UNDERSTANDING THE 1992 ISDA MASTER AGREEMENT

1. UNDERSTANDING THE 1992 ISDA MASTER AGREEMENT ENERGY AND WEATHER DERIVATIVES WORKSHOP JUNE 17, 1999 Kevin D. Leitao - LeBoeuf, Lamb, Greene & MacRae, L.L.P. Mark E. Taylor - Enron Capital & Trade Resources Corp.

2. ENERGY DERIVATIVES Sample Transactions Documentation Issues Counterparty Issues WEATHER DERIVATIVES The Market Types of Transactions Case Study

3. ENERGY DERIVATIVES $18.50/bbl on 2,500 bbl/day 10,000 bbl/day Dealer DrilPro, an independent oil producer of 10,000 bbl/day, is analyzing exploration and development programs over the next five years. The firm wants predictable cash flows in order to determine its ability to capitalize on drilling opportunities during this period. To help accomplish its objective, DrilPro enters into a five-year swap agreement with Dealer to hedge 25% of its current production at a fixed price of $18.50/bbl. With this cash-flow assurance, DrilPro can better leverage its existing resources to build its future production capacity. DrilPro Customers DrilPro

4. ENERGY DERIVATIVES During the life of this swap: DrilPro continues to sell crude oil to its customers at an agreed-upon crude oil index price. DrilPro and Dealer exchange payments on a monthly basis equal to the difference between the fixed price of $18.50/bbl and the floating index price, as specified in the swap agreement. For example, if the index price for a given month is $17.88/bbl, DrilPro will receive $0.62/bbl from Dealer. However, if the index price is $18.64/bbl, DrilPro will pay Dealer $0.14/bbl. The net effect is that by combining the swap with its current physical crude oil contract, DrilPro receives $18.50/bbl for its crude oil. DrilPro has stabilized a portion of its operating cash flow with the swap. This swap gives the company more confidence to participate in additional drilling opportunities, which could potentially increase its overall revenues.

5. ENERGY DERIVATIVES Chicago City Gate Index Chicago City Gate Index Dealer MidPower, a regional electric power company, uses a large amount of natural gas to fuel its power plants. It currently purchases gas from a producer at prices based on the delivery price of gas at the Chicago city gate. MidPower eventually wants to lock in the price of its gas supply. However, it currently wants to lock in only the basis between the NYMEX price and the Chicago city gate index. MidPower enters into a basis swap with Dealer, and still has the flexibility to either lock in its gas supply price by entering into a futures-based (Henry Hub) swap or let its price float with the market. Producer MidPower Average Last 3 Days’ NYMEX + $0.10 Gas at Chicago City Gate

6. ENERGY DERIVATIVES During the life of the transaction: MidPower receives its gas supply from the producer and pays the producer the Chicago city gate index price. MidPower enters into a basis swap to eliminate basis risk in the transaction. MidPower agrees to pay Dealer an amount equal to the NYMEX price (average of the last three trading days) plus $0.10 in exchange for receiving the Chicago city gate index. The swap is usually settled monthly. This ensures that the net price MidPower will pay for its gas is the NYMEX price plus $0.10. MidPower can choose to either lock in its price by entering into a futures-based (Henry Hub) swap or let its price float with the NYMEX price.

7. ENERGY DERIVATIVES Documentation Issues Cross-defaults “Specified Transactions” Keep physical and financial trading separate or tie together? Calculation of termination amounts Market Quotation or Loss? Adequate assurance provisions Credit considerations Recent price volatility - dramatic swings in exposure Documents to be delivered Resolutions may tell you more than you want to know Authorized trader lists are a two-edged sword

8. ENERGY DERIVATIVES Documentation Issues (cont’d) Dispute resolution mechanisms Waiver of jury trial, arbitration? Confidentiality Market Disruption Events De Minimis trading? Tax disruption Trading limitation - definition Market Disruption Fallbacks Get commercial input! Postponement Fallback reference price Negotiated fallback (specify period to negotiate) Dealer quotations No-fault termination?

9. ENERGY DERIVATIVES Counterparties in the New Energy Markets Integrated Utilities (with generation, transmission and distribution assets) “Disaggregated” Distribution Utilities Power Generation Companies Power Marketers (with few, if any, physical generation assets) New Transmission Entities (“transcos” and “independent system operators”) Energy Services Companies Cooperatives and Municipalities (with distribution and, sometimes, transmission and generation assets) Federal Government Power Administrations and Instrumentalities (with generation and transmission assets) Industrial and Commercial Energy End-users Financial Institutions

10. ENERGY DERIVATIVES Counterparty Issues Issues Authority of signer Power of Counterparty Bankruptcy Counterparty Types Governmental & Quasi-Governmental Entities Municipalities Municipally owned utilities Crown corporations (Canada) Regulated Entities Utilities Insurance companies

11. ENERGY DERIVATIVES Counterparty Issues (cont’d) Solutions Documentation Additional representations and warranties “Incipient Illegality” Automatic Early Termination? Due diligence Legal opinions, advice of local counsel Resolutions, officers’ certificates

12. WEATHER DERIVATIVES The Market Weather affects an estimated $2 trillion of the $9 trillion US economy The first OTC weather derivative transaction, designed to stabilize weather-sensitive revenues, was completed in August 1997 In February 1999, CME announced plans for the first exchange-traded weather temperature futures and options Today, more than 1,200 OTC transactions have occurred with a notional value of over $2 billion Positions out to 2004 Growing number of international deals

13. WEATHER DERIVATIVES Types of Transactions Degree Days (Heating/Cooling) Maximum/Minimum Temperatures Rainfall Snowfall Wind Perceived Temperature Combinations

14. WEATHER DERIVATIVES Possible Structures Types of Contracts Swaps, caps, floors, collars, exotics Term Mainly seasonal Multi-year transactions Size $200/DD - $500,000/DD Limits Most transactions to date have been capped to reduce aggregate exposure Locations Hundreds of weather stations Baskets (multiple locations) Hybrids Weather linked financings Securitizations

15. WEATHER DERIVATIVES Wisconsin Gas Case Study Risk management need: Volatility in winter temperatures affecting earnings (and management incentive compensation) Stabilize earnings Facts: Regulated utility 500,000 customers 40% of gas used in Wisconsin AIG approached them between 1994 and 1996 but no deal was done In 1997 WICOR wanted to protect against El Nino Regulatory Problem: No weather normalization clause Regulators did not permitthe purchase of derivatives since it is a regulated utility based on the thought that derivatives are risky

16. WEATHER DERIVATIVES Wisconsin Gas Case Study (cont’d) The Answer: Have the parent, WICOR, purchase a weather collar derivative Weather Collar: The collar combined calls and puts. The buyer is assured not to have to pay more than a specified maximum price The seller is assured of receiving a specified minimum price The Benefit: WICOR only pays out when they have increased revenues due to colder than normal weather. WICOR only receives a payment when their revenues are impacted negatively due to warmer than normal weather.

17. WEATHER DERIVATIVES Wisconsin Gas Case Study (cont’d) The Effect: With the collar WICOR gave up some of the upside potential for protection during a colder than normal winter In return, WICOR obtained protection against a mild winter due to El Nino. The Outcome: WICOR received $1.3MM in payments Alternatives: WICOR could have also paid for a derivative thereby capping out any effects on a colder than normal winter Calls, Puts, Collars, Swaps, Strangles