ERCOT Market Credit Working Group Presentation to the Finance and Audit Committee Payment Short Pay/Default and Uplift for Congestion Revenue rights (CRRs) May 20, 2009

Issue Present nodal protocols for a short pay by an entity in the Congestion Revenue Rights (CRR’s) market will result in the Day Ahead Market (DAM) being short paid Stakeholders have identified the present nodal protocol CRR short pay methodology as problematic (see next slide) NPRR147 drafted by stakeholders attempts to remedy the existing issue of short paying in the DAM

NPRR147 NPRR 147 changes the way short pays to the Day-Ahead Market (DAM) are handled. –Reallocates short payments using a procedure that draws from the Congestion Revenue Right (CRR) Auction revenue account first and then draws any additional shortfalls from the CRR Balancing Account –Allocation to the DAM of short pays is ineffective due to the voluntary nature of the DAM. This NPRR will prevent the potential collapse of the DAM should a large default event occur with CRRs or the DAM. Benefit: The NPRR should prevent distortion of the DAM results or complete failure of the market. Impact: Qualified Scheduling Entities (QSEs) serving Load would receive reduced CRR Auction revenue disbursement payments and potentially receive reduced Balancing Account closure payments should a CRR account holder default on an obligation.

Alternative Proposal 1 Concerns were raised with NPRR147 by some stakeholders including the amount that would ultimately be “uplifted to load” at one time and that those benefiting from the CRR market bear the cost of a default---should this be bear the least cost of the default.. CPS offered an alternative to NPRR147 that would result in a charge being added to CRR bids and offers to “fund” a short pay fund to reduce the magnitude of any loss that would need to be uplifted, and after the shortfall fund was exhausted would revert to the methodology contained in PRR147 –Issues were raised with Alternative 1, that it would impact price convergence for the CRR markets –Other issues raised included Should there be a cap on the fund, and if so, what amount? What to set the charge at for the “fund”, do you charge after funded? System Impact Inefficient use of capital by “prefunding” Refunding of amounts?

Other Issues Raised With both NPRR147 and Alternative Proposal 1 a further issue was raised by some stakeholders that all losses from CRR’s in the DAM ultimately are uplifted to load Alternative Proposal 2 (next slide) attempts to address concerns brought up by parties with respect to the existing nodal protocols, risks to price convergence, impact of large losses at one time, and the loss uplift methodology (broaden)

Alternative Proposal 2 ERCOT, Inc. funds short payments in the DAM through a debt facility established for that purpose DAM immediately paid Short pays allocated to ERCOT membership on a loss mutualization methodology like the northeast ISO/RTO markets –TBD (broader loss mutualization across all stakeholders, i.e. using absolute gross $$ injected and withdrawn from system) Short-pays above a certain level that become defaults would be allocated up to a predetermined maximum per billing period (i.e. $2MM per participant)

Alternative Proposal 2 Benefits –Allows for price convergence in the CRR markets (no adder to bids/offers) –Does not unnecessarily tie up scarce collateral of stakeholders to fund a prepay account –Allows for a cap on any amount to be charged in any period to any one counterparty (smoothes impact) –Socialized losses across all market participants (and keeps the markets integrated –all market participants are sharing in losses across all ERCOT nodal markets) –Cost to market is less by obtaining a facility in case of loss Open Issues –ERCOT Inc., obtaining approvals to enter into such a facility Other markets do have such facilities (NYISO has a $50MM fund) –Amount of facility –Cap for charges for a single period, per participant –System Impact –Methodology for uplifting to market participants –Conforming changes to Protocols