DSWG LaaR Bidding Update

1. DSWG LaaR Bidding Update February 22, 2006

2. LaaR Overview • Current limit for LaaR provided RRS in ERCOT 50% or 1,150 MW per hour (ERCOT nominates percentage limit monthly) • REPs can self arrange 50% of their Responsive Reserve obligations with LaaR Responsive • LaaRs that are not self arranged can participate in the Daily ERCOT auction • Currently 94 LaaRs (spread across 10 QSEs) are qualified to provide services in the AS and BES markets for a total capacity of 1826 MW • While the vast majority of LaaRs are less than 50 MW, the large LaaRs make up most of the capacity. A breakdown by capacity is as follows:

3. LaaR Bidding Behavior Created Credit Issue

4. Special Task Force Formed • A Special Task Force was assembled to evaluate and propose long term solutions • Team consists of a range of market participants including: • Mary Anne Brelinsky – Reliant • Keith Emery – Tenaska • Clayton Greer – Constellation • Randy Jones – Calpine • Steve Krein – ERCOT • John Lightbourn – TXU • Task Force initially identified eight potential long term solutions and narrowed those down to four • Mark Patterson – ERCOT • Malcolm Smith – Energy Data Source • Randa Stephenson– TXU • Michael Walker – Exxon • Scott Wardle – Oxy Chem • Fred Young – Air Liquide

5. A B C D Long Term Solutions Evaluated Team reviewed eight potential long term solutions: • Revise settlement process and how defaults are processed • Revise credit provisions to require protection prior to bidding and create ability to monitor real time • Shift credit risk to Resources rather than QSEs • Create two separate markets, one for LaaRs and one for Gen • Maintain a single market clearing engine, but when LaaR is oversubscribed post separate clearing prices for LaaR and Gen • Pay all ancillary services as bid (both Gen and LaaR) • Modify current award mechanism for LaaRs; LaaRs offered at a price below MCPC are awarded • Eliminate sunset date on short term solution and modify system to reject negative offer prices

6. A. Collateralization for Negative Bids Proposed Solution: Modify the ERCOT EAL credit program. EAL calculation would capture negative bidding by QSE and incorporate into QSE credit requirements. Solution creates a similar process as TEL but based on bidding behavior not clearing price. Negative bidding behavior could require 5 to 10 QSEs to post additional credit collateral based on their EAL calculation. QSE is responsible for establishing their own credit requirements with LaaR. Pros: • Credit based Solution that does not significantly impact market design • Similar process to Balancing Energy requirements now in place Cons: • Reduces but does not eliminate possible market disruption by negative clearing bid since EAL looks back on average 20 days historical behavior (during which negative bidding may not have taken place so "no" or "minimal" credit is required) • Possible reduction in LaaR participation in ERCOT auction from QSEs without collateral sufficient to support large negative bids.

7. B. Modified Market Clearing Engine – Separate Bid Stacks and MCPCs Proposed Solution: Creates two different Responsive Reserve services, one provided by LaaR and one supplied by Gen. Separate clearing price for LaaR and Gen. = LaaR offer 2,300 MW of RRS = Gen offer = Self Arranged MCPC LaaR MCPC Gen 1,150 MW of LaaR 1,150 MW of Gen + = LaaR Bid Stack Gen Bid Stack

8. B. Modified Market Clearing Engine – Separate Bid Stacks and MCPCs Proposed Solution: Creates two different Responsive Reserve services, one provided by LaaR and one supplied by Gen. Separate clearing price for LaaR and Gen. Pros: • Recognizes that RRS supplied from Gen provides a different aspect of reliability service than RRS from LaaR (fine vs. coarse frequency adjustment respectively) • Market based solution; bids reflect cost to provide service Cons: • Requires market participants to manage two MCPCs for Responsive Reserve and makes settlement more complex • Could result in lower LaaR participation if LaaR MCPC is consistently lower than Gen clearing price (opposite result could also occur) • Expected to have significant costs to implement ($500 K to $1 MM) • Market power issues need to be addressed • May require alternate solution to secondary market if LaaRs are not fully subscribed

9. C. Single RRS Bid Stack with Separate LaaR and Gen MCPCs if Oversubscribed Proposed Solution: Solution leverages ERCOT's existing clearing engines. If LaaR limit is reached a separate MCPC price for LaaR would be posted. To the extent the LaaR limit is not reached only one MCPC for both LaaR and Gen is cleared. = LaaR offer = Gen offer = Self Arranged More than 1,150 MWs of LaaRs Offered Below MCPC Less than 1,150 MWs of LaaRs Offered Below MCPC Gen MCPC Single MCPC 2,300 MW of RRS 2,300 MW of RRS = = LaaR MCPC Single Bid Stack Single Bid Stack

10. C. Single RRS Bid Stack with Separate LaaR and Gen MCPCs if Oversubscribed Proposed Solution: Solution leverages ERCOT's existing clearing engines. If LaaR limit is reached a separate MCPC price for LaaR would be posted. To the extent the LaaR limit is not reached only one MCPC for both LaaR and Gen is cleared. Pros: • If current LaaR participation levels persist, two separate RRS MCPCs would frequently occur; likely to result in a short term reduction in market RRS costs • Need for secondary RRS solicitations unlikely • Market based solution; bids should be more reflective of cost to provide service Cons: • Requires market participants to manage two MCPCs for Responsive Reserve and makes settlement more complex • May drive LaaR out of the RRS market if LaaR MCPC is consistently/significantly lower than Gen MCPC and result in higher total costs to market • Solution concedes that LaaR provides inferior RRS product which is not the consensus view held by the market

11. D. LaaR RRS Offered Below MCPC is Prorated when Market Oversubscribed Proposed Solution: Solution awards LaaRs offered below the cleared MCPC and allocates LaaR RRS capacity across awards. Removes any incentive to submit negative bids. = LaaR offer = Gen offer = Self Arranged More than 1,150 MWs of LaaRs Offered Below MCPC Less than 1,150 MWs of LaaRs Offered Below MCPC Single MCPC Single MCPC 2,300 MW of RRS 2,300 MW of RRS = = Single Bid Stack Single Bid Stack

12. D. LaaR RRS Offered Below MCPC is Prorated when Market Oversubscribed Proposed Solution: Solution awards all LaaRs offered below the cleared MCPC and removes any incentive to submit negative bids. Solution was originally proposed by the Demand Side Working Group via PRR619 and was rejected by TAC in November. Pros: • Impact on ERCOT and Market Participants’ systems is minor and cost to implement is expected to be less than $50 K • Eliminates the incentive for LaaRs to bid negative • Need for secondary RRS solicitations unlikely Cons: • Requires QSEs to closely monitor LaaR awards and ensure that LaaRs “unarm” as required • Proration of all LaaR bids is likely and will be up to the QSEs bidding LaaR to manage the amount of LaaR armed at any one time to conform to Protocol limits (not perceived at this time to be a significant problem)

13. High Level Overview * * Icon size represents relative impact when compared with other alternatives.

14. Next Steps • We still have diverging views on the “optimal solution” among members of Special Task Force • Asking for feedback on four proposed solutions and identify areas where more analysis is required; specifically with regards to Nodal