APEX CONFERENCE 2004 October 11 th - 12 th Leipzig Session 1. Market Evolution. Main issues in Europe. Main issues in the Spanish market and cooperation with neighbouring market operators. Mª Luisa Huidobro President & CEO of OMEL

CONTENT 1.Recent evolution of the Spanish energy market. 2.Spanish price convergence with other European organized markets. 3.Main factors influencing market prices. 4.Explicit auctions, market splitting and market coupling. 5.Improving the market structure and security of supply in electric systems. 6.The Iberian Market.

1.RECENT EVOLUTION OF THE SPANISH ENERGY MARKET.

èDaily market started operations on January Intraday market started operations in April èSettlements of all markets and processes started on January èEconomic volume traded in 2003: 8,185 million euros. èEnergy traded: 228,571 GWh. èInstalled generation in the market 56,333 MW. è5,769,532 transactions where done last year. è92 companies act as purchasing agents on the market, 12 of them are external agents and 78 are independent resellers. è86 companies act as producers, 12 of them are external agents. èDomestic technical constraints are very reduced, around 2,2% of the daily energy. èThe market price is a reference for many commercial transactions. MAIN FIGURES OF THE SPANISH MARKET

MARKET AGENTS

INVESTMENT PROCESS Planning (MW) Currently (MW)% In Market (%) CCGT ,25%100% COGENERATION ,42%29% WIND ENERGY ,23%3% PLANNING EVOLUTION

44,04 %

SPANISH DAILY MARKET RESULTS

FINAL PRICE

ENERGY BY PRODUCTION TECHNOLOGY

2.SPANISH PRICE CONVERGENCE WITH OTHER EUROPEAN ORGANIZED MARKETS.

COMMERCIAL CAPACITY Source: REE July 2004

IMPORTS FROM PORTUGAL

EXPORTS TO PORTUGAL

IMPORTS FROM FRANCE

EXPORTS TO FRANCE

COMMERCIAL CAPACITY AND ENERGY TRADED

CAPACITY GENERATION RESERVE AND MARKET PRICES èIn the Spanish Market it exists a high inverse correlation between market price evolution any generation capacity reserve evolution. l Organised market prices strongly depends on the relative scarcity of the commodity. l Demand for electricity also influences market prices. l Fuel prices have had a lower influence on electricity prices. èLooking at the evolution of the organised Market European prices, it seems that the capacity generation reserve has a greater influence on price levels and on price volatility than fuel prices.

RECENT EVOLUTION OF THE ELECTRICITY PRICES IN SPAIN èDebate about the recent level and evolution of the Spanish electricity prices in the organized market. Daily market prices have followed an stable path despite of the increase of fuels prices (gas and coal). èDemand for electricity would have been higher if: l Export commercial capacity have not been limited to 250 MW since April and èLower prices under the above mentioned circumstances would not have been different, because: l Capacity generation reserve is high because of the new combined cycle gas plants. l Spanish prices are in line with the prices of the European organized markets. If the Spanish prices would have been higher, import would have increase and if they have been lower, exports would have been higher.

INTERCONNECTION CAPACITY IN 2005 AACORDING TO THE PLANNING INTERCONNECTIONFUTURE WINTER COMMERCIAL CAPACITY (MW) With France3,000 (Delayed) With Portugal1,200 With Morocco 900 Total5,100 Source: Spanish Electricity and Gas network planning

3.MAIN FACTORS INFLUENCING MARKET PRICES.

MAIN FACTORS INFLUENCING INTERNATIONAL TRADE (I) èDriven by relative price difference between organised markets. èAvailable commercial capacity l Always occupied in the right direction if the congestions are solved by implicit auctions or market coupling/splitting. l Non used when the price difference remains under other methods to solve congestions. èLevel of other generation components of the final electricity price. l Deviation prices. l Capacity payments. l Ancillary services. l Charges derived from explicit auctions when they exist. èBarriers from regulation. l The principle “use it or loose it” alone is difficult to be applied in practice. l Characteristics and timing existing in the procedures to communicate transactions to the TSOs. èLevel of charges derived from the tariffs for the use of the distribution and transport networks.

MARKET POWER AND CONGESTIONS. èMarket power can be exercised easier when explicit auctions of the capacity are used. The value of the non used commercial capacity is higher than its value when it is totally used form the point of view of a significant number of market participants. èImplementing counter trading in the daily market. A generator with several units can get an extra payment for creating the congestion and for solving it. èNot applying or considering final electricity prices, which include ancillary services up to meter readings, could facilitate market power abuse at the side of the congested border where they are higher. èImplementing a unit commitment optimization method to solve domestic constraints. èFixing reference costs caps for generation plants regarding technical constraints procedure instead of solving the problem will aggravate it, since it will only establish a set of minimum prices. èVirtual power plant auctions can maintain the market power of the owner of the physical generation plants and distort market prices (the minimum auction price will be the minimum price).

STATEMENT INCLUDED IN THE LAST FLORENCE FORUM CONCLUSIONS è“Director-General Lamoureux, whilst underlining the progress that proper implementation of the new package could potentially bring, pointed out the currently persisting limitations of the electricity market: transposition of the new directives in Member States is insufficient; market opening in Member States remain at the moment still rather asymmetrical; since the market opening process started the degree of concentration in the industry has consistently increased and there is a clear risk that the public will assimilate recent price increases in electricity with this ongoing concentration process; infrastructure development is still not satisfactory, despite the political objective of the European Council, agreed in Barcelona in 2002, to have in each Member State an interconnection capacity of at least 10% of the generation capacity. In this context, the Commission envisages to make the integration of an electricity cable in railway or road tunnels a condition for co financing of projects comprising such tunnels under the transeuropean networks programme for transport.”

4.EXPLICIT AUCTIONS, MARKET SPLITTING AND MARKET COUPLING

COMPARISON BETWEEN EXPLICIT AUCTIONS AND A FINANCIAL MARKET TO HEDGE THE PRICE DIFFERENCE (I) èIf there is a liquid spot energy market in the countries of origin and destination of an international physical bilateral contract, the international physical energy contract is just a price difference hedging. èIf there are no liquid spot energy markets at either end, since the electricity can not be stored, and taking into account the structure of the present electricity business on the EU states, the liberalization progress will be very complicated èExplicitly auctioning the rights over an interconnection is equivalent to a financial hedge over the price difference between the two spot markets at both sides of the interconnection

COMPARISON BETWEEN EXPLICIT AUCTIONS AND A FINANCIAL MARKET TO HEDGE THE PRICE DIFFERENCE (II) èIf the prerequisite of the existence of a liquid spot market at each side of the interconnection is not in place, assigning to an individual party the rights to use the interconnection will aggravate any existing market structure/power problem that prevented the liquid spot market price to be formed

ROLE OF THE REGIONAL MARKETS (I)  The Document of strategy of the European Commission presented in the Florence Forum Emphasizes, in the first place, the role that can play the following regional markets:  Iberian Peninsula, United Kingdom and Ireland, Northern countries, Italy, Western Europe, East Europe, Southeast Europe and Baltic Sea, as well as the importance that these market will be developed as a necessary step in the integration process. Development of the international interchanges. Improvement of the interconnections and reduction of the market concentration. To facilitate the consumers choice and to obtain a universal service.

COOPERATION BETWEEN ORGANIZED MARKETS  Why a methodology of cooperation between interconnected organized market ? Maximum price convergence between all cooperating markets in case of congestions  The energy flows from the low price area to the high price area  Maximum use of the bottleneck capacity Equal price if there are no congestions Enlarge the relevant market and therefore decreases the market power of the regional participants Is the only way to apply the “use it or lose it rule” of the physical rights over the interconnection capacities Allows market bids and bilateral trades to compete under the same conditions Makes clear that, when liquid markets exist, explicit auctions of the capacity are pure financial hedging tools.

5.IMPROVING THE MARKET STRUCTURE AND SECURITY OF SUPPLY IN ELECTRIC SYSTEMS

FACTORS THAT IMPROVE THE MARKET STRUCTURE FROM THE DEMAND SIDE èDemand flexibility and efficient response to prices by consumers. èThe procedures for consumer protection regarding information and guarantee to the exercise of a right to change supplier. èA link must be created between wholesale transactions and retail transactions. It requires: l The existence of prices formed on liquid public organised markets l The accessibility to all forms of contracting to all consumers, even to the organized market (since it avoids the practice of excessive retails margins in commercialization). l Effective conditions for non-discrimination to any type of suppliers or retailers in the market including the access to the international trades. l Total guarantee of access to the transportation and distribution networks and effective right to change of supplier for consumers.

FACTORS THAT IMPROVE THE MARKET STRUCTURE FROM THE PRODUCTION SIDE èThe elimination of entrance barriers for the access to the production activity: l Administrative or similar authorizations. l Access to the networks. èExistence of organized markets liquid and open to the participation of any producer. èProgressively that the producer faces a flexible demand. èThe competition from the international trade: l Imports prevent excessive prices. l The possibility of exporting at a competitive market price stimulates the investment process in the mid term. èA forward market accessible to any type of producer can facilitate the entry to the market of these agents.

6.THE IBERIAN MARKET.

TOWARDS THE IBERIAN MARKET (I) èMemorandum of understanding for the electricity between Spain and Portugal (July 1998). l Removed of obstacles to electricity trade l REN become external agent of the Spanish market l Spanish electricity companies can sell electricity in Portugal l Coordination between REE and REN as system operators l In march 1999 a joined document is released èThe Iberian market protocol (November 2001). l Guarantee of access to the OMI and to the interconnections in conditions of equality and freedom of contracting. The OMI must open its capital to the participation of Spanish and Portuguese companies. Performances of the OMI of strict impartiality. l Amplification of the interconnections. Line Alqueba-Balboa (2004). Line Cartelle-Lindoso (2006). Reinforcement of the interconnection of the Douro. Increase of the transit capacity of the line Cedillo-Oriol. l Harmonized technical procedures to operate the system.

TOWARDS THE IBERIAN MARKET (II) èConclusions of the Valencia Summit (April 2002) l Spot market in Spain. l Forward market in Portugal. èMemorandum of Understanding signed in the Figueira da Foz Summit (November 2003). l Principles for the Iberian Markets. l International agreements to be subscribed on January l Shareholding exchange between OMEL and OMIP of 10% of this respective social capital. èInternational Agreement on the Iberian Market (January 2004) revised in October 2004 l First step: Spot Market in Spain and Forward in Portugal (July 2005) l Both markets are integrated in 2007 l Regulation harmonization including tariffs structure