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Power Supply & Fuels Briefing to the COO FY09 Key Initiatives

Power Supply & Fuels Briefing to the COO FY09 Key Initiatives October 6, 2008 – Draft as of 10/3/08. Agenda. Draft. 10:00 Open & Governance Framework - Van 10:10 Hedging Ladders - Multiple commodities – Chris / All 10:25 Integrated Strategy / Objective - Chris / All

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Power Supply & Fuels Briefing to the COO FY09 Key Initiatives

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  1. Power Supply & Fuels Briefing to the COO FY09 Key Initiatives October 6, 2008 – Draft as of 10/3/08

  2. Agenda Draft 10:00 Open & Governance Framework - Van 10:10 Hedging Ladders - Multiple commodities – Chris / All 10:25 Integrated Strategy / Objective - Chris / All 10:30 Buying Limits - Jacky 10:40 Merrill Lynch Coal Optimization - Mike 10:50 Review Fuel Supply Matrix of other items (dates of key deliverables) - Jacky / Mike 10:55 Gas Storage & Transport - Dianne 11:05 Capacity Additions Trajectory - Belinda 11:15 Review ET&O Matrix of other items (dates of key deliverables) - Dianne / Belinda 11:20 IT Strategy (ETRM focus) - Mike 11:30 PSP Process Improvement / FIPS Phase II* / Transmission Strategy / System Planning 11:50 Q&A 11:55 Wrap-Up - Van 12:00 Adjourn

  3. Governance Framework

  4. Coal Hedging Initiatives Background Information Initiative • Adjust the 5 year laddered portfolio to increase the hedge target and timing and to incorporate strategic alliances agreements with key suppliers to increase price predictability in the coal portfolio Approved Program • Enter each fiscal year 85% to 95% physically hedged, rolling off approximately 20% per year in subsequent years. FY09 Items Under Consideration • Accelerate the coal procurement process to facilitate a 95% hedge position prior to establishment of upcoming year fuel budget by April 2008. This supports the existing strategy to adjust buying strategies to best match market conditions. Longer-Term Opportunities • Within 3 years have 30% to 40% of the total portfolio comprised of strategic alliances • Financial Coal Hedging – currently little activity in U.S. market, very active in Europe Coal F.O.B. Mine net of Expected Defaults FY09 Estimated Commodity Costs $2,456 Million • Natural Position • TVA owned fossil assets Hedges • Physical contracts with coal suppliers • Default rates by basin increase need (26% Uinta, 21% CAPP, 21% ILB, 5% PRB) Dollars exclude base transportation charges ($722 million), Rail Fuel Surcharges ($261 million), other/inventory reconciliation ($97 million)

  5. Natural Gas Hedging Initiatives Background Information Initiative • Increase quantity and timing of natural gas hedging Ladder to increase portfolio price predictability Approved Program • Hedge 50% of combined gas and economic replacement power position 6 months prior to delivery, limited by 90% of expected gas burns. Layer in hedges over 24 month period • $60 million transaction limit (one-day VaR) • Ramping into ladder for FY10 by April FY09 Items Under Consideration • Increase limit on 90% of expected gas burn to 100% by October 31 • Increase ladder minimum target from 6 months to 15 months to reduce gas exposure prior to budgeting cycle by December 31 (expand trading limits) • Create dynamic hedging targets that take into account both budget price targets and long-term “value” targets by June 31 Longer-Term Opportunities • Cross-commodity hedging – using natural gas to hedge open power position (small need currently) • Long-term fixed price purchases from physical suppliers Natural Gas Owned Assets and Tolling/Gas Indexed Contracts FY09 Budgeted Commodity Cost $1,042 Million • Natural Position • TVA owned assets, e.g., CT sites and Southaven • Contracted Assets, e.g., tolls like Suez and Decatur and gas-indexed power purchases like Morgan Energy Center • Planned contracts and construction units, e.g., KGen and Lagoon Creek CC • Need based on ~8,000 GWh of hydro in FY09 consistent with August PSP; hedge minimums based on normal hydro (~18,000 GWh) for FY10 Hedges • NYMEX Futures and Options (currently XX% of portfolio) • NYMEX Cleared Swaps (currently XX% of portfolio) • OTC Swaps and Options (currently XX% of portfolio) Dollars exclude $59 million fixed transportation charges, $4 million storage demand fees, and $34 million of variable transportation charges

  6. Power Hedging Initiatives Background Information Initiative • Continue physical purchases and pilot financial trading activity to mitigate short-term price risk associated with RTO purchases and to ensure desired deliveries from those markets Approved Program • $5 million transaction limit on financial hedges (one-day VaR) FY09 Items Under Consideration • Pilot activities have been limited due to …and the limited availability of transmission from MISO • Financial trading inside the TVA footprint limited due to the poor liquidity of the Into-Tva product Longer-Term Opportunities • Expanding transaction limits on financial program Power Owned Assets and Tolling/Gas Indexed Contracts FY09 Energy Commodity Costs $817 million • Natural Position • Economic position to serve TVA sales filled by economic replacement power and for long-term contracts • TVA Variable Priced Interruptible (VPI) and ESP Rate that float at the top of the stack offset need. VPI terminates at the end of FY09, ESP terminates at end of Alcoa contract Hedges • Red Hills long-term contract with energy rate not indexed to fuel costs • Forward physical power purchases, currently 300 MW On-peak Oct-Dec 09 Dollars exclude $340 million of demand charges, $85 million of transmission related charges, and $12 million of non-fue energy charges (VO&M fees, start fees, etc)

  7. Oil Hedging Initiatives Background Information Initiative • Expand transaction ($) limits for increased hedging of fuel oil and to incorporate crude oil to hedge eastern rail surcharges Approved Program • $5 million transaction limit (one-day VaR) FY09 Items Under Consideration • Work with western rails to explore costs of hedging costs through existing contracts – neither rail carrier has an existing mechanism to do so. Complete exploration by October 31. • Hedge high percentage (80+%) of eastern & western rail exposure with financial contracts under existing authority. Program in place by December 31; • Expand transaction limits to complete hedging by April 30 for FY10 • Physically purchase fuel oil to meet winter needs by Nov 15th Longer-Term Opportunities • Long-term fixed price purchases from physical suppliers Oil CT Fuel, Fossil Start-up, Fuel Surcharges for Rail (est.) FY09 Budgeted Commodity Costs $353 million • Natural Position • Fuel Surcharges on Rail Contracts; On-Highway Diesel for western rails (UP & BNSF for ~$208 million), and WTI for eastern rails (NS, CSX, and P&L for ~$53 million) • Light-off oil on fossil units ~$84 million • Combustion turbine alternative fuel ~$7 million Hedges • None currently)

  8. Integrated Commodity Strategy Initiative • Develop an integrated commodity and transportation strategy and incorporate tactical learning into revised commodity strategies Current Process • Completed Coal, Natural Gas, and Power strategies during FY08 Planned FY09 Items • Complete Integrated Strategy by November 30 • Identify key commodity and transportation linkages • Ensure common risk mitigation approach • Frame Price Predictability / Low Cost issue • Completing Fuel Oil & Reagent Strategy by November 30 • Update existing strategies during first quarter and gain approvals during second quarter in preparation for FY10 budget process Longer-Term Opportunities • Improve coordination of Strategies and Revised Risk Mapping Process • Develop commodity and transportation Post-Op Framework

  9. Coal – Expanding Buying Limits • Initiative • To ensure reliable, cost-competitive fuel in today’s rapidly changing markets, TVA must be able to quickly and efficiently respond, review, commit and execute contracts. • Update Buying Limits (Delegation of Authority from CEO to PS&F) to reflect changes in market prices since the original Authority was put in place in the late 90s. • Current Status • PS&F provides detailed annual fuel supply budget and contracting plan that is reviewed and approved by COO, CEO and appropriate Board Committees. • CEO has been delegated authority to approve contracts as per Board approved delegation to CEO (within approved contracting plan and not more than 7 year commitment). • EVP Power Supply & Fuels currently has the authority to execute contracts that are $15 million or less. • Near Term Action • Update Delegation of Authority to increase execution authority to COO, EVP PS&F and down into the organization

  10. Coal – Expanding Buying Limits * All contracts approved within subject delegation limits must be in the approved contracting plans and budgets plus align with approved fuels strategy. Current Delegation $3 million $5 million $5 million $5 million $10 million None $15 million None See note Proposed Delegation* $15 million $25 million $25 million $25 million $50 million $100 million $150 million $200 million See note Position Contract Administrator Fossil Fuel Buyer Manager, Transportation/Terminals Manager, Coal Acquisition Senior Manager, Coal Acquisition and Supply General Manger, Coal Acquisition and Supply EVP, Power Supply & Fuels Chief Operating Officer CEO NOTE: Subject to Board approved delegation to CEO (within approved contracting plan and not more than 7 year commitment). Must have appropriate evaluations and approvals

  11. Coal – Merrill Lynch Opportunities • Initiative • Utilize Merrill Lynch (ML) expertise to optimize coal structure and strategic opportunities (market arbitrage) to find value for TVA. • Gain insights on market intelligence and “point of view” from ML experts. • Current Status: • Follow up meeting with Merrill Sep 29 in Houston, TX • Established framework for possible structure optimization • Working with ML on specifics of possible contractual agreements • Near term (FY 09) Action Items & Due Dates: • ML to provide TVA with term sheet outlining economic terms and conditions. Oct 15th. • TVA to provide coal contract and transportation for “pilot plants”. Nov 30th. • John Siever and Kingston (primary), Widows Creek 1-6 (secondary) • ML to bring arbitrage opportunities to TVA for consideration Jan 1st. • Long-term Opportunities: • Reduce costs via arbitrage market opportunities • Improved market intelligence resulting in better procurement/hedging decisions • Bring increased sophistication to management and structure of coal portfolio

  12. Other FY09 Key Initiatives & Strategic Direction - Coal

  13. Power – Accelerate Capacity Purchases • Meet summer 09 requirements by March 2009 • Meet summer 10 requirements (within ~500 MWs) by June 2009 Completed Purchases • Red Hills (432 MW) • Invenergy (27 MW) - wind • Caledonia (768 MW) • Suez Choctaw (650 MW) • Calpine/Decatur Energy Center (720 MW) • Calpine/Morgan Energy Center (500 MW)Unit firm call option; January 2009 – December 2011 In Negotiation • JAron/Batesville (276 MW) • Union Power (218 or 300 MW) Additional Sources • KGen Murray (500 MW) • Magnolia (870 MW) • Customer Owned Generation • Alcoa/Tapoco (250 MW included in plan) • Weyerhaeuser (approx. 65 MW) Morgan 500 MW Decatur 720 MW Caledonia 768 MW Suez 650 MW Tapoco 250 MW Red Hills 432 MW 1,043 MW Gap 1,783 MW Hydro Capacity Loss vs 2011 Drought 1,100 MW 1,020 MW TVA, SEPA, Tapoco Hydro Capacity in 2011 is 3,965 MW

  14. Natural Gas – Diversify and Optimize • Initiatives • Explore incremental opportunities to diversify gas supply away from the Gulf Coast Basin • Optimize existing transportation and storage network through capacity release and market optimization • Current Status: • Strategy utilizes Gulf sources as the cost of low cost supplies • Hurricane Gustav cost of $400 K due to loss of supplies and Egan Storage • Grown into 500,000 MMBtu/day of firm transportation contracts • Near term (FY 09) Action Items & Due Dates: • Finalize decision on 100 MMBtu/day northern back-haul on Tennessee Gas Pipeline by October 31 • Complete gas optimization model (build or buy) by September 30 • Participate in capacity release markets, pilot by December 31 • Long-term Opportunities: • Explore opportunities to participate in Shale Gas transportation expansions • Diversification of storage assets

  15. Other FY09 Key Initiatives & Strategic Direction – Power & Gas

  16. IT Strategy Initiative PS&F Data Infrastructure needs resource investment to increase the speed and accessibility of data used for decision making Current Status: Completed IT Strategy as a framework for the development, maintenance, and improvement of the technology utilized by PS&F in all of its roles for fuel and power purchases and sales for TVA Formed IT Steering Committee and Program Management Office to prioritize, deploy, and re-deploy resources Near-term (FY09) Action Items & Due Dates: Incorporate System Planning into IT Strategy Coal Business Improvement project (begun FY07 and to be completed FY11) Issue RFP for integrated Energy Trading Risk Management (ETRM) System – ?DATE? Data Integration / Warehousing effort (begun FY07 and to be completed FY12) Key future projects: ETRM implementation FY10 & 11 15

  17. Power Supply Plan – Process Improvement • Initiatives • Initiate and Complete Scott Madden Study • Formation of Planning Council • Choose Project Mgr to implement improvements (Roger Field) • Current Status: • Roger Field – leading improvement efforts and teams • Beth Creel – Capacity/Long Term Plan • Mark Meigs – LT Financial Plan • Cass Larson – FCA • Wayne Hilson – Mid Term Plan • Steve Birchfield – Budget • Near term Action Items • Nov 4 – Update on Team progress, and draft 2009 schedule • Get approval to proceed with FIPS phase II – reduce coal contract overlay time from 15 days to 4 • Long-term Opportunities: • Improve Speed and Turnaround • Address Enhancements and Tool issues • Gain consistency around process, schedule, and sensitivities/cases

  18. Process Improvement - Coal Information Infrastructure • Initiative • Improve the fuel supply information infrastructure to facilitate more timely (faster turn around) fuel forecasts, budgets, and supply plans • Current Status: • Fully scope & perform data/information assessment for Fuel Information Planning System (FIPS) Phase 2 and Fuel Supply Plans • FY09 Actions Under Consideration: • Accelerate implementation of FIPS Phase 2 by March 30, 2009 to reduce fuel forecasting from 15 days to 4 days • Accelerate implementation of Supply Plans to complete by mid-2009 • The two above accelerations are dependent upon identifying additional funding sources ($616 K in FY09 budget; $3 million needed) • Longer-Term Opportunities: • Within three years have fully functional Fuel Information and Planning System to allow (1) quick turnaround on fuel forecasts and budgets and (2) have real time access to fuels information

  19. Transmission Strategy • Initiatives • Unified Long Range Transmission Plan (ULRT Plan) • Best Start/Head Start Plan (BSHS Plan) • Optimum New Gen Sites • 60 GW Plan (Pole Star Plan) • Current Status: • Begun meetings with Distributors on ULRT Plan – concept well received • Working with FPG to rank potential new generation sites • Near term Action Items • Long-term Opportunities:

  20. System Planning – Other Initiatives • Other Initiatives: • Improve overall Speed • Process clarity and schedule • Enhanced Tools • Succession Planning / Bench-strength • Recruiting / Retention • One annual LT Capacity Plan • Indicators / Metrics / Dashboards • Uniform Reports / Templates • Improve forecast of on/off peak (5x16) energy. • Move DP forecast from main-frame to server. • Add impacts of dryness to normalization process • Improved Outage Planning – Next 2-6 seasons • Reliability Assessment Process Enhancement • CPPP Stakeholder process implementation/refinement • Add Stochastics in production costing modeling of the TVA integrated power system. • DSM: modeling DSM program impacts as a resource within TVA’s Portfolio. • Databases: Upgrade integrated database to Include production cost model (PaR), expansion planning, and System Optimizer.

  21. Other FY09 Key Initiatives & Strategic Direction – System Planning

  22. Next Steps • Near term follow-up items • Coal Information Infrastructure • Fuel Buying Limits • Natural Gas and Fuel Oil Transaction Limits

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