Reliability Committee Meeting February 14, 2006 Sturbridge Host Hotel

1. Review of Order 672: Rules Concerning Certification of the Electric Reliability Organization; and Procedures for the Establishment, Approval, and Enforcement of Electric Reliability Standards Reliability Committee Meeting February 14, 2006 Sturbridge Host Hotel

2. Overview of Final Rule • The Final Rule will be published in 18 CFR Part 39. The Final Rule incorporates: • Definitions relating to the formation of Electric Reliability Organization and the Bulk Power System for which it may promulgate Reliability Standards (§39.1); • Definitions regarding the applicability of the Reliability Standards to each “user, owner and operator” of the Bulk Power System (§39.2) • Criteria that an entity must satisfy to qualify to be the Electric Reliability Organization (ERO) which the Commission will certify as the organization that will propose and enforce Reliability Standards for the Bulk Power System in the United States (§39.3); • Regulations pertaining to the funding of the ERO (§39.4); • Procedures under which the ERO may propose new or modified Reliability Standards for Commission review (§39.5);

3. Overview of Final Rule (continued) • A process for timely resolution of any conflict between a Reliability Standard and a Commission-approved tariff or order (§39.6); • Procedures governing an enforcement action by the ERO or a Regional Entity (“RE”) (§39.7), or the Commission (§39.9); • Criteria under which the ERO may enter into an agreement to delegate authority to an RE for the purpose of proposing Reliability Standards to the ERO and enforcing Reliability Standards (§39.8); • Rules governing changes in ERO and RE rules (§39.10) • Regulations governing the issuance of periodic reliability reports by the ERO that assess the reliability and adequacy of the Bulk Power System in North America (§39.11);

4. Overview of Final Rule (continued) • A process for resolution of an inconsistency between a state action and a Reliability Standard (§39.12); • Procedures for the establishment of Regional Advisory Bodies that may provide advice to the Commission, the ERO or an RE on matters of governance, applicable Reliability Standards, the reasonableness of proposed fees within a region, and any other responsibilities requested by the Commission. (§39.13)

5. Features of Final Rule • ERO Certification • Commission will certify one entity as the ERO • Certification application should include a standard (referred to as “pro forma”) RE Delegation Agreement • ERO will undergo a performance assessment three (3) years after certification, and thereafter every five (5) years. • ERO & RE Funding • Commission intends to authorize funding for: (a) development and enforcement of Reliability Standards; and (b) monitoring the reliability of Bulk Power System • Discusses appropriateness of billing net energy for load • ERO may pursue other activities, but may not use Commission-authorized funding to do so. • ERO will fund RE’s and approve the RE’s budgets

6. Features of Final Rule (continued) • Reliability Standards • Only ERO may propose Reliability Standards to Commission • Regional differences are permissible, particularly where regional difference: • Is more stringent than a continent-wide Reliability Standard • Addresses a matter that the continent-wide Reliability Standard does not; and • Is necessitated by a physical difference in the Bulk Power System • Enforcement • The ERO/RE is expected to have a compliance program, which includes proactive enforcement audits to determine if users, owners and operators are complying with Reliability Standards • The ERO/RE will conduct investigations of alleged violations of Reliability Standards, and the ERO must inform Commission of these investigations; • The ERO/RE may assess a monetary/non-monetary penalty, subject to Commission review

7. Features of Final Rule (continued) • Delegation • Rule explains process and criteria for becoming a Regional Entity • Requires ERO Applicant to file pro forma Delegation Agreement • Requires RE to submit variations to Reliability Standards to ERO for approval. • Enforcement • Commission may take enforcement action against ERO/RE • In conclusion: • Final Rule is generally limited to developing and implementing the procedures for the formulation and functions of the ERO and Regional Entities. • Final Rule does not establish or approve any Reliability Standards.

8. Final Rule Discussion and ISO-NE Comments • Principles for Establishing Reliability Standards: FERC articulated the following principles for its review of ERO-proposed Reliability Standards: • Reliability Standards must relate to the reliable operation of Bulk Power System facilities (including design issues related to reliability and cybersecurity.) • Reliability Standards may impose requirements only on users, owners, or operators of Bulk Power System facilities. • A Reliability Standard must be designed to achieve a specified reliability goal and must contain a technically sound means to achieve it. The ERO approval process should be fair and open to all interested parties. • A Reliability Standard should be clear and unambiguous. • Consequences for violations, including the range of penalties, should be clear and unambiguous.

9. Final Rule Discussion and ISO-NE Comments (continued) • Principles for Establishing Reliability Standards (continued): • There must be clear, objective, and enforceable criteria for determining compliance and non-compliance. • A Reliability Standard need not reflect optimal or best practices without regard to cost or historical regional infrastructure design but should be effective and efficient. • Reliability Standards should not be based on lowest-common denominator stakeholder compromises. FERC warns that it will not hesitate to remand inadequate standards. • Reliability Standards may account for the size of the entity that must comply and the cost of implementation, but all users, owners, and operators of the Bulk Power System must expect to pay the “reasonable costs” required for reliability excellence.

10. Final Rule Discussion and ISO-NE Comments (continued) • Principles for Establishing Reliability Standards (continued): • Reliability Standards should apply throughout the North American Bulk Power System to the greatest extent possible. It should not be based on a single geographic or regional model but should account for regional differences, including with respect to market design if they affect the proposed standard. • The ERO should attempt to develop proposed Reliability Standards that will not have an undue negative effect on competition. Among other things, Standards should not unnecessarily restrict available transmission capability, should not limit use of the system in an unduly preferential manner, and should not create undue competitive advantages. • FERC will consider the implementation timetable, and weigh the urgency of implementation against the reasonableness of the time allowed. • FERC will consider arguments that the process used to develop a proposed Reliability Standard was not just and reasonable but will not be sympathetic to arguments by those who fail to participate in the process.

11. Final Rule Discussion and ISO-NE Comments (continued) • Principles for Establishing Reliability Standards (continued): • FERC will require the ERO to explain any balancing of reliability goals against other policy interests such as environmental or social goals. • FERC will consider “other appropriate factors” in considering Reliability Standards originally developed by a Regional Entity only for application within its own region, including whether regional differences are necessary or appropriate. • Finally, FERC refused to adopt a presumption (favored by NERC) that proposed Reliability Standards satisfy the standard of review if they were produced through an ANSI-certified process. • Regional Differences :FERC believes that differences are more appropriate between interconnections than within them, but recognizes need for variations from continent-wide Reliability Standards. • FERC acknowledged, that it would, as a practical matter, give “appropriate weight” to the expertise of any Regional Entity. As per the statute, the ERO need not “rebuttably presume” that Regional Standards proposed by smaller regional entities are just and reasonable.

12. Final Rule Discussion and ISO-NE Comments • ERO Funding:Appropriate to fund based on “net energy for load method. Notes that this approach will avoid “double-counting” by assessing costs only on LSE’s, not on ISOs/RTOs/TO’s and LSE’s. • Rule clarifies that a “net energy for load” is not the only possible “fair and reasonable” alternative. • FERC held that the ERO/RE must use penalty monies to offset its budget for the following year. Penalties collected pursuant to investigations initiated directly by FERC, or by FERC in response to a complaint, would go to the U.S. Treasury. • ISO-NE and NEPOOL believed that penalty monies should not fund the ERO/RE enforcement or standards-setting programs because of the appearance of impropriety. • Conflicts between Reliability Standards and Tariffs/Orders/etc… • Conflicts should be identified and addressed during the Reliability Standard development process. FERC rejected EEI’s suggestions that ISOs/RTOs be required to raise any objections or concerns during the stakeholder process. ISOs/RTOs should notify FERC when a new or modified tariff potentially conflicts with an existing Reliability Standard.

13. Implementation of Final Rule • Stakeholders may file Requests for Rehearing/Clarification • An entity (NERC) will file an Application with the Commission – approximately 60 days after Final Rule (i.e., Early April). • Interested parties can comment on that Application • Commission will issue order after receiving Comment (Fall (?), 2006)