SPP-Entergy Market Power Analysis Presented By: David B. Patton, Ph.D. President, Potomac Economics September 16, 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 the ETI Area and within the ETI Area, we define two relevant markets for these analyses:Because there are significant transmission constraints that bind into the ETI Area and within the ETI Area, 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 Jacinto and Cypress substations). The Western Subregion of ETI (which is defined as the load and resources west of the Jacinto 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 effect 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 effect 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 percent, 50 percent, and 100 percent.) Hence, we generally consider three alternative assumptions regarding the portion of utilities load it is obligated to serve (0 percent, 50 percent, 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); The company totals represent a simple steel in ground figure. They do not reflect contract sales, transmission limitations, or other complications. The company totals represent a simple steel in ground figure. They do not reflect contract sales, transmission limitations, or other complications. The following table shows our analysis. ETI has a capacity share of 4.4 percent and no supplier has a market share greater than 20 percent.The following table shows our analysis. ETI has a capacity share of 4.4 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 is under 2,100.; The HHI in the ETI Area is under 2,100.; ETI has a market share of 42.5 percent; and ETI has a market share of 42.5 percent; and There are over 900 MW of imports, mostly from Entergy units in Louisiana to ETI load, although some imports serve municipal entities. There are over 900 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 2,416. The HHI in this case was 2,416. This is high for levels that would typically be deemed workably competitive. This is high for levels that would typically be deemed workably competitive. –However, it does not account for the effects of load obligations, excess capacity and other factors that improve the competitiveness of the market. –It is below the 2500 benchmark used in the prior study.

HHI for Installed Capacity in ETI Area

HHI Calculations for ETI Area Mitigation Results Based on the prior results, we evaluated two types of market power mitigation:Based on the prior results, we evaluated two types of market power 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 ETIs market share. We start at 500 MW because it is 15 percent of ETIs capacity in the area (the floor in Senate Bill 7). Capacity sales by ETI, which would reduce ETIs market share. We start at 500 MW because it is 15 percent of ETIs capacity in the area (the floor 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. Both mitigation approaches are effective at reducing market concentration to less than 2000, but capacity sales are generally more effective because they reduce the market share of the largest supplier more quickly.Both mitigation approaches are effective at reducing market concentration to less than 2000, but capacity sales are generally more effective because they reduce the market share of the largest supplier more quickly. With Cottonwood out of the market, 500 MW of capacity sales reduces the HHI to 1782 while the same amount of new transmission reduces it to With Cottonwood out of the market, 500 MW of capacity sales reduces the HHI to 1782 while the same amount of new transmission reduces it to These approaches may be combined: 200 MW of each reduces the HHI below These approaches may be combined: 200 MW of each reduces the HHI below As explained later in the study, however, we do not find that mitigation is necessary in either the ETI Area or the Western Subregion.As explained later in the study, however, we do not find that mitigation is necessary in either the ETI Area or the Western Subregion. HHI analyses ignore the effects of load obligations, excess capacity, and RMR obligations that are better captured in the uncommitted capacity and pivotal supplier analyses discussed below. HHI analyses ignore the effects of load obligations, excess capacity, and RMR obligations that are better captured in the uncommitted capacity and pivotal supplier analyses discussed below.

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 LSEs total resources.The next analysis of uncommitted capacity shares accounts for load obligations by subtracting the peak load obligation from the LSEs 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 case (no retail load switching). 100 percent load obligation case (no retail load switching). 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); The 100 percent case indicates an HHI of less than 1000.The 100 percent case indicates an HHI of less than The 50 percent case is shown in the following figure.The 50 percent case is shown in the following figure. It also shows an HHI of less than It also shows an HHI of less than These results do not raise any competitive concerns or indicate the need for market power mitigation.These results do not raise any competitive concerns or indicate the need for market power mitigation.

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

Pivotal Supplier in ETI Area Our next analysis sought to determine if and under what conditions there is a Pivotal Supplier in the ETI Area.Our next analysis sought to determine if and under what conditions there is a Pivotal Supplier in the ETI Area. A supplier is pivotal if the load and reserves within the area (ETI Area) cannot be satisfied without the resources of the supplier (ETI). A supplier is pivotal if the load and reserves within the area (ETI Area) cannot be satisfied without the resources of the supplier (ETI). Pivotal supplier analyses provide a more reliable indicator of market power than HHI analyses in electricity markets because they capture the effects of excess capacity and other factors that affect the competitiveness of the market. Pivotal supplier analyses provide a more reliable indicator of market power than HHI analyses in electricity markets because they capture the effects of excess capacity and other factors that affect the competitiveness of the market. We examine four cases:We examine four cases: We determine whether ETI is pivotal when it must serve 100%, 50%, or 0% of its load. We determine whether ETI is pivotal when it must serve 100%, 50%, or 0% of its load. We perform the analysis with and without the Cottonwood facility. We perform the analysis with and without the Cottonwood facility.

Pivotal Supplier in ETI Area The results of our analysis show that ETI is only pivotal in the 0% load case.The results of our analysis show that ETI is only pivotal in the 0% load case. Although this result raises potential competitive concerns, we do not find that market power mitigation is necessary for the following reasons:Although this result raises potential competitive concerns, we do not find that market power mitigation is necessary for the following reasons: A significant portion of ETIs capacity is reliability must run, which means that they must be operated to support the transmission system. ETI is not pivotal if it cannot withhold such capacity. A significant portion of ETIs capacity is reliability must run, which means that they must be operated to support the transmission system. ETI is not pivotal if it cannot withhold such capacity. ETI will likely continue to be obligated to serve load as a provider of last resort (POLR). ETI will likely continue to be obligated to serve load as a provider of last resort (POLR). –POLR prices in ERCOT are capped relative to prevailing wholesale prices. It is unclear what price-to-beat or POLR provisions would be applied in ETI. –Given the quantity that ETI would have to withhold to be pivotal, withholding to receive the price-to-beat or POLR price from the remaining retail customers would not likely be economic. The SPP market monitor could easily detect the magnitude withholding that would be necessary for ETI to take advantage of its pivotal supplier status. The SPP market monitor could easily detect the magnitude withholding that would be necessary for ETI to take advantage of its pivotal supplier status. Lastly, the peak load assumed in the pivotal supplier test is substantially higher than the average load – ETI would not be pivotal in most hours. Lastly, the peak load assumed in the pivotal supplier test is substantially higher than the average load – ETI would not be pivotal in most hours.

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 the ETI Area 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 the ETI Area 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 by entities serving load in the area.Rights to the import capability (which can be used to serve a large share of the load in the area) can only be held by entities serving load in the area. 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 (0 percent load obligation): the HHI in the Western region was less than 1,000 due in part to the mitigating effects of the import capability. Installed capacity (0 percent load obligation): 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 close to Uncommitted capacity, 50 percent case: HHI is close to Uncommitted capacity, 100 percent case: HHI is high, but all load serving entities have sufficient capacity to serve their 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 their own load so competitive concerns are limited. These results raise no significant market power concerns.These results raise no significant market power concerns.

Pivotal Supplier in Western Subregion We also performed a pivotal supplier analysis for the Western Subregion for the 0 percent, 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 0 percent, 50 percent load obligation case and the 100 percent load obligation case. We found that ETI is not pivotal in any of the cases; We found that ETI is not pivotal in any of the cases; This result is due primarily to the import capability into the Western Subregion, which we assume cannot be withheld by ETI to the extent that it is not serving load in the area; This result is due primarily to the import capability into the Western Subregion, which we assume cannot be withheld by ETI to the extent that it is not serving load in the area; 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 performed an array of local market power analyses for both the ETI Area and the Western Subregion (within the ETI Area).We performed an array of local market power analyses for both the ETI Area and the Western Subregion (within the ETI Area). The cases that are reflective of the future retail competition in the area are the 0 percent and 50 percent load obligation cases, which indicate the following:The cases that are reflective of the future retail competition in the area are the 0 percent and 50 percent load obligation cases, which indicate the following: The market concentration results raise no competitive concerns. The market concentration results raise no competitive concerns. ETI is not a pivotal supplier in the Western Subregion. ETI is not a pivotal supplier in the Western Subregion. In the ETI Area, ETI is only pivotal in the 0 percent load obligation case. We find that this does not raise significant competitive concerns due to: In the ETI Area, ETI is only pivotal in the 0 percent load obligation case. We find that this does not raise significant competitive concerns due to: –ETIs RMR obligations; –ETIs load obligations as a provider of last resort (POLR). –The ease with which the SPP market monitor could detect the withholding that would be needed for ETI to take advantage of its pivotal supplier status.