Alternative Models of Electric Industry Restructuring Bruce Edelston Director, Southern Company Presentation to Carnegie Mellon Electric Industry Center September 23, 2004

Who We Are Southern Company is an investor owned energy company in the Southeastern U.S. and a holding company for: Alabama Power Company Georgia Power Company Gulf Power Company Mississippi Power Company Savannah Electric & Power Company Southern Power Company supplying electric service in the states of Alabama, Florida, Georgia, Mississippi. Other Businesses Southern Company Gas Southern Nuclear Southern LINC Southern Telecom

Southern Company Profile Generated 183 billion KWh of electricity in 2002 with 39,000 MW Earnings for 2002 of $1.3 billion on total revenues of $10.5 billion More than 26,000 employees Fortune magazine’s most admired electric and gas utility in America for the past two years Rates 20% below national average

Generating Mix 281 generating units at 69 plants in the Southeast 2004 Generation Fuel Mix:

ALTERNATIVE MODELS OF ELECTRIC INDUSTRY COMPETITION AND RESTRUCTURING

The Original California Model Generation -- Utility, IPPs, Marketers Power Exchange/Pool Contracts Contracts Network Operator (ISO) Contracts Distribution Utilities Competitive Suppliers Contracts Customers

The Original California Model (cont.) All utility generation had to be sold into Power Exchange Customers could buy from the distribution utility, directly from a generator, or from a competitive supplier Distribution utility had to buy all its needs from the Power Exchange Retail rates of distribution utilities remained regulated Competitive suppliers could buy their needs from generators or from the Exchange, or some combination

Customer Choice Model (TX) Generation -- Utility, IPPs, Marketers Competitive Suppliers Network Operator (RTO/ISO) Contracts Contracts T & D Utilities Customers

Customer Choice Model (cont.) Customers may contract directly with generators or competitive suppliers (power marketers) for their own needs Network operator runs transmission system, does planning and scheduling, balances supply and demand through bid-in balancing market, and is responsible for reliability Distribution company simply operates distribution system - it may put out bids for “standard offer service”

Centralized Dispatch Model (PJM) Generation -- Utility, IPPs, Marketers Centralized Pool (e.g., PJM) Network Operator Distribution - “POLR” Service Competitive Suppliers - Billing - Value Added Services

Centralized Dispatch Model (cont.) Retailers (either utilities or competitive suppliers) buy all of their needs from pool, resell to end users All generators bid into pool on an hourly basis Pool dispatches generation from lowest cost bid to highest cost bid Highest cost bid that gets dispatched becomes market clearing or “spot” price All generators that are dispatched are paid the spot price

Centralized Dispatch Model (cont.) Pool is either “energy only” or energy and capacity are separate products (and markets) May be a minimum capacity requirement for suppliers Customer choice is really a matter of risk management for suppliers

Vertically-Integrated, Incremental Wholesale Competition Model Existing Generation -- Regulated New Generation – Competitive Network Operator (RTO/ISO) (Plans and Operates) Integrated Utility Distribution Existing Needs - Use Own Units Incremental Needs -- Buy from Market

Vertically-Integrated, Incremental Wholesale Competition Model (cont.) No customer choice (limited exceptions) Existing generation used for retail sales remains regulated New generation and existing (excess) generation available for wholesale sales are market-based (assuming regulatory approval) Integrated utilities with service obligations buy incremental needs via requests for proposals Utilities may or may not bid a “self-build” (rate base) option Utilities choose incremental option based on price and non-price factors and signs purchase power agreement (typically 5-7 years)

Vertically-Integrated, Incremental Wholesale Competition Model (cont.) Utility affiliates may also bid if permitted by state regulators Over time, more and more generation is acquired through purchase power agreements, rate base diminishes Transmission and distribution planning and operations continue to be performed by integrated utility Integrated utility also distributes power and makes retail sales at rates set by state regulators

CURRENT MODELS

Customer Choice States Retail Choice State Non-Retail Choice State Source: EIA

Centralized Dispatch Areas New England New York PJM ERCOT California Planned: Midwest ISO

Vertically-Integrated States Unbundled Vertically-Integrated Source: EIA

Comparison of Models

Customer Choice - Pros Lets customers decide Risks shifted from customers to suppliers Spurs product innovation Spurs technical innovation Maintains competitiveness of economy

Customer Choice: Issues Are Prerequisites for Competition Satisfied? Competitive Markets: Electric Markets: Consumers should face true costs of supply Consumers have regulated option available, regulators likely to cap very high prices Customers should be responsive to prices Demand is very inelastic Large number of sellers and buyers Few sellers, few buyers Customers can choose level of reliability Reliability is a public good No inter- and intra-class subsidies Subsidies abound

Customer Choice – Issues (cont.) Do small customers want choice? Can regulators/politicians let competition work? Who will pay for reserves needed for reliability but not revenue producing? Are there significant economies of scope that are lost by unbundling? Should any one care about fuel diversity? What about externalities? Transaction costs vs. savings? How is success measured?

Centralized Economic Dispatch: Pros Production efficiency clearly the greatest potential benefit Locational price signals tell where generation and transmission should be built Physical system is separated from financial system Relatively easy for areas with existing traditional power pools Provides hourly price signals to customers Lessens market power concerns PJM has made it work (some experience)

Centralized Economic Dispatch: Issues Costs of RTOs (vs. benefits)

RTO Costs (2003) Revenue Requirement Cost per Unit ($/MWh) PJM $252,164,806 0.723 NYISO 117,578,796 0.718 ISO–NE 102,924,000 0.787 CA ISO 235,240,000 1.020 ERCOT 184,159,748 0.545 Ontario 107,204,400 0.705 Source: Public Power Council

Source: Public Power Council

Centralized Economic Dispatch: Issues (cont.) Will regulators (politicians) accept price volatility and high prices necessary to pay for peakers (that must recover fixed costs in only a few hours per year)? If not, how will sufficient generating capacity be ensured?

Centralized Economic Dispatch: Issues (cont.) How will demand side interact with pool? Who will build transmission? What incentives will they have? Fuel diversity Externalities/public benefits

Centralized Economic Dispatch: Issues (cont.) What is appropriate size? Seams issues Requires transfer of jurisdiction from states to FERC Reliability responsibilities dispersed (more complicated) Unregulated utilities (coops and government-owned) must participate, especially where they are a major presence (NW, SE)

Vertically-Integrated, Incremental Wholesale Competition: Pros Clear accountability for reliability and service obligations Fuel choice and externalities can remain part of resource planning Generation, transmission and distribution can be planned jointly, lowering total costs (economies of scope)

Vertically-Integrated, Incremental Wholesale Competition: Pros (cont.) Because of stranded cost recovery, most of the benefits of competition come from incremental generation, not existing Customers get benefits of wholesale competition without transaction costs (and hassle) of choosing supplier Integrated utility manages risks on behalf of customers States retain jurisdiction

Vertically-Integrated, Incremental Wholesale Competition: Issues Perception of market power Generation dominance Transmission access Other barriers to entry No transparency of dispatch Few buyers Lack of regional planning Retail customers retain risks of bad utility decisions

Possible Additions to Vertically-Integrated Model Independent operation of OASIS and granting of interconnections and transmission access Regional planning and security coordination by independent entity Short-term formal competitive procurement process More formalized long-term RFP process with greater transparency and independent oversight

Other Critical Issues Lack of investment in both generation and transmission Credit ratings of IPPs/marketers Relationship between federal and state regulators August 14 blackout and its ramifications Lack of mandatory reliability rules Tug of war between environmental objectives and competitive objectives Elected vs. appointed Commissions

Conclusions All of these models (except California) can work if issues are properly addressed Regional characteristics and concerns drive choices Competition should be a means to an end (reliability at lowest possible cost) rather than the end itself