SPP-Entergy Market Power Analysis Presented By: David B. Patton, Ph.D. President, Potomac Economics June 20, 2008

- 2 - Market Power Study Potomac Economics has been engaged to:Potomac Economics has been engaged to: Perform an evaluation of market power related to ETI joining the SPP; and Perform an evaluation of market power related to ETI joining the SPP; and Identify mitigation options that would address any market power issues found. Identify mitigation options that would address any market power issues found. The study addresses:The study addresses: The market power requirements of Texas Senate Bill 7 for the SPP to be a Qualified Power Region (“QPR”); as well as The market power requirements of Texas Senate Bill 7 for the SPP to be a Qualified Power Region (“QPR”); as well as Local market power issues associated with serving load in the ETI area. Local market power issues associated with serving load in the ETI area. It is the local market power analysis that is most likely to generate the need for some form of market power mitigation.It is the local market power analysis that is most likely to generate the need for some form of market power mitigation.

- 3 - Market Power Study For the prospective QPR region as a whole, Senate Bill 7 requires only that suppliers’ market shares be less than 20 percent.For the prospective QPR region as a whole, Senate Bill 7 requires only that suppliers’ market shares be less than 20 percent. Hence, we will focus on this test for the SPP-wide analysis. Hence, we will focus on this test for the SPP-wide analysis. However, Senate Bill 7 and subsequent PUCT precedent do not provide specific guidance or requirements for the evaluation of local market power.However, Senate Bill 7 and subsequent PUCT precedent do not provide specific guidance or requirements for the evaluation of local market power. Therefore, we produce a number of market power indicators for the local ETI area.Therefore, we produce a number of market power indicators for the local ETI area. Because there are significant transmission constraints that bind into ETI and within ETI, we define two relevant markets for these analyses:Because there are significant transmission constraints that bind into ETI and within ETI, we define two relevant markets for these analyses: The entire ETI control area; and The entire ETI control area; and The Western Subregion of ETI (which is defined as the load and resources west of the Jacinta and Cypress substations). The Western Subregion of ETI (which is defined as the load and resources west of the Jacinta and Cypress substations). Accordingly, we generally conducted our local market analyses for both ETI and the Western Subregion of ETI. Accordingly, we generally conducted our local market analyses for both ETI and the Western Subregion of ETI.

- 4 - Market Power Study To evaluate the SPP/ETI area as a QPR, we perform a market share analysis to determine whether any suppliers have a market share greater than 20 percent.To evaluate the SPP/ETI area as a QPR, we perform a market share analysis to determine whether any suppliers have a market share greater than 20 percent. To evaluate local market power, we conduct the following analyses:To evaluate local market power, we conduct the following analyses: Market concentration based on installed capacity (i.e., capacity shares and HHI statistics); Market concentration based on installed capacity (i.e., capacity shares and HHI statistics); Market concentration based on uncommitted capacity; Market concentration based on uncommitted capacity; Pivotal supplier test for the ETI Area and Western Subregion, which seeks to determine whether the load can be served if the largest supplier withholds its resources. Pivotal supplier test for the ETI Area and Western Subregion, which seeks to determine whether the load can be served if the largest supplier withholds its resources. Load obligations have a significant affect on market power findings because a supplier will not have an incentive to withhold resources it needs to serve its load.Load obligations have a significant affect on market power findings because a supplier will not have an incentive to withhold resources it needs to serve its load. Hence, we generally consider three alternative assumptions regarding the portion of utilities’ load it is obligated to serve: 0, 50, and 100 percent. Hence, we generally consider three alternative assumptions regarding the portion of utilities’ load it is obligated to serve: 0, 50, and 100 percent.

- 5 - Capacity Share in Combined SPP/ETI Area In the first analysis, we calculate simple installed capacity market shares for the combined SPP/ETI Area.In the first analysis, we calculate simple installed capacity market shares for the combined SPP/ETI Area. To calculate the market shares, we use the maximum ratings from the SPP summer power flow base case; To calculate the market shares, we use the maximum ratings from the SPP summer power flow base case; Imports from outside the SPP/ETI Area are not counted (hence, capacity shares are likely slightly understated); Imports from outside the SPP/ETI Area are not counted (hence, capacity shares are likely slightly understated); Because of certain transmission limits, our analyses include the following limitations:Because of certain transmission limits, our analyses include the following limitations: We limit the 1250 MW Cottonwood facility (owned jointly by Bechtel and Royal Dutch Shell) to 600 MW. We limit the 1250 MW Cottonwood facility (owned jointly by Bechtel and Royal Dutch Shell) to 600 MW. We limit the combined Frontier and Gateway plants owned by Tenaska to 300 MW. We limit the combined Frontier and Gateway plants owned by Tenaska to 300 MW. The following table shows our analysis. ETI has a capacity share of 5.3 percent and no supplier has a market share greater than 20 percent.The following table shows our analysis. ETI has a capacity share of 5.3 percent and no supplier has a market share greater than 20 percent.

- 6 - Capacity Shares in Combined SPP and ETI Area

Analysis of Local Market Power in ETI Area - 7 -

- 8 - Market Concentration in the ETI Area We use the Herfindahl-Hirschman Index (“HHI”) to measure market concentration.We use the Herfindahl-Hirschman Index (“HHI”) to measure market concentration. The HHI is a measure of market concentration and is calculated as the sum of the squares of the market shares of each individual firm. The HHI is a measure of market concentration and is calculated as the sum of the squares of the market shares of each individual firm. The index ranges from 0 to 10,000, increasing as suppliers’ market shares increase and the number of suppliers serving the market falls. The index ranges from 0 to 10,000, increasing as suppliers’ market shares increase and the number of suppliers serving the market falls. Economists use the HHI index because there is evidence in some markets that the competitive performance improves as the HHI decreases. Economists use the HHI index because there is evidence in some markets that the competitive performance improves as the HHI decreases. The antitrust agencies consider a market with HHI greater than 1800 as highly concentrated, but HHIs in the range of 2000 to 2500 have been considered workably competitive in electricity markets. The antitrust agencies consider a market with HHI greater than 1800 as highly concentrated, but HHIs in the range of 2000 to 2500 have been considered workably competitive in electricity markets. We calculate the HHI using two capacity metrics:We calculate the HHI using two capacity metrics: Installed Capacity: calculated based on the summer ratings of all supply in the market and import capability into the market (with no offset for load obligations). Installed Capacity: calculated based on the summer ratings of all supply in the market and import capability into the market (with no offset for load obligations). Uncommitted Capacity: calculated based on the installed capacity minus load obligations of each supplier – this metric better addresses the effect on incentives of being obligated to serve load at a fixed price. Uncommitted Capacity: calculated based on the installed capacity minus load obligations of each supplier – this metric better addresses the effect on incentives of being obligated to serve load at a fixed price.

- 9 - Market Concentration in the ETI Area: Installed Capacity The following table shows the HHI calculation in the ETI area for the installed capacity measure. The table shows:The following table shows the HHI calculation in the ETI area for the installed capacity measure. The table shows: The HHI in the ETI area exceeds 3,200; The HHI in the ETI area exceeds 3,200; ETI has a market share of 54 percent; and ETI has a market share of 54 percent; and There are over 1,300 MW of imports, mostly from Entergy units in Louisiana to ETI load, although some imports serve municipal entities. There are over 1,300 MW of imports, mostly from Entergy units in Louisiana to ETI load, although some imports serve municipal entities. Due to the potential that Cottonwood may disconnect from the Eastern Interconnect, we calculated an HHI assuming Cottonwood has 0 MW in ETI.Due to the potential that Cottonwood may disconnect from the Eastern Interconnect, we calculated an HHI assuming Cottonwood has 0 MW in ETI. The HHI in this case was almost 3,900. The HHI in this case was almost 3,900. These levels are higher than would typically be deemed workably competitive, however they do not account for the effects of load obligations.These levels are higher than would typically be deemed workably competitive, however they do not account for the effects of load obligations.

HHI for Installed Capacity in ETI Area

HHI Calculations for ETI Area Mitigation Results Because the prior results show that the market in the ETI area is highly concentrated, we evaluated a limited number of mitigation scenarios.Because the prior results show that the market in the ETI area is highly concentrated, we evaluated a limited number of mitigation scenarios. We evaluated two types of mitigation.We evaluated two types of mitigation. Expansion of the transmission capacity into ETI, which would allow increased competition from external suppliers; and Expansion of the transmission capacity into ETI, which would allow increased competition from external suppliers; and Capacity sales by ETI, which would reduce ETI’s market share and the concentration of the market. We start with 500 MW because it is 15 percent of ETI’s capacity in the area (the floor amount in Senate Bill 7). Capacity sales by ETI, which would reduce ETI’s market share and the concentration of the market. We start with 500 MW because it is 15 percent of ETI’s capacity in the area (the floor amount in Senate Bill 7). The following Table shows the results of the mitigation analyses assuming Cottonwood with 600 MW of capability and 0 MW of capability.The following Table shows the results of the mitigation analyses assuming Cottonwood with 600 MW of capability and 0 MW of capability. These mitigation scenarios showing increasing levels of transmission expansion and/or capacity sales that will reduce the HHI to less than 2500.These mitigation scenarios showing increasing levels of transmission expansion and/or capacity sales that will reduce the HHI to less than In general, these results show both mitigation approaches are effective at reducing the market concentration, but that capacity sales reduce market concentration more than an equivalent amount of new transmission.In general, these results show both mitigation approaches are effective at reducing the market concentration, but that capacity sales reduce market concentration more than an equivalent amount of new transmission. In the most concentrated case (assuming Cottonwood is out of the market), the market concentration may be mitigated with 1500 MW of new transmission, 850 MW of capacity sales, or 500 MW of both. In the most concentrated case (assuming Cottonwood is out of the market), the market concentration may be mitigated with 1500 MW of new transmission, 850 MW of capacity sales, or 500 MW of both.

Summary of HHI Impact of Mitigation Measures

Market Concentration in the ETI Area: Uncommitted Capacity The next analysis of uncommitted capacity shares accounts for load obligations by subtracting the peak load obligation from the LSE’s total resources.The next analysis of uncommitted capacity shares accounts for load obligations by subtracting the peak load obligation from the LSE’s total resources. This measure is typically a more accurate indicator of market power because it reflects the mitigation effects of load obligations (i.e., there is no incentive to withhold resources needed to serve load). This measure is typically a more accurate indicator of market power because it reflects the mitigation effects of load obligations (i.e., there is no incentive to withhold resources needed to serve load). The move toward retail competition complicates assumptions regarding the load obligations. Hence, we consider multiple scenarios:The move toward retail competition complicates assumptions regarding the load obligations. Hence, we consider multiple scenarios: 100 percent load obligation (no retail load swithching); 100 percent load obligation (no retail load swithching); 50 percent load obligation (reflective of the load switching experience in ERCOT with ~40 percent switching); 50 percent load obligation (reflective of the load switching experience in ERCOT with ~40 percent switching); 0 percent load obligation (same as installed capacity analysis presented above); 0 percent load obligation (same as installed capacity analysis presented above); We show the 50 percent case is shown in the following figure because it is likely the most realistic. It shows an HHI of under 1900.We show the 50 percent case is shown in the following figure because it is likely the most realistic. It shows an HHI of under In the subsequent table, we summarize the HHI results at both the 50 percent and 100 percent load obligation levels with Cottonwood in and out of the market.In the subsequent table, we summarize the HHI results at both the 50 percent and 100 percent load obligation levels with Cottonwood in and out of the market. These results shows that the HHI is less than 2500 in all cases and less than 2000 in all but one case. Hence, no mitigation is warranted. These results shows that the HHI is less than 2500 in all cases and less than 2000 in all but one case. Hence, no mitigation is warranted.

Market Concentration in ETI: Uncommitted Capacity 50 Percent Load Obligation Case

Market Concentration in ETI Area: Uncommitted Capacity

Pivotal Supplier in ETI Area Our next analysis sought to determine if and under what conditions is there a “Pivotal Supplier” in the ETI Area.Our next analysis sought to determine if and under what conditions is there a “Pivotal Supplier” in the ETI Area. A supplier as pivotal if the load and reserves within the ETI Area cannot be satisfied without the resources of the supplier (“ETI”). A supplier as pivotal if the load and reserves within the ETI Area cannot be satisfied without the resources of the supplier (“ETI”). Pivotal supplier analyses are generally more reliable than HHI analyses in electricity markets because they account for the effects of excess capacity other factors that can substantially affect the competitiveness of the market. Pivotal supplier analyses are generally more reliable than HHI analyses in electricity markets because they account for the effects of excess capacity other factors that can substantially affect the competitiveness of the market. We examine four cases:We examine four cases: We determine whether ETI is pivotal when it must serve a) 100 percent of its load; and b) 50 percent of its load. We determine whether ETI is pivotal when it must serve a) 100 percent of its load; and b) 50 percent of its load. We perform the analysis with and without the Cottonwood facility. We perform the analysis with and without the Cottonwood facility. The results of our analysis of this analysis show that ETI is only pivotal in the 50 percent load obligation case when Cottonwood is removed.The results of our analysis of this analysis show that ETI is only pivotal in the 50 percent load obligation case when Cottonwood is removed. The table also shows that either 600 MW of transmission expansion or 600 MW of capacity sales would cause ETI to no longer be pivotal. The table also shows that either 600 MW of transmission expansion or 600 MW of capacity sales would cause ETI to no longer be pivotal.

Pivotal Supplier Analysis -- ETI Area

Analysis of Local Market Power in Western Subregion of ETI

Market Concentration in the Western Region: Installed Capacity We cannot show specific results for the Western Subregion of ETI because these results would allow one to calculate the import capability into the area, which is confidential information.We cannot show specific results for the Western Subregion of ETI because these results would allow one to calculate the import capability into the area, which is confidential information. Rights to the import capability (which can be used to serve a large share of the load in the area) can only be held entities serving load in the Western Region.Rights to the import capability (which can be used to serve a large share of the load in the area) can only be held entities serving load in the Western Region. Hence, we assume the rights cannot be hoarded. Hence, we assume the rights cannot be hoarded. Our analysis of the Western Subregion shows:Our analysis of the Western Subregion shows: Installed capacity: the HHI in the Western region was less than 1,000 due in part to the mitigating effects of the import capability. Installed capacity: the HHI in the Western region was less than 1,000 due in part to the mitigating effects of the import capability. Uncommitted capacity, 50 percent case: HHI is less than Uncommitted capacity, 50 percent case: HHI is less than Uncommitted capacity, 100 percent case: HHI is high, but all load serving entities have sufficient capacity to serve there own load so competitive concerns are limited. Uncommitted capacity, 100 percent case: HHI is high, but all load serving entities have sufficient capacity to serve there own load so competitive concerns are limited. These results raise no significant market power concerns.These results raise no significant market power concerns.

Market Concentration in the Western Region: Uncommitted Capacity Our next analysis focuses on uncommitted capacity in the Western Region.Our next analysis focuses on uncommitted capacity in the Western Region. Like the analysis for the entire ETI Area, we consider three load-obligation scenarios: 100 percent, 50 percent, and 0 percent (same as installed capacity analysis).Like the analysis for the entire ETI Area, we consider three load-obligation scenarios: 100 percent, 50 percent, and 0 percent (same as installed capacity analysis). All load is served in the Western Subregion either by generation located there or by transfers from outside the ETI area.All load is served in the Western Subregion either by generation located there or by transfers from outside the ETI area. Therefore, in the 100 percent load-obligation case, because all load is served by existing arrangements, there is no demand for uncommitted capacity and, hence, no market power. Therefore, in the 100 percent load-obligation case, because all load is served by existing arrangements, there is no demand for uncommitted capacity and, hence, no market power. In the 50 percent case, our analysis indicates an HHI less than 1000.In the 50 percent case, our analysis indicates an HHI less than We do not present the results here because of confidentiality with respect to certain operating data. We do not present the results here because of confidentiality with respect to certain operating data.

Pivotal Supplier in Western Subregion We also performed a pivotal supplier analysis for the Western Subregion for the 50 percent load obligation case and the 100 percent load obligation case.We also performed a pivotal supplier analysis for the Western Subregion for the 50 percent load obligation case and the 100 percent load obligation case. Due to the levels of import capability available into the Western Subregion and other factors, we found that ETI is not pivotal in any of the casesDue to the levels of import capability available into the Western Subregion and other factors, we found that ETI is not pivotal in any of the cases Our analysis contains confidential information that prevent us from showing more detailed results.Our analysis contains confidential information that prevent us from showing more detailed results.

Conclusions The SPP/ETI area satisfies the QPR standards.The SPP/ETI area satisfies the QPR standards. We perform an array of local market power analyses for both the ETI are and the Western Subregion within ETI.We perform an array of local market power analyses for both the ETI are and the Western Subregion within ETI. The cases that are most reflective of the future retail competition in the area are the 50 percent load obligation cases, which indicate:The cases that are most reflective of the future retail competition in the area are the 50 percent load obligation cases, which indicate: The market concentration results raise no competitive concerns. The market concentration results raise no competitive concerns. ETI is not a pivotal supplier in the ETI area or Western Subregion unless Cottonwood is removed. ETI is not a pivotal supplier in the ETI area or Western Subregion unless Cottonwood is removed. If Cottonwood is removed, ETI would be pivotal only in the ETI Area and less than 600 MW of new transmission or capacity sales would be effective mitigation. If Cottonwood is removed, ETI would be pivotal only in the ETI Area and less than 600 MW of new transmission or capacity sales would be effective mitigation. These results remain preliminary and subject to change.These results remain preliminary and subject to change.