Frontier Economics, Inc. Cambridge, Massachusetts Boston London Melbourne Project Stanley - July 20th Review Meeting Initial market analysis Privileged and Confidential Communication with Counsel Frontier Economics, Inc. Cambridge, Massachusetts

Outline of presentation Market power in the Power Pool of Alberta Sample transaction analysis Examples from other hours Transaction profitability Initial estimates of impacts on prices Preliminary conclusions Privileged and Confidential - Communication with Counsel

Structure of the Alberta power market Three main utilities were functionally unbundled during restructuring but have remained contractually integrated “Legislated hedges” based on regulated rates determine actual prices paid by customers for most power - hedge out variation in Pool prices for most final sales Historically the Pool price has been a ‘virtual’ transfer price between gencos and distcos - little actual volume sold at this price Demand Supply MW $/MWh Power Pool of AB ATCO EPCOR IPPs Imports TAU Enmax Other Gencos/importers Discos Privileged and Confidential - Communication with Counsel

Relevant aspects of the Pool design Ex post design - binding settlement prices and quantities are set in real-time during dispatch Clearing second-price auction Prices are set on a 5 minute basis - hourly Pool price is an average Bids are submitted day ahead - quantities can be re-declared (on a limited basis) although prices cannot Pool releases estimated prices (and sensitivities day ahead) to all participants MW MWh Settlement supply curve Day ahead supply curve Privileged and Confidential - Communication with Counsel

Exercising market power in a clearing pool Trader can seek to increase prices by bidding up prices in the Pool or withholding capacity Profitable if the increase in Pool price over marginal cost is greater than the lost quantity Price-quantity relationship for each trader described by a “reaction function” Reaction function is steep when supply is highly inelastic or when there are few other sellers Profitability increased if a trader has other infra-marginal capacity offered to market MWh Reaction function P’ P’ MC Q’ Q MW Privileged and Confidential - Communication with Counsel

Re-declarations as a search strategy Assume all variation is in demand (supply is constant) If demand is high, bidding in small block (e.g. 50 MW) may set price high But if demand is low, then would lose opportunity to sell MW at lower (but still profitable) price Re-declaration of blocks to price-taking when not accepted by Pool allows bidder to “search” for periods in which withholding would be profitable with low opportunity costs Final block Low demand outcome $/MWh High demand outcome Supply curve incl. withholding MW Privileged and Confidential - Communication with Counsel

Alberta supply curve illustrates potential for exercising market power Large “step function” between coal and gas plant variable costs and gas and combustion turbine variable costs - significant ability to bid up or withhold Little flexible CT capacity - supply curve turns nearly vertical > 7400 MW High levels of concentration in generation: TAU - ~ 4100 MW ATCO - ~ 1675 MW EPCOR - ~ 1639 MW Imports - ~ 950 MW IPPs and munis- ~ 1300 MW 1999 sample supply curve - availability unadjusted Privileged and Confidential - Communication with Counsel

Illustrative transaction - June 18th HE16 Pool price set at $998/MWh from Enron bid Very tight supply-demand balance - only 56 MW shift in day ahead supply will increase price from $80/MWh to $500/MWh Substantial contraction in supply at $0/MWh and at $3-5/MWh (TAU or EPCOR coal most likely) as well Privileged and Confidential - Communication with Counsel

Effect of re-declarations on Pool price ENR bid Supplemental offers ??? bid Base and coal bid withdrawals Privileged and Confidential - Communication with Counsel

Many high price hours not associated with E/PX transactions Other hours Hourly pool prices: June 1st - Sept 30th 1999 Privileged and Confidential - Communication with Counsel

High price hour with no E/PWX transaction: August 30th HE14 PWX bid Powerex made 414 MW re-declaration which pegged Pool price at $998/MWh Other substantial withdrawals as well from ATCO or EPCOR gas units? Privileged and Confidential - Communication with Counsel

An unsuccessful transaction: June 7th HE15 Non ENR bid PWX offered option on 125 MW at PP with $400/MWh cap Bid into Power Pool at $740/MWh - not in merit. Pool cleared at $85.1/MWh over hour with demand at 6164 MW (average settlement load) Privileged and Confidential - Communication with Counsel

What would prices have been otherwise? True counterfactual would require re-dispatch of all bids - not yet estimated Can approximate simple ‘but for’ price by a shift in supply curve ENR/PWX transactions eliminated zero-price bids – will restore these bids to estimate ‘but for’ price Generally, the steeper the bid stack at the actual Pool Price, the greater the impact of these transactions P P P’ Privileged and Confidential - Communication with Counsel

Assumptions of price impact analysis Initial price impacts model assumes: price will be set by next bid after removal of ENR-PWX transaction bid - may be another ENR bid all other bids stay the same - in reality, many players have been using withholding and re- declaration strategies In most hours, ENR strategy likely would not have been possible without other withholding by AB gens and/or PWX ENR- PWX bid Price $/MWh Other ENR bid P’ P’’ MW offered Withholding by other bidders Privileged and Confidential - Communication with Counsel

Estimated impact of increased prices Higher prices will be detrimental to any purchasers from the Pool In reality, most volume is covered by legislated hedges or commercial contracts Assume 85% total cover in example Will need to calculate exact UOA Impact estimated as the increase in price due to transactions over the affected volume traded in the Pool On average, trades appear to have increased prices by over $300/MWh Privileged and Confidential - Communication with Counsel

Who benefited from the transactions? Direct benefit to ENR in most hours – received Pool price minus settlement price with PWX No direct benefit to PWX - lost opportunity PWX indirect benefit – increase in Pool price on other sales ENR had an ‘independent business reason’ to enter into profitable transactions Indirect benefits (higher price on other volumes) larger than direct benefits, but not by much Privileged and Confidential - Communication with Counsel

Conclusions - Transaction structure Given small magnitudes of MW - transactions had little possibility of success except in hours when supply-demand balance was already very tight Transactions (and attempts) made in hours when demand was > 6000 MW, so small shifts in net supply could have large impacts on prices Structure of Pool rules (ex post market with limited re-declarations) is well-suited to this type of strategy. Aided by day ahead information published by Power Pool of Alberta Use of withholding and re-declaration strategies by many players to influence prices appear to have been fairly common across the period Privileged and Confidential - Communication with Counsel

Conclusions - Benefits from transactions ENR benefited (on average) from transactions with PWX directly, and by leveraging higher Pool price on other volumes PWX lost money (on an economic basis) on sales to ENR, but benefited on leveraging higher Pool prices across other MW Sample calculation does not show benefits from BC Fort Nelson plant which sells into Power Pool of Alberta - is it hedged? Based only on PWX intertie volumes from settlement data Assumes PWX could have achieved same impact on Pool prices through a unilateral bidding strategy - no political restrictions Privileged and Confidential - Communication with Counsel

Conclusions - Impact on Pool prices Based on a simplified initial analysis, there was an impact on Pool prices: raised Pool revs by ~ $45 million in 22 hours on total Pool volume actual financial impact would likely be under $7million after accounting for legislated hedges Need to model legislated hedge and price impacts more precisely Privileged and Confidential - Communication with Counsel