DR Valuation RON-01 Phase 2 Proposal January 31, 2006

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 2 of 36 Presentation Overview Objectives and Process Approach: Phase 1 Findings Valuation Framework Standard Practice Approach Gaps in Standard Practice Phase 2 Proposal

pg 3 of 36 Objectives and Process

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 4 of 36 Starting Point 1.Broad definition of DR: Our proposed valuation approach is suitable for evaluating Both Price-based (e.g., RTP, CPP and TOU) and Quantity-based (interruptible/ curtailable, cycling/ load control, and demand subscription) programs Programs implemented by utilities, scheduling coordinators, or CAISO Both voluntary and mandatory rates 2.Integration of value and rates: Our DR Valuation and DR Rate Design research proposals are integrally tied together

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 5 of 36 Linking DR Valuation & Rate Design Overall objective of Phase 2: Integrate DR Design and DR Valuation to maximize benefits for California energy consumers Develop High Potential DR Designs DR Rate & Program Design RON screens Identify and Address Gaps in Existing Standard Practice DR Valuation RON Develop New Standard Practice for Valuation

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 6 of 36 DR Valuation Phase 2 Objective Objective: Develop a valuation methodology that fully and consistently captures the costs and benefits of a wide variety of DR programs types Interruptible / Curtailable Rates Time of Use (TOU) Rates Critical Peak Pricing (CPP) Real-time Pricing Demand Subscription Service Programmable Communicating Thermostats (PCTs) Other dynamic, enabling technologies End-use Cycling; A/C, Pool Pump, and others

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 7 of 36 Need for a New Standard Practice Expanding existing valuation to address DR will provide significant value to California’s electricity consumers. The inconsistency among valuation methodologies is demonstrated by the utility DR filings in California over the last 18 months. The CPUC in Decisions D , D and D established preliminary avoided cost estimates PG&E’s Valuation of CPP, (2005) was developed using both the CPUC AMI business case numbers and its own internal valuation methodology. Valuation of Programmable Communicating Thermostats (2005) for the 2006 new building standards Both SCE and PG&E have filed avoided generation capacity cost testimony in the respective rate cases. In the existing utility generation procurement rules there was a negotiated settlement that established how much DR would be counted to meet a scheduling coordinators planning reserve requirement.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 8 of 36 Vision of New Standard Practice New Standard Practice for Dispatchable Resources Desired characteristics: Fully documented and transparent Consistent valuation across all dispatchable resources Clearly define differences between non-dispatchable (DSM) and dispatchable (DR) resources Full use of publicly available market price data Not dependent on the use of proprietary data or models Process: Use consultation process similar to successful EE avoided costs to develop new valuation standard for dispatchable resources. Schedule goal: Complete prior to Phase 3 of CPUC’s avoided cost proceedings beginning in late 2006.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 9 of 36 Phase 3 of CPUC Avoided Cost Proceeding Stated Goal of Proceeding “…address long-run avoided cost forecasts and calculations and the potential use of the E3 avoided cost methodology to calculate long-run avoided cost for use in valuing other resource options and programs.” “…continue to focus on the development of a common methodology, consistent input assumptions and updating procedures to quantify all elements of long-run avoided cost across the various Commission proceedings.” Schedule Schedule to be issued following the proposed decision on the consolidated QF policy and pricing issues (Hearings begin Jan. 28, 2006, reply briefs due Mar. 17, 2006). We expect Phase 3 to begin at the end of 2006.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 10 of 36 Team is Designed for Research Objective Each member of the E3 Team contributes specific expertise to address complex California electricity market issues: E3 Team Member Primary Research Focus Key California Market Issues E3, Utilipoint/ Neenan, LBNL Impact of evolving market structure on cost effective design Ancillary Services 2007 nodal market structure Capacity market 2006 Avoided Cost proceedings HMG, FSCTechnical potential and customer acceptance Evolution of DR pricing to capture enhanced enabling technologies enhanced metering technologies customer acceptance & program enrollment customer response

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 11 of 36 E3 Research Team

pg 12 of 36 Approach: Phase 1 Research Findings

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 13 of 36 Phase 1 Research Findings Current Valuation Framework Cost Minimization Other Important Characteristics Resource Portfolios Reliability Standard Practice What it Does Do What it Doesn’t Do Existing Avoided Cost Components Need for New Standard Practice Summary of Gaps in Standard Practice

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 14 of 36 Current Valuation Framework Objective Minimize Cost of Delivered Energy Under existing framework, DR has only a cost and a resource value Cost = Cost to utility, society or customer Define Resource Value of DR = (Cost of Resource Portfolio without DR) - (Cost of Resource Portfolio with DR) Calculate Resource Value of DR = (Avoided Cost of Capacity) x (Avoided Capacity Purchases)

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 15 of 36 IRP Using Existing Framework New resources include both dispatchable (DR, DG, Hydro, CTs) and non-dispatchable (DSM) resources Each resource has 6 characteristics: cost cost variance (e.g., fuel cost variability) cost covariance with each other resources quantity if perfectly available probability of availability potential impact on reliability Goal of IRP: Determine the mix of resources that minimizes costs subject to procurement constraints

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 16 of 36 Portfolio Development Portfolio = combination of new and old resources IRP compares the performance of different portfolios according to three metrics: Cost (C) – The total cost of delivered energy needed to serve peak load Cost variance (V) – The combination of resource-specific cost variances and covariances Reliability (R) – Probability of meeting peak load in a given year Comparative portfolio valuation requires an analysis in three dimensions Can trace a “frontier” or contour among two variables while holding the third constant

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 17 of 36 Portfolio Selection 0 Variance Cost R = 0.95 R = 0.99 For a fixed reliability target, an LSE chooses a portfolio that minimizes cost subject to an acceptable cost variance. Portfolio A Portfolio B Portfolio C Portfolio D Portfolio E Portfolio F Cost-Risk contours with fixed reliability

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 18 of 36 DR Valuation: Basic Assumptions DR is one of many dispatchable resources CPUC adopted avoided costs for EE provide a good starting point for valuing dispatchable resources A new dispatchable resource standard practice must account for: Changes in costs Changes in cost variance Changes in portfolio variance Changes in reliability

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 19 of 36 Types of Avoided Costs The avoided costs adopted in California were designed to reflect the value of long term, non-dispatchable conservation programs. RTP = Real time pricing rates; CPP = Critical peak pricing; DLC = Direct load control; DB = Demand Bidding Program; PCT = Programmable controllable thermostats (Title 24 Building Standards); TOU = Time of use rates; I/C= Interruptible/Curtailable Program DispatchableNon-Dispatchable Short-TermDR (RTP, CPP, DLC, DB, I/C) PJM Market Rate Long-TermCT, CCGT, DR (PCT)Energy Efficiency, (TOU) Resource Matrix

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 20 of 36 Existing Avoided Cost Components Existing avoided cost methodology for EE adopted by CPUC (R / R ) provide starting point for the following components: Generation Energy ($/kWh) Transmission Capacity ($/kW-period/area) Distribution Capacity ($/kW-period/area) Marginal Losses at the Generation, Transmission and Distribution voltage levels by utility service territories Emissions Avoided Costs ($/MWh) Multiplier Impact from reducing market prices Ancillary Services Dispatchable resources require additional avoided cost components

pg 21 of 36 Six Research Gaps Gap 1: Generation Capacity Value ($/kW-Time Period) Gap 2: Consumer Surplus ($/Time Period) Gap 3: Option Value ($/kW-Time Period) Gap 4: DR Modularity and Value of Information Gap 5: Value of Lost Load ($/Use) Gap 6: Portfolio Hedge Value ($/Portfolio)

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 22 of 36 Gap 1: Generation Capacity Value Issue A dispatchable DR program is often used only during a few critical hours in a year. What is the value of these programs to the generation system? Starting Point Load relief during those hours can offer two direct benefits Long-term procurement benefit through less capacity and energy needed to maintain the same reliability target Reliability benefits through incremental improvement in reliability and value. Methodology must be careful not to double count the value of capacity and the value of maintaining reliability.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 23 of 36 Gap 2: Consumer Surplus 3 Issues: 1. General Consumer Surplus 2. Mitigation of Market Power 3. Individual Customer Consumer Surplus Starting Point for the Estimation of General Consumer Surplus: AB970 of 2000, Section 7(b)(8) requires a “Reevaluation of all efficiency cost-effectiveness tests in light of increases of wholesale electricity costs and natural gas costs to explicitly include the system value of reduced load on reducing market clearing prices and volatility”)) CPUC D , p.13 “[T]he escalators are determined by looking at the “load reduction value” or “consumer surplus” relative to the market price and taking a ratio. The escalators are multiplied by the market price - either during peak or off-peak - to arrive at system value.” (ALJ Linda R. Bytof’s 10/25/00 ruling in connection to UDC compliance with D , p.13)

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 24 of 36 Bill savings for all customers General Consumer Surplus Bill Savings for all customers

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 25 of 36 Gap 3: Real Options Analysis Issue The existing standard practice is designed to reflect the benefits of non-dispatchable resources. Dispatchable resources provide an additional option value. Starting Point DR as an option to dispatch against energy costs Buyers purchase rights to curtailments Seller (customers) sell curtailment obligation Buyers exercise options if they are “..in the money.” Analogous to utility I/C programs, but Option value is not avoided costs, but expected value Option exercise driven by market price or other transparent market condition More flexible: supports alternative options that vary by strike price, number of times exercisable, notice, duration, etc.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 26 of 36 Gap 4: DR Modularity & Value of Information Issue DR can be more pliable, nimble, scalable, and targeted to high value areas than other DR resources. This additional flexibility helps minimize the costs of expansion planning costs and is not currently captured in the California standard valuation practice. Starting Point Preliminary Value Estimation Value of Shorter Lead Time, Value of Information Value of Shorter Contract Period, Option to ‘Retire’ Value of Local Targeting, Option to ‘Move CT’

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 27 of 36 Percent change is the increase in value of a CT Option Value Low Value Base High Value Description Value of Information 1%2%4% The value of a shorter lead-time does not provide significant value given our assumptions. The reason is that even if the CT is built a year or two early, it has a low probability of being built more than a few years earlier than needed. Early Retirement 1%7%21% The value of shorter contract periods is larger and depends on the assumption about the relative value of the plant over time. Local Targeting 16%43%82% Targeting the program to capture local value as well as system value has the greatest increase in potential benefits. Summary of Option Value Results

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 28 of 36 Gap 5: Value of Operating Reliability Issue DR used as an emergency resource has the ability to reduce the number, scope, and size of rotating black- outs. This gap addresses the value customers receive through improved system reliability. Starting Point Evaluate DR’s ability to improve system reliability Evaluate DR operation during system emergencies. Characterize the existing reliability of the system. Avoid double counting the same capacity for operating reserves and for emergency load relief. Estimate the value of that improved reliability. Characterize the improvement in social welfare of reduced outages.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 29 of 36 Northeastern Markets Reliability Value Estimation “Emergency DR”: load curtailments dispatched during periods when operating reserves are low Objective: Measure the impact of this DR on the consequences of forced outages Avoided outage cost analysis monetizes this benefit Value = Change EUE * VOLL Change EUE = Change LOLP * Load at Risk Essential features Estimate the difference in Expected Unserved Energy (EUE) between scenarios with and without load curtailments Avoided outage cost calculated as the product of the reduction in EUE and the Value of Lost Load (VOLL) Key input variables: Change in Loss of Load Probability (LOLP) for each hour of each event Percent of load at risk VOLL

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 30 of 36 Gap 6: Portfolio Hedge Value Issue The energy efficiency standard practice valuation approach considers each resource as an alternative to the “avoided cost” of the utilities portfolio. It does not consider cost variance. Adding DR to a portfolio can reduce the portfolio’s exposure to high market price scenarios. 0 Portfolio A Portfolio B Portfolio C Expected Cost Risk

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 31 of 36 Portfolio Hedge Value Starting Point Several threshold research questions Does the existing valuation framework adequately capture DR’s risk mitigating benefits? Once option value (GAP 3) is built into the standard practice, is the portfolio hedge value needed? As DR adds uncaptured value to the portfolio, what is the best valuation methodology Approaches to assess risk mitigation include: Simulation with DR optimization Simulation without DR optimization Direct computation

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 32 of 36 Example: Efficient Frontier With DR Using the input assumptions we have made, the cost of the portfolio at a given level of risk is reduced. The closed-form solution of the efficient frontier is useful for calculation. However, the usefulness of the result depends on whether reasonably accurate input data can be developed and incorporated into a complete valuation standard practice that makes sense at the individual program and portfolio levels. Forward Price ($/MWh)F$39 DR cost c $30 DR MW K 4,000 Expected Demand (MW) DD 50,000 Variance (D) DD 12,131 Expected Price PP Variance (P) PP 11.7 Correlation (P,D)r0.42 Correlation (PD,P)  0.93

pg 33 of 36 Phase 2 Proposal

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 34 of 36 DR Valuation Phase 2 Proposal Summary Deliverables A new “standard practice” for the valuation of dispatchable resources. Initiate and manage a consultative process with key stakeholders. Base the new standard practice for dispatchable resources on the existing avoided costing approach adopted for energy efficiency Each gap in methodology or data will be addressed as a research question. Process The E3 team will be responsible for first drafts, revisions, and final drafts addressing each research question and the final standard practice description. The E3 team will give monthly presentations on the work in progress, with follow-up telephone discussions and working meetings scheduled as needed.

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 35 of 36 Task Description and Consultation Process

Energy & Environmental Economics, Inc. / Utilipoint International, Inc. / Freeman Sullivan & Co. / Heschong Mahone Group, Inc. / Lawrence Berkeley National Laboratory pg 36 of 36 Schedule and Deliverables