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Secure Trading and Clearing

Secure Trading and Clearing. SECTION ONE: NGX BACKGROUND. Introduction to NGX. Business Concept: Provide electronic trading and clearing services to North American energy market participants NGX is a service provider and therefore does not trade or take positions

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Secure Trading and Clearing

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  1. Secure Trading and Clearing

  2. SECTION ONE: NGX BACKGROUND

  3. Introduction to NGX • Business Concept: • Provide electronic trading and clearing services to North American energy market participants • NGX is a service provider and therefore does not trade or take positions • Headquartered in Calgary, Alberta, Canada • Incorporated in 1993, began trading operations in Feb 1994 • Ownership History • Initial Ownership by Westcoast Energy Inc. • Acquired by OM on Jan 1, 2001 • Acquired by TSX Group March 1, 2004

  4. Ownership: Introduction to TSX • TSX Group is a cornerstone of the Canadian financial system and is at the centre of Canada’s equity capital market • TSX Group owns and operates Canada’s two national stock exchanges, the Toronto Stock Exchange, serving the senior equity market, and TSX Venture Exchange, serving the public venture equity market • From its preeminent domestic base, TSX Group’s reach continues to extend internationally, through TSX Markets and TSX Datalinx which provide the trading and data to the global financial community who access Canada’s equity capital market

  5. Ownership: History of TSX • 1861 - Launched the Toronto Stock Exchange • 1977 - Launched the World’s First Computer Assisted Trading System (CATS) • 1996 - Became the first Exchange in North America to introduce Decimal Trading • 1997 – Became the largest stock exchange in North America to close it’s trading floor and choose a floorless electronic trading environment • 1999 – Through realignment, became the sole Exchange for trading senior equities in Canada • 2000 – Demutalized into a “for-profit” exchange • 2001 – Acquired Canadian Venture Exchange • 2004 – Acquired NGX

  6. NGX Core Competencies • Electronic Trading • 10 years experience developing and operating high-reliability, high-performance electronic trading systems • Clearinghouse Operations • Physically and financially settled over 600,000 trades • Zero-default history • Liquidity Development • Focus on customers and quality of service • Commitment to the reduction of trading impediments

  7. Current NGX Products NGX Products & Services Physical Products Financial Products Upcoming Products ATCO NORTH STATION #2 ALBERTA POWER SWAPS TEP ALBERTA SWAPS NGX INTRA-ALBERTA EMERSON/GREAT LAKES EMPRESS IROQUOIS SUMAS SWAPS PARKWAY MID-C POWER SWAPS DAWN MALIN SWAPS MICHCON SWAPS NIAGARA FALLS CHIPPAWA CHICAGO SWAPS NBPL VENTURA NICOR-NGPL ROCKY MTN SWAPS FUTURES SWAPS HENRY SWING SWAPS LDS FOR GDD

  8. Current NGX Services • Marketplace • Centralized electronic trading • Standardized contracts • Pipeline balancing instruments • Market advocacy (facilitating transactions) • Market agency (facilitating order entry) • Real-Time Price Index Generation • Clearing House • Assured performance • Trade and counterparty netting • Centralized collateral management • Centralized risk management

  9. Contracting Parties Concord Energy LLC ConocoPhillips Canada Limited Constellation Power Source, Inc. Cook Inlet Energy Supply LLC Coral Energy Canada Inc. Devon Canada Corporation Direct Energy Marketing Limited Direct Energy Regulated Services Dominion Energy Clearinghouse Canada Partnership Dominion ExplorationCanada Ltd. Dow Chemical Canada Inc. Duke Energy Marketing Limited Partnership Duvernay Oil Corp. Dynegy Canada Inc. El Paso Merchant Energy, L.P. Enbridge Gas Services Inc. Encana Corporation Encana Gas Marketing Encana Gas Storage Energy Trust Marketing Ltd. Energy West Resources EnerMark Inc. Enerplus Resources Corporation ENMAX Energy Marketing Inc. Enserco Energy Inc. Entergy-Koch Trading Canada, ULC Entergy-Koch Trading, LP EOG Resources Canada EPCOR Merchant and Capital L.P. Esprit Exploration Ltd. Gas Alberta Inc. Gibson Energy Ltd. Glencoe Resources Ltd. Hunt Oil Company of Canada Inc. Husky Energy Marketing Inc. Husky Gas Marketing Inc. J. Aron & Company KeySpan Energy Canada Partnership Louis Dreyfus Energy Canada L.P. Mirant Americas Energy Marketing, L.P. Mirant Canada Energy Marketing, Ltd. Morgan Stanley Capital Group Inc. Murphy Canada, Ltd. National Bank of Canada Nexen Marketing Nexen Marketing U.S.A. Inc. NJR Energy Services Company Northrock Resources, Limited Nova Chemicals Corporation ONEOK Energy Marketing and Trading Company, L.P. ONEOK Energy Services Canada, Ltd. Ontario Power Generation Inc. OXY Energy Canada, LLC PacifiCorp Energy Canada Ltd. Pacific Gas and Electric Company Pan-Alberta Gas Ltd. Paramount Energy Operating Corp. Paramount Resources Pengrowth Corporation Penn West Petroleum Petro-Canada Oil and Gas Petrocom Energy Group Ltd. Pioneer Natural Resources Canada Inc. Portland General Electric Company Powerex Corp. Primewest Energy Inc. Producers Marketing Ltd. Progress Energy Ltd. Reliant Energy Services, Inc. Royal Bank of Canada Samson Canada, Ltd. San Diego Gas & Electric Company SaskEnergy Incorporated Selkirk Cogen Partners, L.P. Seminole Canada Gas Company Seminole Canada Gas Corporation Sempra Energy Trading Corp. Sprague Energy Corp. Suncor Energy Marketing Inc. Syncrude Canada Ltd. TD Commodity & Energy Trading Inc. Talisman Energy Canada Tenaska Marketing Canada Terasen Gas Inc. The Toronto Dominion Bank TransAlta Energy Marketing Corp. TransCanada Pipelines Limited TransCanada Power TXU Energy Trading Canada Limited UBS Energy Canada Ltd. Union Gas Limited Unocal Canada Limited USGen New England, Inc. Virginia Power Energy Marketing West Fraser Timber Co. Ltd. WGR Canada, Inc. Williams Power Company, Inc. WPS Energy Services of Canada Corp. WPS Energy Services Inc. Acanthus Resources Limited AEP Energy Services, Inc. Agrium Partnership AltaGas Services Inc. Anadarko Canada Corporation Apache Canada Ltd. Aquila Merchant Services – International, Limited Astra Canada Resource Marketing Inc. ATCO Midstream Ltd. Avista Energy, Inc. BP Canada Energy Company Barclays Bank PLC Burlington Resources Canada Partnership Calpine Canada Natural Gas Partnership Calpine Energy Services Canada Partnership Canadian Fertilizer Limited Canadian Natural Resources CanNat Energy Inc. Cargill Energy Trading Canada Inc. Cargill, Incorporated Cargill Limited Centra Gas Manitoba Inc. Chevron Canada Resources CIBC World Markets, PLC Cinergy Canada, Inc. Citadel Financial Products S.a.r.l. City of Medicine Hat CoEnergy Trading Company

  10. Operational Statistics • 119 NGX Contracting Parties • “Member” firms eligible to transact through theExchange • List 60 physical and derivative products • Average in Excess of 375 Traders Online Daily • Approximately 100 View-Only Users Online Daily • 2003 Trading Statistics: • Volume = 6.4 Tcf • Transactions = 136,721 • Average Daily Deliveries in Excess of 10.0 Bcf

  11. NGX Trading Volume History

  12. NGX Product Dispersion

  13. SECTION TWO : CLEARING STRUCTURE

  14. $ $ $ or Natural Gas $ or Natural Gas CPA CPA NGX Clearing Operations Buyer Seller • NGX Intermediation • NGX acts as buyer to every seller, and seller to every buyer, for the purpose of facilitating anonymous trading and clearing • Private Clearing Operation • Contracting Parties are not mutually exposed to another Contracting Party’s default

  15. NGX Role as Clearing House • Assure Delivery and Payment • NGX is obligated to assure the delivery of natural gas from seller to buyer, and the payment for all gas deliveries • Standardize Rules • Develop common contract specifications, rules and regulations that provide for a fair and efficient marketplace as well as a secure clearing operation • Measure and Manage Risk • NGX develops and enforces rules to mitigate risk on behalf of all Contracting Parties • Risks must be measured accurately in real-time, and NGX proactively manages risks using worldwide clearing principles

  16. How is Clearing House Risk Mitigated? • Standard Rules • All Contracting Parties are subject to the same rules and regulations as set forth in the CPA • Collateral Provisions • NGX holds liquid collateral from all Contracting Parties equivalent to their highest probable failure scenario • Liquidation Rights • In the event that a default occurs, NGX is able to close-out (or accelerate) all forward positions for the defaulting party • Collateral is utilized to cover any liquidated damages

  17. $ $ $ or Natural Gas $ or Natural Gas Clearing Structure NGX Emergency Fund ($30MM CIBC Mellon Trust) NGX Cash Reserves Deposit Agreement Deposit Agreement Defaulting Party Collateral (100% Coverage Under NGX Exposure Model) Settlement Banking Credit Facility Payer Payee Physical Backstopping (storage)

  18. Collateral Makeup

  19. NGX Central Clearing Benefits • Neutral, Independent Risk Management • NGX is impartial and the nature of the clearing business provides a strong incentive to maintain a default-free clearing operation • NGX is not a market participant, does not take a market view and earnings are not directed by commodity prices • Centralized Collateral Requirements • Concentration of capital affords most efficient use across all other contracting parties

  20. NGX Central Clearing Benefits • Counterparty Netting Facilities • Central clearing operator and standardized netting rules create an environment to net physical and financial exposures across multiple counter parties and locations • Acceleration, Liquidation, Close-Out Procedure • NGX has embedded, and has enforced, rights of acceleration for all contracts traded through the Exchange to mitigate risks to all Contracting Parties

  21. Value Proposition of Clearing • Value of Reduced • Exposure • Will I get paid? • Will my gas get delivered? • Cost of Collateral • Is the risk reduction worth the cost? • Risk Mitigation “Trade-Off” • When a Contracting Party introduces risk to the clearing operation (ex. Receivable exposure or Mark-to-Market losses) they must provide collateral to support the risk • In return, all Contracting Parties that are exposed to the clearing operation due to the introduction of risk (ex. Payable positions and Mark-to-Market gains) are secured against defaults

  22. A D C B D C B A A A $10MM $10MM $10MM Collateral Concentration OTC Bilateral Buyer Seller NGX (centralized) Buyer Seller $20MM $30MM $7MM $3MM Access to choose bids/offers from 100+ other market participants under the same collateral umbrella

  23. A C B A A C B D D A A 5 Units 5 Units 10 Units Exchange Netting OTC Bilateral Buyer Seller NGX (net effect) Buyer Seller 10 Units Netted 10 10 Units 10 Units 5 Units 5 Units

  24. Clearing Statistics • Cleared Transactions • 150,000+ transactions cleared annually • Notional value of transactions consummated through NGX is in excess of CAD $35 Billion annually • Margin • Over 120 corporate margin accounts held by NGX • Manage margin accounts in excess of CAD $1.5 Billion in cash and letters of credit • Settlement • Settlement of $US and $CAD cash streams • Monthly settlement values over CAD $1 Billion processed by the clearing house

  25. Oversight • Regulatory • ASC – Exemption order, compliance with operating principles • CFTC – 2(h)(iii) exemption, “Eligible Commercial Market” status • Clearing Bank • TD Bank, NGX’s Clearing Bank, maintains oversight of NGX clearing operations to support credit facility, $300MM daylight, $30MM LC, $20MM demand • Clearing Bank controls segregated collateral accounts • Clearing Bank authorizes movement of funds from collateral accounts • Clearing Bank has full access to NGX trade/clearing data and reporting, ensures collateral accounts are sufficient to manage Contracting Party margin requirements

  26. SECTION THREE: RISK MANAGEMENT

  27. Product Risk Management Profiles

  28. Position Tracking • Consolidation and Netting • Positions within each product and date range are consolidated into gross long and short positions • Risk is managed against the net of the long and short positions • Instruments and Date Ranges • Trades across all instruments in a product are grouped by date ranges in real-time • Instruments may overlap, but date ranges are unique • Ex. A M-Nov instrument and a WB-Nov instrument would each populate a position for November 1 to November 30th

  29. Exchange Exposure Management • Collateral Requirements • To the fullest extent possible, NGX enforces stringent collateral policies to protect Contracting Parties • Risk Measurement • NGX must accurately determine and measure risks to ensure the collective security of Contracting Parties • Risk Mitigation Tools • NGX utilizes globally accepted, standard clearinghouse practices such as penalty mechanisms and liquidation provisions to mitigate the introduction of risks to the clearing operation

  30. Performance Risks • Failure to Make/Take Delivery • NGX is exposed to the price at which an alternative supply/market can be found • Risk is managed with backstopping contracts, penalty mechanisms, collateral requirements and credit policy • Failure to Pay • NGX is exposed to receivables risk on settlement dates • Risk is managed with penalty mechanisms, collateral requirements and credit policy • Failure to Provide Collateral • NGX is exposed to the risk that Contracting Parties will not provide sufficient collateral to manage their risks • Risk is managed with liquidation provisions

  31. Collateral • Collateral Policy • Contracting Parties must have sufficient collateral to cover their Margin Requirement, utilizing any combination of the forms of collateral and offsets below • Collateral is held to support the Contracting Party’s traded positions and can only be used to remedy a performance failure by the Contracting Party pledging the collateral • Collateral Requirements • Collateral is accepted in the form of cash and irrevocable letter of credit from an A or higher rated bank • Collateral requirement can be reduced with an accounts payable or positive variation margin offset

  32. Margin Requirements • Risk Measurement • NGX measures risk in real-time and calculates margin requirements to quantify the risk measurement • Margin Requirements and Collateral • If margin requirements reach 80% of collateral pledged, NGX will request additional collateral • At 90%, NGX will halt the Contracting Parties trading capabilities • At 95%, NGX is entitled to invoke the liquidation procedure

  33. Physical Risk Measurement • Accounts Receivable/Payable • A calculation of the value of gas delivered • Margin requirements are increased if gas has been taken prior to payment, and decreased if gas has been delivered prior to payment • Variation Margin (Mark-to-Market) • A calculation of the price at which a forward position could be instantaneously liquidated given current market prices • Initial Margin • A calculation of the probability of a movement in market prices during a two-day holding period • Initial margin coverage protects against a prolonged liquidation

  34. Physical Risk Management Payment Exposure - Margined at full value Current Month Exposure - Deliveries margined at full value - Open position initial margin - Variation margin all positions • Forward Position Exposure • - Open position initial margin • Variation margin all • positions 31 Days 26 Days 48 Months Last Day of Delivery Month 25th of Payment Month 1st of Delivery Month

  35. Swap Risk Measurement • Accounts Receivable/Payable • A calculation of the value of the final gain/loss on the swap, also called the Swap Clearing Amount • Swap Clearing Amounts that result in payment obligations will increase the Swap Margin Requirement • Variation Margin (Mark-to-Market) • A calculation of the price at which a forward position could be instantaneously liquidated given current market prices • Initial Margin • A calculation of the probability of a movement in market prices during a two-day holding period • Initial margin coverage protects against a prolonged liquidation

  36. Swap Risk Measurement • Forward Position Exposure • - Open position initial margin • Variation margin all positions Payment Exposure - Margined at full value 10 Day 48 Months 6th Business Day of Month 1st of Month

  37. What are Initial Margins? • Defined • Initial Margin is an estimation of the value to which the clearing house might be exposed during a period of liquidation • Initial Margin is intended to measure potential change in a value of a portfolio beyond the last mark-to-market price during a period of liquidation • How Does NGX Utilize Initial Margin? • NGX applies initial margin to Contracting Parties’ net open positions that would be subject to liquidation in the event of a default • Initial margin acts as additional position coverage that NGX can utilize in the event of a default to ensure that the clearing operation remains secure

  38. Initial Margin Methodology • Utilization of VaR • NGX utilizes a Value-at-Risk methodology to determine initial margins • VaR is a method of assessing risk that uses standard statistical techniques routinely used in a variety of technical fields • VaR measures the worst expected loss over a given time interval under normal market conditions at a given confidence level • VaR, while imperfect and subject to several limitations, provides a measurement tool that is generally considered adequate to evaluate potential exposure in a portfolio

  39. Margin Offsetting • Accounts Receivable/Payable • All receivables/payables are offset across all NGX products • Variation Margin (Mark-to-Market) • All mark-to-market calculations are offset across all NGX products • Initial Margin • Initial margin is offset on all net forward positions for a single product profile when the positions have known, fixed settlement values • Initial margin offsets will be available for net forward positions across different product profiles (cross-margining) that are highly correlated historically

  40. Margin Example • Example • On Monday, June 24, BUYCO (buyer) purchases 5,000 GJ/Day of the NGX Intra-Alberta month of July 2002 physical contract from SELLCO (seller) at a price of CAD $3.500/GJ • Position Management • As soon as the transaction is matched, BUYCO shows a net long position of 5,000 GJ for each day from July 1 to July 31, thus a total net long position of 155,000 GJ (ie. 5,000 GJ/Day multiplied by 31 days) • Conversely, SELLCO shows a net short position of 5,000 GJ for each day from July 1 to July 31, thus a total net short position of 155,000 GJ

  41. Margin Example • Initial Margin • Immediately following the creation of the long and short positions, initial margin is applied • The initial margin rate for July is currently CAD $0.600/GJ, as statistically generated by NGX • Both BUYCO and SELLCO must have collateral deposited with NGX to cover the initial margin requirement, ie. CAD $93,000 (155,000 GJ multiplied by $0.600/GJ) • The initial margin requirement will remain in place, unchanged, until one of the following events occurs: • Either BUYCO or SELLCO offset all or part of their open long/short position, thus reducing their initial margin requirement to zero, or; • The July long/short position becomes a current month position on July 1st

  42. Margin Example • Mark-to-Market • The following table illustrates the margin requirements for the July position through each remaining day in June:

  43. Margin Example

  44. Margin Example

  45. SECTION FOUR: NEW INITIATIVES

  46. What’s New at NGX? • OTC Clearing • Providing a clearing service for legacy bilateral transactions or OTC transactions at the point-of-sale • Addition of Western Products • Station #2 physical products • Rockies, Malin natural gas swaps • California swaps • PG&E Citygate, Sumas (Huntingdon) physical • Projects Underway • Margin model revisions

  47. Questions and Contact Information Gary Gault – Vice President 403.974.1707 gary.gault@ngx.com Dan Zastawny – Vice President, Clearing & Compliance 403.974.4335 dan.zastawny@ngx.com Kenny Foo – Clearing Manager 403.974.1737 kenny.foo@ngx.com Natural Gas Exchange Inc. Suite 2330, 140 4th Avenue SW Calgary, Alberta Canada T2P 3N3 Phone 403.974.1700 Fax 403.974.1719

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