transition process) Credit exposure is currently mitigated (although not fully) with Collateral (QSEs) or QSE notice period (LSEs) Mass Transition process For QSEs, collateral currently covers approximately 2 weeks forward for “exit” process With the reduced credit exposure from PRR 568 and no change to the EAL “40 day” calculation, there will be 3 weeks coverage at historical levels of BES usage For LSEs, QSE notice period covers 12 business days forward (approx 16-18 days) for “exit” process Credit exposure – around Mass Transition

  15. Based on recent experience, it takes approx 3 weeks for “exit” process Including notice periods and Mass Transition Market losses have been experienced (and are likely to continue) due to a combination of How collateral is calculated per Protocols How long it currently takes the market to transition end users Credit exposure – Mitigation shortfalls

  16. Two PRRs have been approved and were effective Jan 1, 2006 to address some of the issues PRR 624 – Clarified language in the default section Sponsored by Mass Transition task force (WMS portion) PRR 643 – Shorten payment default timelines Sponsored by CWG Changed due date for collateral calls from 5:00 pm to 3:00 pm on the second business day to allow default notice to go out on the second business day Changed the cure period from 3 business days to 2 business days New entrance to the market will sign contracts with the 2 day requirement Existing QSEs, LSEs and Resources will sign new contracts with the 2 day requirement by Mar 2006 Credit exposure – Mitigation actions to date

  17. Expected forward liability LSE no longer represented by a QSE QSE Similarities Market exposure is directly impacted by how quickly a Mass Transition (move customers away from the defaulted entity) occurs Differences Market exposure “collateralization” is different for each scenario QSE – direct collateral held by ERCOT LSE – notice period provided by QSE dropping the LSE provides protection to the market Credit exposure – 2 scenarios

  18. Expected forward liability LSE no longer represented by a QSE QSE Credit exposure – First scenario

  19. ERCOT does not 1) receive financials, 2) evaluate credit or 3) hold collateral for LSE s in the market, only QSE s (not required by Protocol) The QSE that represents a LSE evaluates and collateralizes for the credit exposure The Protocols define how a QSE can “drop” an LSE in section 16.2.4.3 The Protocols define what the “dropped” LSE must do and the timeline in which it must act in section 16.2.13 Emergency QSE Market coverage (effectively collateral) is provided by the notice period required by the QSE before “dropping” an LSE Until Feb 1, notice period was 5 business days PRR625 addresses several issues around this process and reduces market exposure PRR625 became effective Feb 1 Credit exposure – LSEs

  20. PRR 625: Clarification of Emergency QSE Language Sponsored by Mass Transition task force (WMS portion) Strengthens or clarifies Protocol language that address when and how Emergency QSEs may be used. In a default where an LSE is no longer represented by a QSE, provides for use of a virtual QSE for tracking and scheduling of the LSE’s load at ERCOT. Extends notification requirement to 12 Business Days for a QSE intending to terminate its relationship with an LSE. By noon on the 4th Business Day, LSE must either name a new QSE or qualify as an EQSE. If LSE does not meet either, then LSE is in breach of contract. Notice provided on afternoon of 4th Business Day and cure period begins on 5th Business Day. If LSE does not cure, initiate mass transition of customers. At end of 12th Business Day, current QSE/LSE relationship is terminated and LSE is assigned to a virtual QSE for tracking purposes. PRR 625 - Summary

  21. QSE notice of intent to end LSE relationship QSE/LSE relationship ends LSE must name new QSE or post collateral ERCOT notices EQSE of collateral call End of cure period Last ESI ID transitions from Defaulting LSE Notice of LSE Breach Mass transition of ESI IDs begins QSE Liability EQSE Liability/Potential Market Exposure - Current QSE Liability extends to 12 Business Days Potential Market Exposure – Post PRR625 LSE must name new QSE or post collateral for EQSE End of cure period Last ESI ID transitions from Defaulting LSE Mass transition of ESI IDs begins Notice of LSE Breach PRR 625 Review 2 4 5 6 7 8 9 10 12 0 19 21 *Current process above timeline. *Proposed process below timeline. *Dates in Business Days.

  22. Market dynamics are just that – dynamic Must prepare for the possibility that more LSEs will represent themselves directly as QSE s for credit purposes given the provisions of PRR 625 QSE collateralization issue remains Credit exposure – Changing market dynamic

  23. Expected forward liability LSE no longer represented by a QSE QSE Credit exposure – Second scenario

  24. Identify problem and make collateral call BDay 0 Notice periods (4 BDays, down from 6) Collateral due BDay 2 Notice of default given BDay 2 2 BDays to cure default BDay 4 Mass transition (9-11 BDays) Conference call to begin Mass Transition BDay 5 POLRs initiate switches (5 BDays allowed, switches to date have taken, on avg 3 BDays) BDay 8 Time until switch complete by TDSP BDay 14 (Note: 14 business days + 6 weekend days = 20 days of liability) Approx Timeline to Remove a Troubled QSE

  25. Potential loss (simplified – w/3 weeks of collateral) Collateral held 1,000 MWh/day x $100/MWh x 10% x 21 days = $ 210,000 At default 1,000 MWh/day x $100/MWh x 100% x 21 days = $ 2,100,000 Potential loss to the market $ 1,890,000 For 100 MWh/day $ 189,000 For 10,000 MWh/day $ 18,900,000 Open question: Is 20 days a reasonable estimate if the MP is a larger entity? Potential loss in exit scenario

  26. Potential loss range – w/ 3 weeks of collateral (assume MCPE = $100/MWh) Collateralized based onBES 10%BES 100% At Default BES 100% BES 100% For 100 MWh/day $ 189,000 $ 0 For 1,000 MWh/day $ 1,890,000 $ 0 For 10,000 MWh/day $ 18,900,000 $ 0 Potential loss in exit scenario

  27. Potential loss range – w/ 2 weeks of collateral (assume MCPE = $100/MWh) Collateralized based onBES 10%BES 100% At Default BES 100% BES 100% For 100 MWh/day $ 196,000 $ 70,000 For 1,000 MWh/day $ 1,960,000 $ 700,000 For 10,000 MWh/day $ 19,600,000 $ 7,000,000 Potential loss in exit scenario

  28. # of LSEs by average daily MWh for August 2005 Potential MWh/dayCRNOIE Tot%Loss by cat < 200 23 25 48 31% $ 200k ea 200-2,000 21 41 62 40% $ 2,000k ea 2,000-20,000 24 12 36 23% $20,000k ea > 20,000 7 3 10 6% Total 75 81 156 100% Market Statistics

  29. Average daily MWh for August 2005 MWhCRNOIETotal% < 200 1,569 2,291 3,860 0.4% 200-2,000 16,504 27,828 44,332 4.3% 2,000-20,000 182,528 76,488 259,016 25.1% > 20,000578,401 148,377 726,778 70.3% Total 779,002 254,984 1,033,986 100.0% Market Statistics

  30. Entity Est MWh/day Est ESIDs Tot Est Exposure LSE 1 350 3,000 $ 400,000 QSE 1 50 500 $ 30,000 QSE 2 65 550 $ 220,000 LSE 2 3,500 12,250 $ 5,500,000 LSE 3 1,500 10,000 $ 200,000 QSE 3 125 2,500 $ 100,000 Total $ 6,450,000 Credit Exposure – Mass Transitions 2005/2006

  31. Understand current status of changes to the Mass Transition process and the impact on credit exposure – updates next Understand range of “residual credit exposure” Begin addressing “residual credit exposure” Determine the level of acceptable unmitigated credit exposure Identify possible ways to get to desired level of risk For today

  32. Questions ?

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