Wholesale Electricity Costs May 19, 2006 Massachusetts Electricity Restructuring Roundtable Bob Ethier, Chief Economist and Director, Resource Adequacy

Overview Power prices have increased Higher fuel prices Increased power use Average and on-peak Steps can be taken to reduce electricity costs New England must become more efficient (price responsive) Time-differentiated retail rates can encourage consumers to use power when its cheaper Market investment in lower cost base load resources needed MA Roundtable © 2006 ISO New England Inc.

Dispatching Resources ISO uses least expensive mix of resources to meet minute-to-minute power needs of the region Accounting for transmission constraints and potential outages Most expensive needed resource sets market clearing price for all (Uniform Clearing Price Auction) Sends a clear signal to investors and the region on what resources should be developed Responds immediately to changed market conditions Encourages marginal-cost based offers so that the most efficient units are dispatched Region-wide economic dispatch in place for 35 years in New England MA Roundtable © 2006 ISO New England Inc.

Dispatching Resources: All Resources Needed to Meet Demand Paid Uniform Clearing Price $65 Demand Forecast Actual Demand UCP $0 $10 $30 $45 $100 Demand and generation (MW) MA Roundtable © 2006 ISO New England Inc.

Electricity Prices Increased in 2005 Average system price of $79.96/MWh was 47% higher than 2004 Increase is due to increased fuel costs and increased demand 44% increase in natural gas prices Increase in peak and average use over previous years Higher cost gas and oil units set price more than 80% of the time Changes in the prices of these fuels are quickly reflected in wholesale electricity prices Retail price increases for the 05/06 winter were also significant In most states the timing of the increase lags behind wholesale market conditions Reduces the ability of consumer behavior to lower wholesale prices MA Roundtable © 2006 ISO New England Inc.

New England’s Generation Mix: More Than 60% Natural Gas and Oil MA Roundtable © 2006 ISO New England Inc.

Electricity Prices Track Fuel Prices Average Monthly Electricity, Natural Gas and Oil Prices $0 $20 $40 $60 $80 $100 $120 $140 Mar-03 Aug-03 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 $/MWh $2 $4 $6 $8 $10 $12 $14 $16 $/MMBTu Hub Nat Gas Oil MA Roundtable © 2006 ISO New England Inc.

Which Units Are Setting Prices in the Energy Market? MA Roundtable © 2006 ISO New England Inc.

Electricity Use on the Rise New England set new record for electricity use in 2005 Peak growth Average consumption Projected annual growth in New England peak demand 2006-2015: 1.9% MA Roundtable © 2006 ISO New England Inc.

Addressing Increased Prices Reduce demand Energy efficiency Demand Response Peak shaving Conservation Investment in lower cost resources Efficient units, and those with lower fuel costs MA Roundtable © 2006 ISO New England Inc.

Higher Prices Drive Investment Higher electricity prices provide increased incentives for investing in resources that don’t use higher-priced natural gas Large increase in interest in wind power Interest in developing coal gasification plants Siting of generating resources is difficult in New England MA Roundtable © 2006 ISO New England Inc.

Analyzing Electricity Costs 2006 Regional System Plan (RSP06) will estimate how certain actions can affect costs RSP06 will model a number of scenarios to determine their effect on prices, including: Addition of a 1,000 MW base load resource Addition of a 1,000 MW clean-coal generator 5% load growth without generation addition 5% on-peak conservation Addition of 500 MW of load response MA Roundtable © 2006 ISO New England Inc.

Controlling Electricity Costs: Results 1 Add baseload - 5.70% $600 million $470 million 2 Add coal 5.60% $590 million $300 million 3 5% growth 5.80% $420 million $90 million 4 5% reduction 4.70% $490 million $360 million 5 Load response 0.02% $2 million $0.5 million $30 million % Change in Wholesale Electricity Price Change in Total Consumer Costs Change in Total Production Costs Change in Total Capacity Costs Note: RSP06 will provide an indication of the relative market and reliability benefits from different resources in each sub-area. MA Roundtable © 2006 ISO New England Inc.

Wholesale-Retail Linkages Retail and wholesale markets are disconnected Flat retail pricing provides no incentive to reduce use when wholesale prices are highest States can encourage energy efficiency and conservation by adopting time-differentiated retail rates Consumers shifting power use to cheaper hours of the day will make better use of the existing power system Lowers energy market prices Reduces capacity payments by deferring need to build infrastructure MA Roundtable © 2006 ISO New England Inc.

Recommendations for Massachusetts Adopt time-differentiated retail pricing for large customers Encourage efficiency Offer opportunity to manage energy costs The more eligible consumers, the better Adopt policies that encourage a more diverse set of resources (i.e. nuclear, clean coal, renewables) Including facility siting and air permits that provide flexibility needed for reliability and economics Continue active involvement in the regional planning process for the power system and wholesale markets MA Roundtable © 2006 ISO New England Inc.