Appeal of Proposed Real Time Market Mitigation Measures Texas Nodal Market May 18, 2004

TNT’s Compromise on Real Time Mitigation Has Incentives for Everyone Except Combined Cycle Plants What’s in it for new investment? –New Investment would be capped at a 14.5 HR, which would have adequate head room (or incentives) for new combined cycle units to recover their capital cost What’s in it for older, less efficient plants? –Most of the older, less efficient gas plants across ERCOT, which typically have low capacity factors, are provided a substantial incentive (as much as cost plus 50%) which allows them to recover their costs and make a profit What’s in it for loads? –Loads acting as a resource would not be mitigated What’s in it for combined cycle plants? –Existing combined cycle plants, which typically have capacity factors greater than 50%, would be mitigated to their short run costs plus 10%, which does not allow for recovery of capital This is clearly unfair and must be changed!

What’s the Problem? We want existing combined cycle generators to take all the financial risk for their investment decision, but we are proposing a mitigation rule that guarantees they won’t recover any of their fixed costs when mitigated It is conceivable, in any system, that transmission topology can change over time, what were good siting decisions by generators are overtaken by change, and relatively new generation can find itself in a constrained area without a competitive solution If this rule were adopted, combined cycle plants would be mitigated to a price that is less than a generator would have made in a cost of service based regulated market…This is neither just nor reasonable.

What’s the Problem? (cont.) Let’s take a simple example: A combined cycle unit, over one year, is mitigated 30% of of it’s hours of operation Typical capital costs range from $18 to $20/MWh for new units Since the unit would not be allowed to recover any of their fixed costs when mitigated, the combined cycle owner is now forced to try to recover their capital costs in the remaining 70% of the hours This means their cost structure is now substantially raised to around $25 to $28/MWh Given how competitive markets work, combined cycle units can’t simply raise their prices in bilateral markets to recover this higher level of costs and therefore they begin the “Death Spiral” The “Death Spiral” is characterized by mothballing or retirement declarations, bankruptcies, and inadequate new resources because banks consider ERCOT an inhospitable market for investment

What Should the Board of Directors Do? The Board needs to level the playing field and ensure that combined cycle plants have the same incentives as other plants, when mitigated The best way to achieve this is to modify the TNT real time mitigation compromise to define costs as long run costs, which includes the actual cost of capital for each unit Or alternatively, the Board could modify the bid cap for combined cycle resources to a 14.5 Heat Rate, which would allow for recovery of capital costs