1. NPRR639 Discussion CWG/MCWG August 20, 2014 1

2. Current MCE Calculation MCE ignores net purchases of bilateral energy. See red portion of MCE formula below. MCE = Max[{ [[[L o, i, d, k * T2 - G o, i, d, k * (1-NUCADJ o ) * T3] * RTSPP i, d, k *SAF] + [RTQQNETES o, i, d, k * T1]]/n}, { [G o, i, d, k * NUCADJ o * T1 * RTSPP i, d, k *SAF]/n},{ DARTNET o, i, d, k * T4/n}] RTQQNETES o, i, d, k = Max [0, [[RTQQES o, i, d, k, c * RTSPP i, d, k *SAF] - [RTQQEP o, i, d, k, c * RTSPP i, d, k *SAF]]] 2

3. Flaw of current MCE design MCE calculates an inflated credit exposure which does not reflect the actual risk posed to the market. Purchases of bilateral energy reduce credit exposure. MCE penalizes prudent hedging decisions. This flaw in MCE gets magnified with SAF increase. Example: Market Participant serves 100MW of Load (L). Market Participant does not own any Generation (G). Market Participant purchases 100MW of firm physical power through bilateral trades (RTQQEP). Market Participant is 100% hedged. MCE zeroes out the hedge and treats Market Participant like it is short its entire load obligation. MCE = (100*T2 – 0)*RTSPP + Max (0, 0 – 100*RTSPP)*T1 = 100MW*T2*RTSPP – MP is actually flat so poses no credit risk to the market Why collateralize them like they didn’t hedge? 3

4. Hedged Counterparty Price spike occurs on Day 7 L = 100MW, RTQQEP = 100MW, Normal Price = $50/MWh, Price Spike = $9,000/MWh SAF = 100% Note: EAL = $0 4 Actual Exposure is Zero

5. Why is MCE designed this way? MCE ignores net energy purchases to capture this scenario: A Market Participant in the process of defaulting will not be able to find a trading partner willing to sell them power. This design is misguided for the following reasons: – At any given time, the vast majority of Market Participants are not in the process of defaulting. So why treat everyone like they are? Don’t use a market-wide rule to try to catch exceptions specific to a single Market Participant (or very few). – EAL will immediately pick up the change in hedging behavior when it matters and much more timely than MCE. See slide 6. – MCE allows for netting of DAM bids and offers so inconsistent. – ERCOT has better tools to address the situation with the discretion to ask for more collateral from a Market Participant if their ability to meet credit requirements is threatened. 16.11.4.1 (3). An MP-specific issue is better managed through an MP-specific solution. 5

6. Counterparty that cannot hedge Price spike occurs on Day 7 L = 100MW, RTQQEP = 0MW, Normal Price = $50/MWh, Price Spike = $9,000/MWh SAF = 100% 6 EAL addresses the situation faster than MCE

7. Why NPRR639? Credit exposure should more closely match the actual risk posed by the behavior. Prudent hedging practices should be incentivized and reflected in the credit risk exposure evaluation (like the rest of our credit rules). Don’t apply a market-wide rule to try to catch exceptions. Current design of MCE punishes the population of MPs for little benefit. Use better tools to address concerns, not a discriminatory approach which creates the wrong incentives. NPRR639 MCE = Max[{ [[[L o, i, d, k * T2 - G o, i, d, k * (1-NUCADJ o ) * T3] * RTSPP i, d, k *SAF] + [RTQQNET o, i, d, k * T1]]/n}, { [G o, i, d, k * NUCADJ o * T1 * RTSPP idk *SAF]/n},{ DARTNET o, i, d, k * T4/n}] RTQQNET o, i, d, k = Max [0, [[RTQQES o, i, d, k, c * RTSPP i, d, k *SAF] - [RTQQEP o, i, d, k, c * RTSPP i, d, k *SAF]]] 7