1. UNDERSTANDING THE 1992 ISDA MASTER AGREEMENT
ENERGY AND WEATHER DERIVATIVES WORKSHOP
JUNE 17, 1999
Kevin D. Leitao - LeBoeuf, Lamb, Greene & MacRae, L.L.P.
Mark E. Taylor - Enron Capital & Trade Resources Corp.

2. ENERGY DERIVATIVES WEATHER DERIVATIVES Sample Transactions
Documentation Issues
Counterparty Issues
WEATHER DERIVATIVES
The Market
Types of Transactions
Case Study

3. ENERGY DERIVATIVES DrilPro Dealer DrilPro Customers
$18.50/bbl on
2,500 bbl/day
10,000 bbl/day
Dealer
DrilPro
Customers
DrilPro
DrilPro, an independent oil producer of 10,000 bbl/day, is analyzing exploration and development programs over the next five years. The firm wants predictable cash flows in order to determine its ability to capitalize on drilling opportunities during this period.
To help accomplish its objective, DrilPro enters into a five-year swap agreement with Dealer to hedge 25% of its current production at a fixed price of $18.50/bbl. With this cash-flow assurance, DrilPro can better leverage its existing resources to build its future production capacity.

4. ENERGY DERIVATIVES During the life of this swap:
DrilPro continues to sell crude oil to its customers at an agreed-upon crude oil index price.
DrilPro and Dealer exchange payments on a monthly basis equal to the difference between the fixed price of $18.50/bbl and the floating index price, as specified in the swap agreement.
For example, if the index price for a given month is $17.88/bbl, DrilPro will receive $0.62/bbl from Dealer. However, if the index price is $18.64/bbl, DrilPro will pay Dealer $0.14/bbl. The net effect is that by combining the swap with its current physical crude oil contract, DrilPro receives $18.50/bbl for its crude oil.
DrilPro has stabilized a portion of its operating cash flow with the swap. This swap gives the company more confidence to participate in additional drilling opportunities, which could potentially increase its overall revenues.

5. ENERGY DERIVATIVES Dealer Producer MidPower
Chicago City Gate Index
Chicago City Gate Index
Dealer
Producer
MidPower
Average Last 3 Days’ NYMEX
+ $0.10
Gas at Chicago City Gate
MidPower, a regional electric power company, uses a large amount of natural gas to fuel its power plants. It currently purchases gas from a producer at prices based on the delivery price of gas at the Chicago city gate. MidPower eventually wants to lock in the price of its gas supply. However, it currently wants to lock in only the basis between the NYMEX price and the Chicago city gate index. MidPower enters into a basis swap with Dealer, and still has the flexibility to either lock in its gas supply price by entering into a futures-based (Henry Hub) swap or let its price float with the market.

6. ENERGY DERIVATIVES During the life of the transaction:
MidPower receives its gas supply from the producer and pays the producer the Chicago city gate index price.
MidPower enters into a basis swap to eliminate basis risk in the transaction. MidPower agrees to pay Dealer an amount equal to the NYMEX price (average of the last three trading days) plus $0.10 in exchange for receiving the Chicago city gate index. The swap is usually settled monthly. This ensures that the net price MidPower will pay for its gas is the NYMEX price plus $0.10.
MidPower can choose to either lock in its price by entering into a futures-based (Henry Hub) swap or let its price float with the NYMEX price.

7. ENERGY DERIVATIVES Documentation Issues Cross-defaults
“Specified Transactions”
Keep physical and financial trading separate or tie together?
Calculation of termination amounts
Market Quotation or Loss?
Adequate assurance provisions
Credit considerations
Recent price volatility - dramatic swings in exposure
Documents to be delivered
Resolutions may tell you more than you want to know
Authorized trader lists are a two-edged sword

8. Documentation Issues (cont’d)
ENERGY DERIVATIVES
Documentation Issues (cont’d)
Dispute resolution mechanisms
Waiver of jury trial, arbitration?
Confidentiality
Market Disruption Events
De Minimis trading?
Tax disruption
Trading limitation - definition
Market Disruption Fallbacks
Get commercial input!
Postponement
Fallback reference price
Negotiated fallback (specify period to negotiate)
Dealer quotations
No-fault termination?

9. Counterparties in the New Energy Markets
ENERGY DERIVATIVES
Counterparties in the New Energy Markets
Integrated Utilities (with generation, transmission and distribution assets)
“Disaggregated” Distribution Utilities
Power Generation Companies
Power Marketers (with few, if any, physical generation assets)
New Transmission Entities (“transcos” and “independent system operators”)
Energy Services Companies
Cooperatives and Municipalities (with distribution and, sometimes, transmission and generation assets)
Federal Government Power Administrations and Instrumentalities (with generation and transmission assets)
Industrial and Commercial Energy End-users
Financial Institutions

10. ENERGY DERIVATIVES Counterparty Issues Issues Counterparty Types
Authority of signer
Power of Counterparty
Bankruptcy
Counterparty Types
Governmental & Quasi-Governmental Entities
Municipalities
Municipally owned utilities
Crown corporations (Canada)
Regulated Entities
Utilities
Insurance companies

11. Counterparty Issues (cont’d)
ENERGY DERIVATIVES
Counterparty Issues (cont’d)
Solutions
Documentation
Additional representations and warranties
“Incipient Illegality”
Automatic Early Termination?
Due diligence
Legal opinions, advice of local counsel
Resolutions, officers’ certificates

12. WEATHER DERIVATIVES The Market
Weather affects an estimated $2 trillion of the $9 trillion US economy
The first OTC weather derivative transaction, designed to stabilize
weather-sensitive revenues, was completed in August 1997
In February 1999, CME announced plans for the first exchange-traded
weather temperature futures and options
Today, more than 1,200 OTC transactions have occurred with a
notional value of over $2 billion
Positions out to 2004
Growing number of international deals

13. WEATHER DERIVATIVES Types of Transactions
Degree Days (Heating/Cooling)
Maximum/Minimum Temperatures
Rainfall
Snowfall
Wind
Perceived Temperature
Combinations

14. WEATHER DERIVATIVES Possible Structures Types of Contracts Term Size
Swaps, caps, floors, collars, exotics
Term
Mainly seasonal
Multi-year transactions
Size
$200/DD - $500,000/DD
Limits
Most transactions to date have been capped to reduce aggregate exposure
Locations
Hundreds of weather stations
Baskets (multiple locations)
Hybrids
Weather linked financings
Securitizations

15. Wisconsin Gas Case Study
WEATHER DERIVATIVES
Wisconsin Gas Case Study
Risk management need:
Volatility in winter temperatures affecting earnings (and management incentive compensation)
Stabilize earnings
Facts:
Regulated utility
500,000 customers
40% of gas used in Wisconsin
AIG approached them between 1994 and 1996 but no deal was done
In 1997 WICOR wanted to protect against El Nino
Regulatory Problem:
No weather normalization clause
Regulators did not permitthe purchase of derivatives since it is a regulated utility
based on the thought that derivatives are risky

16. Wisconsin Gas Case Study (cont’d)
WEATHER DERIVATIVES
Wisconsin Gas Case Study (cont’d)
The Answer:
Have the parent, WICOR, purchase a weather collar derivative
Weather Collar:
The collar combined calls and puts.
The buyer is assured not to have to pay more than a specified maximum price
The seller is assured of receiving a specified minimum price
The Benefit:
WICOR only pays out when they have increased revenues due to colder than normal weather. WICOR only receives a payment when their revenues are impacted negatively due to warmer than normal weather.

17. Wisconsin Gas Case Study (cont’d)
WEATHER DERIVATIVES
Wisconsin Gas Case Study (cont’d)
The Effect:
With the collar WICOR gave up some of the upside potential for protection during a colder than normal winter
In return, WICOR obtained protection against a mild winter due to El Nino.
The Outcome:
WICOR received $1.3MM in payments
Alternatives:
WICOR could have also paid for a derivative thereby capping out any effects on a colder than normal winter
Calls, Puts, Collars, Swaps, Strangles