Credit Adjustments and Nodal Go Live

1. Credit Adjustments and Nodal Go Live

2. Introduction • Credit is addressed in three areas in Nodal • Section 4 – DAM credit constraint – seeks to ensures DAM activity will not exceed an Available Credit Limit • Section 7 – CRR credit constraint – seeks to ensure CRR Auction activity will not exceed an Available Credit Limit • Section 16 – “Core” credit calculation – seeks to capture historical liability and forward risk for Counter-Parties • As we countdown to Go Live, want to outline how ERCOT plans to monitor and address risk in the early months of the new market • Primarily focused on “core” credit calculation (CMM) • Reasonableness test • Adjustments when there is unusual activity Meeting Title (optional)

3. Background • Section 16 - total potential exposure (TPE) covers both historical risk and forward risk • Historical exposure may be invoiced or estimated (if invoices have not been generated) • Forward risk is, in large part, estimated based on historical activity in the “Core” credit calculation • Underlying assumption - history is a reasonable predictor of the future (e.g. if an entity has been in the ERCOT market at 20% of its load, it is appropriate to assume they will be in the ERCOT market at 20% of load in the future) • Key drivers of forward risk include volume and price • Situations may arise when historical trends may not be the best predictor of future risk • Very low volume (or very low prices) in ERCOT market may result in a collateral requirement that is less than forward risk • Very high volume (or very high prices) in ERCOT market may result in a collateral requirement that is greater than forward risk Meeting Title (optional)

4. Reasonableness Test • To help evaluate the reasonableness of the calculated TPE in the new market, ERCOT has developed a “benchmark” tool • Data used in the report is from the CMM system • A CP’s TPEwill be reviewed relative to a low end and a high end exposure calculation • Generally expect most TPEs to be between the low and high end estimates • The high end exposure relates to some level of default risk • This tool is still a work in process and will be adapted over time • ERCOT plans to use this tool to • Identify trends in the overall market • Identify individual CP’s TPE to review • The fact that a TPE is outside the range does not mean that an adjustment will be made, just that ERCOT will review the activity • May also identify calibrations to be made to the tool • In unusual or stress scenarios (as were experienced in Feb/Mar 2003, May, 2008), provide points of reference for level of adjustment • Benchmark report may be adapted as situations develop (e.g. If prices are expected to remain high, price factor in benchmark may be adjusted) Meeting Title (optional)

5. Benchmark tool assumptions • Low end TPE benchmark • Estimate of all positivehistorical activity (e.g. net liability) PLUS • Low end estimate of forward liability • Differs based on activity (load and generation or entities without load or generation) • CP’s calculated FCE is included “as is” to address CRR risk • High end TPE benchmark • Estimate of positivehistorical activity (e.g. net liability) PLUS • High end estimate of forward activity • Differs based on activity (load and generation or entities without load or generation) • CP’s calculated FCE is included “as is” to address CRR risk Note: The high end estimate is not intended to capture the maximum liability that can be incurred but a reasonable estimate of high end risk Meeting Title (optional)

6. Benchmark tool – historical estimates • Historical activity includes • OIA – Outstanding Invoices • UDAA – Unbilled Day Ahead Activity • RTLCS – Real Time Completed and Settled activity (but not invoiced) from AIL • RTLCNS – Real Time Completed Not Settled activity from AIL • UFTA – Unbilled Final and True-Up Activity • PUL – Potential Uplift • Historical data used in estimating forward risk (from CMM) • Average load volume over last 30 days • High load volume over last 30 days • Average generation volume over last 30 days • High generation volume over last 30 days • Average RT imbalance volume over last 30 days • High RT imbalance over last 30 days • Average RT price over last 30 days (CP specific – derived as total RT liability / RT volume in AIL report) Note: Volume data is settled data where available, RTL estimates from AIL report for days not yet settled Meeting Title (optional)

7. Benchmark tool – forward risk 1 CPs with both load and generation will use the sum of columns 1 and 2 above. 2 CPs with no load and no generation will use the calculation described in column 3 3 CPs with some load or generation but with more imbalance volume than the absolute value of the sum of their load and generation, will use the higher of the calculations – sum of columns 1 and 2 or column 3 (and the high end estimate is based on 9 days in both calculations) Note: The above assumptions are as of October 4, 2010. All factors are subject to change as the tool evolves. Meeting Title (optional)

8. Credit adjustments - Protocol • Section 16.11.4.1 If ERCOT, in its sole discretion, determines that the TPE for a Counter-Party calculated under paragraph (1) above does not adequately match the financial risk created by that Counter-Party’s activities under these Protocols, then ERCOT may set a different TPE for that Counter-Party. ERCOT shall, to the extent practical, give to the Counter-Party the information used to determine that different TPE. ERCOT shall provide written or electronic notice to the Counter-Party of the basis for ERCOT’s assessment of the Counter-Party’s financial risk and the resulting creditworthiness requirements. • Adjustments can be made both globally for the market as a whole and individually for specific CPs • ERCOT currently plans to notify CPs of • global adjustments through a market notice • entity specific adjustments by e-mail to authorized rep or credit contact • Adjustments may increase or decrease Total Potential Exposure Meeting Title (optional)

9. Credit adjustments - process • A credit analyst may identify a need for an adjustment several ways, including by • Reviewing a CPs exposure calculation • Talking with a CP about their activity • Reviewing the Benchmark tool • The credit analyst reviews the issue with the Credit Manager and/or Treasurer and determines the adjustment to be made • The credit analyst enters the adjustment into CMM and the Credit Manager approves the adjustment • The credit analyst notifies the CP of the adjustment made and the reason for it. Meeting Title (optional)

10. Adjustments when there is unusual activity • Some level of price volatility is expected in the market. • However, in conjunction with occasional unusual events (e.g. Feb/Mar 2003 or May 2008), historical activity may not be a good predictor of the future • During such times, ERCOT reserves the right provided by the Nodal Protocols to take actions needed to adjust the core calculation in Section 16 to better reflect the risk profile at the time • When adjustments to TPE are made, ERCOT does not guarantee that any specific CP will have available credit (ACL) for either the CRR auction or the DAM Meeting Title (optional)

11. Adjustments when there is unusual activity • Constraints • ERCOT credit cannot “undo” uneconomic activity – if a CP incurred liability, ERCOT credit must collateralize for it • The CMM system does not retain detailed price and volume information by CP at various settlement points at interval level – CMM holds daily aggregated data • Therefore, when adjusting for unusual events, ERCOT can adjust for high level impacts only • Some adjustments are being made in a short window of time, therefore, ERCOT will consider how best to get to a reasonable “order of magnitude” solution • e.g. – globally adjust forward days in the AIL downward for all CPs, whether forward days were net liability or asset • If assume forward pricing is lower than historical pricing for one CP, assume it is for all • May have different impacts for different CPs Meeting Title (optional)

12. Adjustments when there is unusual activity • ERCOT can make adjustments to various components of the collateral calculation. In the event of some unusual activity requiring global adjustments, components likely to be adjusted include the following: • AIL – captures real time exposure next day and estimates a forward week • Highest ADTE extrapolation – estimates real time exposure based on 60 day look back • DALE – estimates DAM risk based on 7 day average activity • CCE – Current potential exposure • FCE – Forward mark to market Meeting Title (optional)

13. Adjustments when there is unusual activity • Counter-parties are responsible for • Managing their activity within their Total Potential Exposure and Available Credit Limits • Understanding the Nodal Protocols and the impacts of their actions • Maintaining liquidity to meet Protocol requirements • Having contingency plans to adapt their operations as risks are identified • If there are unusual events during the first days after Go Live, communications will be key • Please let credit know if you become aware of a developing issue • When timeframes are tight or when in doubt post collateral and/or adjust actions Meeting Title (optional)

14. Summary • Going into the Nodal market, ERCOT recognizes that there may be “bumps” that effect credit (e.g. high price events, times when CPs transactions didn’t flow as they expected, energy trades that were not confirmed, etc) • ERCOT credit cannot “undo” uneconomic activity (e.g. if prices become high and stay high – the activity must be collateralized) • However, from a credit perspective, ERCOT • Has a tool to help evaluate the reasonableness of calculated TPE • Has the flexibility within the Nodal Protocols and the ability in the CMM system to make adjustments, if appropriate • Will collateralize for its best estimate of incurred exposure • Will work to mitigate the impact of unusual historical activity on estimates of forward exposure while ensuring forward risk is reasonably addressed Meeting Title (optional)