Unit-Specific Bid Limits based on Modified Generic Cost

Market Solution Payments $56,837,671 Historical Market Solution Costs Initial cost for June and July was approximately $60 MM

Request to Remove Market Solution

PUC comments on removal of market solution The staff of the Public Utility Commission of Texas (PUCT staff) recommends approval of PRR 440. The Market Solution concept is currently not working properly, and is producing excessive local balancing energy service payments. PUCT staff also supports suspension, rather than elimination, of the use of Market Solution. As the Commission stated in approving Market Solution in the initial Protocols, “Competitive pricing should be used where feasible, so long as the price is the result of sufficient, active competition.” Docket No , Order on Rehearing, pages PUCT staff also supports a specific suspension period, rather than an indefinite suspension, in order to provide an incentive to correct the functioning of Market Solution and reinstitute it on a prompt basis. PUCT staff is somewhat concerned that the length of the suspension period, five months, may be excessive. However, PUCT staff is not objecting to this suspension period, with the understanding that ERCOT staff and stakeholders will work diligently with PUCT staff to develop and implement a corrected Market Solution on a prompt basis, before December of this year, if possible.

Board Approved PRR 440 In order to avoid the continued possibility of such high costs for resolving Local Congestion, PRR 440 is needed to change the payment structure to only use the formula proxy price for providing this service. A “sunset” date for this change is included (December 31, 2003) to make it clear that ERCOT and the Market Participants must develop a better alternative to this process and payment structure in a reasonable timeframe. Conclusion: Removal of the Market Solution payment option for Local Congestion is appropriate and should be implemented on an expedited basis. A sunset date of December 31, 2003, has been included under the assumption that an alternative Market Solution approach can be developed and implemented prior to that date. Recommendation: PRS and TAC have approved PRR 440 as urgent and recommend that the Board immediately approve the PRR in the form approved by TAC, as indicated in the attached TAC Recommendation Report. ERCOT Staff concurs in these recommendations.

Extension of No Market Solution 466PRR This revision extends the current expiration date for the suspension of Market Solution from December 31, 2003 to Feb.1, 2005.

Goal of Market Solution Replacement Develop a new market solution mechanism that manages the cost of solving local congestion upon the expiration of PRR 466, while allowing Market Participants to bid below an acceptable bid cap when multiple Market Participants are able to solve the same local constraint. NOTE: If PRR 466 is allowed to expire, the present Market Solution mechanism allows a $1000 premium limit.

Working Group’s Approach In order to prevent high congestion costs as experienced in June and July of 2003, the stakeholders agreed to trade-off removing the market solution mechanism in return for incorporating a premium bid limit that is closer to the present generic costs plus a reasonable margin. Remove the “after-the-fact” determination of Market Solution process by developing a mechanism which allows ERCOT to deploy specific units based on actual payment expected to be paid to Market Participant.

Market Solution Compensation for Gas-Steam = $1000 Market Solution Compensation for Combined Cycle = $ Compensation from ERCOT $1000 Compensation from ERCOT $1000 Unit-Specific Payment based on original Market Solution ($ revenue)($ revenue) Combine CycleGas - Steam Marginal Cost (7.2 HR * $4.50) +$4.00VOM= $36.40 Marginal Cost (10.8 HR * $4.50) +$4.00VOM= $52.60

Present Generic Compensation for Gas-Steam = 14.5 HR Present Generic Compensation for Combined Cycle = 9.0 HR Compensation from ERCOT 9.0 HR* $4.50 gas = $40.50 Compensation from ERCOT 14.5 HR * $4.50 gas = $65.25 Unit-Specific Payment based on Current Generic Cost Method ($4.10 net revenue)($12.65 net revenue) Creates incentive to operate inefficient units Combine CycleGas - Steam Marginal Cost (7.2 HR * $4.50) +$4.00VOM= $36.40 Marginal Cost (10.8 HR * $4.50) +$4.00VOM= $52.60

9.5 HR + (Inc. HR inefficiency >7.2) = (9.5 + (10.8 – 7.2)) = 13.1 HR 9.0 Generic HR = 9.5 HR Modified Compensation by ERCOT 9.5 HR* $4.50 gas = $42.75 Previously ($40.50) Modified Compensation by ERCOT 13.1 HR * $4.50 gas = $58.95 Previously ($65.25) ($6.35 net revenue) Develop a method that compensates for increased costs, but does not reward for being inefficient Unit-Specific Payment based on Modified Generic Cost Equalizes compensation to all Market Participants Combine Cycle Gas - Steam Marginal Cost (7.2 HR * $4.50) +$4.00VOM= $36.40 Marginal Cost (10.8 HR * $4.50) +$4.00VOM= $52.60

Up Deployments As part of the submittal of the Resource Plan, QSEs will specify bid premiums by Resource using the following formula: Gas = Daily FIP * [9.5 HR + ( Documented HeatRate – 7.2 HR)] QSEs requesting compensation above the 9.5 HR level, must provide documentation once a year, with ERCOT and the PUCT, attesting to the unit specific HR that will be used to calculate the bid premium. For Nuclear, Hydro, Coal and Lignite, Diesel, Block Load Transfer, and Renewable, the Modified Generic Price will remain the same as the present Generic Price as follows: Nuclear = $15.00/MWH Hydro = $10.00/MWh Coal and Lignite = $18.00/MWh Diesel = FIP * 16 MMBtu/MWh Block Load Transfer = FIP * MMBtu/MWh Renewable = $0/MWh

Down Deployments As part of the submittal of the Resource Plan, QSEs will specify bid premiums by Resource using the following formula: Gas = Daily FIP * [5 HR + ( Documented HeatRate – 7.2 HR)] (Presently 5 to 12 HR * FIP) For Nuclear, Diesel, Hydro, Coal and Lignite, Block Load Transfer, and Renewable, the Modified Generic Price will remain the same as the present Generic Price as follows: Nuclear = $0.00/MWH Diesel = FIP * 12 HR Hydro = $0.00/MWh Coal and Lignite = $3.00/MWh Block Load Transfer = Not Applicable Renewable = $0/MWh

Conclusions Modified Generic Cost Method equalizes net compensation for all Market Participants Equalizing revenues among all units, removes the incentive to freeze efficient units below their maximum capabilities and forcing ERCOT to deploy other inefficient units in the area that provide higher revenues Modified Generic Cost Method compensates for increase costs, but does not reward inefficiency Premiums based on settlement compensation assures deployment in the most efficient manner