TAC Review of PRR 650

1. TAC Review of PRR 650 August 3, 2006

2. Board Charge to TAC Board remanded PRR 650 to TAC for: • “an analysis of how to ensure that consumers pay only one time for the Ancillary Services needed for reliability reasons and • to ensure that PRR 650 is the best way to ensure reliability.” Source: Draft minutes of ERCOT Board Meeting of June 20, 2006

3. PRR 650 Action Report The ERCOT Board “voted to remand to TAC for further consideration of issues raised by BOD discussion: review calculation of MCPE and prices paid for non-spin to keep consumers balanced; study double dipping, clawback and economic fairness of payments; and complete economic analysis and determine whether PRR650 is the best way to encourage new generation.” Source: PRR 650 Action Report dated June 23, 2006

4. NSRS Bidding • In return for a capacity payment, a QSE agrees to the following “risk and opportunity” costs: • Use of the Resource if needed to supply their own capacity shortfall (e.g., loss of a unit), • Use of the Resource for its own profit (when market conditions are favorable) and • Possibility that MCPE will be less than the Resource’s energy cost. • Corrected MCPE price signal will result in lower NSRS offer prices.

6. What PRR 650 Does • Adjusts MCPE when NSRS is deployed by removing NSRS deployments from the bid stack and manually re-running Scheduling, Pricing and Dispatching (SPD) algorithm to determine a new MCPE for that interval. • Requires ERCOT to provide a notice to the market when NSRS is deployed and when NSRS deployment is discontinued.

7. Board Concern About Double Counting • NSRS capacity payment covers lost “risk and opportunity” costs but not the operating cost of the Resource • NSRS energy payments (MCPE) only cover the cost of operating the Resource (possibly with some profit) • Capacity and energy are separate products with separate compensation • PRR 650 does NOT create double-dipping; therefore, no “clawback” is necessary

8. Analysis • Study period: June 2005 through May 2006 (12 months) • Estimated MCPEs assuming PRR 650 was in-place for the entire period (based on actual MCPEs for the period) • Used the Peaker Entry Test (PET) model developed for PUCT Project No. 31972, the rulemaking on resource adequacy and market power in ERCOT • Applied estimated MCPEs to the PET model to determine if PRR 650 would allow a peaker to make enough money to stay in the market

9. Analysis (Continued) • 3 Scenarios were run: • Actual MCPEs (no adjustment for PRR 650) • MCPE adjusted for PRR 650 – with MCSM • MCPE adjusted for PRR 650 – without MCSM • Calculate Annual Net Margin (ANM) for a hypothetical peaking unit • Compare ANM to Target Annual Net Revenue (TANM) to determine if the peaking unit would recover all its annual fixed costs to break even

10. Results • The hypothetical peaking unit would lose more money without the PRR 650 adjustment to MCPE • The current NSRS deployment suppresses scarcity prices in contrast to PUCT policy, resulting in peaking generation disinvestment in ERCOT

11. Results

12. Benefits of PRR 650 to the Market and Consumers • Affect the market in a positive way by reducing energy price risk for NSRS while sending the right price signal to the whole market • In the near-term, reduced risk to providers of NSRS will result in lower NSRS capacity prices as providers remove risk premium from their NSRS offers • In the long-term, reduced risk will also entice additional capacity to the market thereby improving reliability • The impact to MCPE will be relatively minor because of the limited number of NSRS deployments (1.5% of the intervals for the 12 months ending May 31, 2006)

13. Historical Impact of PRR 650

14. Forward Impact of PRR 650