ENERGY MARKETS DIVISION Factors Affecting Resource Investment Decisions in ERCOT June 30, 2011

STRICTLY CONFIDENTIAL What is the Problem?  Supply and demand must be managed in real time / storage of electricity is limited/ reserves are needed for reliability  Efficient Real Time market prices are crucial for maintaining resource adequacy  Markets work, are self correcting and will ultimately result in adequate investment  Efficient investment occurs when the market is efficient  Below market Real Time Prices will result in reduced investment, reserve margins, etc  Above market Real Time Prices will result in increased investment, reserve margins, etc  The manner reserves in ERCOT enter the market is inefficient, undermines Real Time Prices and will result in inefficient investment  Deployment of reserves in ERCOT shifts and flattens the most efficient supply curve  Ancillary services are a reliability tool, not a price mitigation tool  Specific Problems  0-LSL for units providing RUC and NSRS  LSL-HSL for units providing RUC and NSRS

STRICTLY CONFIDENTIAL Supply Curve Shift & Price Effect P Q D S1S1 S2S2 Q2Q2 P1P1 P2P2 Q1Q1 S3S3 E1E1 E2E2 3 E3E3 P3P3 Q3Q3

STRICTLY CONFIDENTIAL Supply Curve Shift & Price Effect – Historical Data

STRICTLY CONFIDENTIAL Supply Curve Shift & Price Effect – Historical Data

STRICTLY CONFIDENTIAL Principles used to resolve the problem  To allow ERCOT the flexibility to use reserves as their expertise dictates to maintain reliability  To achieve the most efficient price  The timing, quantity, duration and supply offers from the market can vary significantly with the timing quantity duration and supply offers from ancillary services  All of these factors affect Real Time Prices  Maintaining the integrity of the supply curve achieves the most efficient price  Market offers should be exhausted prior to deployment of NSRS  The market and competition should respond to price spikes

STRICTLY CONFIDENTIAL Solution  Adjust prices for units providing RUC and NSRS for energy between 0-LSL  Penalty Curve or  Demand Curve Shift/Supply Curve Correction  SCED Offset  Between LSL-HSL  Exhaust all market offers prior to allowing NSRS/RUC units to set prices  Easiest way to ensure a market based solution is to have NSRS/RUC resources offer at the price cap  This solution ensures that:  Market offers will not be displaced by NSRS/RUC offers, and  NSRS/RUC offers will not slow or stop a markets response

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