Energy Auction Alternatives

1. Sam Dinkin Chief Economist Energy Auction Alternatives

2. The kinds problem we are solving • Offshore leases, government sales and foreign concessions • The National Petroleum Reserve has a collection of similar oil leases • Property acquisition and disposition • Power plant sales • Power purchasing and sale • NJ BGS auction • Texas Capacity Auction • Simultaneous Ascending Clock Auctions (SACA) auctions improve results by allowing “switching” Alkera, Inc. Proprietary & Confidential

3. A C B “Switching” Illustration • There are two items being auctioned • Widget X and Widget Y • There is one “strong” bidder, “A” • Willing to buy either item for up to $1000 • Isn’t interested in both – who needs two widgets? • There are two “weak” bidders • Bidder “B” will pay up to $500 for Widget X or up to $200 for Widget Y • Bidder “C” will pay up to $200 for Widget X or up to $500 for Widget Y • Values can be shown in a table Y X X Y A Alkera, Inc. Proprietary & Confidential C B

4. A A C C B B Sequential Auctions • Suppose Widget X is auctioned first • A typical auction might proceed as follows: • Having won Widget X, Bidder A doesn’t bid in the auction for Widget Y: • The total revenue from this auction is $700 • The “afternoon effect” is clear: the price dropped dramatically in the later auction X Y Bought for $500 No longer valued Alkera, Inc. Proprietary & Confidential $300 $500 Sold to Bidder A for $500! Sold to Bidder C for $200! $100 $400 Bought for $200 $200

5. A A C C B B Simultaneous Auction • A simultaneous auction is superior • Bidders, in particular the “strong” bidders, can switch between the two widgets: • Because the strong bidder, “A” was able to switch back and forth between the two items • The end prices were the same • The final revenue was $1000, instead of $700 • Simultaneous bidding avoids the price drop! X Y Bought for $500 $300 on Y $200 on X $400 on X $100 on Y $500 on Y Alkera, Inc. Proprietary & Confidential Bought for $500 $300 on X $100 on X $500 on X X is Sold to B for $500! Y is Sold to A for $500! $400 on Y $200 on Y

6. The “Afternoon Effect” • When items are auctioned in sequence, prices tend to drop off in later auctions • Known as the “afternoon effect” – as the sun begins to fall, so do prices • “Strong” bidders win earlier auctions (certainty) and then go home • I.e. those willing to pay the most • In the later auctions, only the “weak” bidders are left • I.e. those willing to pay the least • With weaker bidders, prices are lower • Actually happened in US Broadcast Satellite auction • It pays for the strong bidder to sometimes bide his time • Even when prices are higher in the second auction, the different prices are unfair and lower revenue overall • Simultaneous auctions have similar prices for similar lots and have higher revenues than sequential auctions Alkera, Inc. Proprietary & Confidential

7. Emerging Answer: Simultaneous Auction • ERCOT and PJM, the two most progressive electric grids, have used simultaneous auction for over $10B in electricity sales • Sources at New Jersey Board of Public Utilities and electricity distribution companies estimate they would have been $1.3B worse off had they used sealed bids • Alberta power generation sales • EDF auction • Upcoming Northeast Regional Capacity Market • FCC used to sell $30B of telecom spectrum in dozens of auctions with geographical synergies Alkera, Inc. Proprietary & Confidential

8. Simultaneous Auctions Are Superior • Iterative nature of multiple rounds means; • Bidders don’t have to guess what it takes to win • Bidders can improve bids each round • Bidder gain valuable information about valuations in the market that reinforce their own valuations • Bidders can be assured of not winning more than they want • Rules are designed to be efficient • The auction is fast: the bid increment is large when there is a lot of competition and small when there is a little competition. • Tie-break rules select the most interested bidder at each step in the bidding process • The high value bidder always wins paying a lower % of their maximum value increasing auction revenue and bidder profit • Fair to all participants • Substitution between similar lots provides additional competition from low-quantity bidders • Expert auction design provides strong weight in Board Room decisions Alkera, Inc. Proprietary & Confidential

9. A A C B B C Sealed Bid vs. SACA: Bidder Values X Y • A typical situation in which a SACA generates higher revenues • Two leases: X and Y • Three bidders: • Bidder A values: • X for $1700 • Y for $1700 • X & Y for $2800 • Bidder B values: • X for $1500 • Y for $1000 • X & Y for $2600 • Bidder C values: • X for $1000 • Y for $1500 • X & Y for $2400 • These values are shown in the table to the left: Y Y X X Alkera, Inc. Proprietary & Confidential

10. A B C Sealed Bid vs. SACA: Sealed Bid Outcome • In a sealed bid auction: • Bidder A’s strategy is to bid: • $1400 on X • $1300 on Y • This allows a profit even in the case where both leases are won • Bidder B’s strategy is to bid: • $1300 on X • $900 on Y • Bidder C’s strategy is to bid: • $800 on X • $1200 on Y • The result: • Total profit: $100 Y Y X X X & Y For $2700 Y X Alkera, Inc. Proprietary & Confidential None None

11. A A B B C C Sealed Bid vs. SACA: SACA Outcome • In an SACA auction, bidders can safely be more aggressive: • Bidding starts at $800 • Ties are broken at random • No further bids above $1500 • Bidders A and C could observe the auction as it progressed • Because Bidder A could avoid the undesirable outcome of winning both leases, higher bids became safe • Because Bidder C could see that a $1200 bid could not win, a higher bid became strategically necessary • Higher efficiency means higher bidder profit Y Outcome Y X X Bought for $1500 Round 1 Round 11 Round 3 Round 8 Round 4 Round 6 Round 2 Round 10 Round 7 Round 9 Round 5 Round 13 Round 12 $1400 $1200 $1500 $1000 $900 $1300 $800 $800 $900 $1100 $800 Alkera, Inc. Proprietary & Confidential $1500 $1000 $900 $1300 $900 $800 $1100 $1000 $800 $1400 $800 $1200 Bought for $1500

12. Alkera’s Auction Experience • Experience in complex, multi-billion auctions with impressive results: New Jersey: Market design and software development for the simultaneous descending clock auction run by electricity distributors Singapore: Market design and auction software developed for the 3G auction organised by the Infocomm Development Agency Italy: Market design and auction software developed for the 3G mobile wireless and Broadband spectrum auctions run by the Ministry of Communications. Guatemala: Market design and auction software developed for the Secretary of International Communications Alkera, Inc. Proprietary & Confidential Canada: Auction software developed for Industry Spectrum Management Agency Mexico: Market design and auction software developed for Commicion Federale de Telecommunicaciones U.S.: Software and hosting for a US water auction in one of the largest metropolitan markets of the United Sates Texas: Market design and software for a simultaneous ascending clock auction run by power generating companies