Why Are Electricity Prices Rising in New England, and What (if anything) Should We Do About It?

1. Why Are Electricity Prices Rising in New England, and What(if anything) Should We Do About It? Richard D. Tabors, Ph.D. Vice President May 19, 2006

2. Why Are Electricity Prices Rising? • The Easy Answer • Today, on the margin, we have all virtually identical gas fired combined cycle generation • Natural gas goes up in price • Electricity goes up in price • BUT… Is this the right question? • The right question may be the ICAP (LICAP) question… • Are Prices Going UP ENOUGH? Private and Confidential

3. Private and Confidential

4. “Missing Money: (From PJM analysis) for a peaker Private and Confidential

5. A FAR TOO SIMPLE ANALYSIS • Using GE MAPS for New England • Holding fuel prices constant at the 2006/7 level • Allowing Demand to increase as forecasted • Allowing no new entry beyond what is currently nearing completion • Allowing no further retirements… • Not a bad scenario in some ways, particularly w/r/t new construction Private and Confidential

6. New England Average Monthly Costs in 2005$ Private and Confidential

7. New England Average Monthly On-Peak Costs in 2005$ Private and Confidential

8. Private and Confidential

9. Why isn’t the Demand Side the Answer? • The market signals may not be right for those for whom cost is a driving force. • Not the residential sector • Not (probably) the small commercial sector • BUT • Large Commercial • Industrial • Governmental • LMP provides the correct (real-time) information but not when large users need it. Private and Confidential

10. Fixing LMP (making the market work) • Day ahead is when the large user needs the hourly price information for the next day • But………… • A large buyer must state what they need before they know what the cost will be. Then after the market clears they find out what the hourly cost will be. • Real time it is the same story. You find out after you consume in that case Private and Confidential

11. A possible solution • Requires a LARGE aggregator (needs to take advantage of law of large(r) numbers) • Day Ahead the aggregator puts in a bid for quantity, (a forecast of the hourly needs of the aggregate of their customers) • Once they get hourly prices based on this estimated quantity they GUARANTEE this price on an hourly basis to their customers. • Customers schedule against a known price having paid a small premium to the aggregator for their assuming the risk of both quantity and price. • In real-time customers consume what they consume but at a price certain • After real-time the aggregator pays or is paid the difference between the day ahead quantity and that actually consumed but at the real-time price Private and Confidential

12. Why does this work • The Law of large numbers on the aggregator side • Price certainty a day ahead (for automated scheduling) for large consumers • Aggregator is able to absorb the risk of a slight error one way of the other whereas the large consumer is not. Private and Confidential

13. Richard D. Tabors CRA International 50 Church Street Cambridge, MA 02138 (617) 354-5304 rtabors@crai.com Private and Confidential