1. BOSTON DALLAS DENVER LOS ANGELES MENLO PARK MONTREAL NEW YORK SAN FRANCISCO WASHINGTON Decoding Developments in Today’s Electric Industry — “Ten Points in the Prism Decoding Developments in Today’s Electric Industry — “Ten Points in the Prism” Susan Tierney COMPETE/EPSA Meeting – November 5 th, 2007

2. 22 Why this study? Electricity prices have been rising around the U.S. in recent years. Almost no part of the country has been spared. In well-known circumstances – e.g., – California, Maryland and Illinois In less-expected places – e.g., – Florida, Arkansas, Louisiana and Hawaii

3. 33 Why this study? There’s especially high scrutiny to price changes in electricity – We take electric power for granted – until prices rise. When prices rise, we tend to think that something is wrong that needs to be fixed. Our traditional regulatory paradigm gives us a predisposition to intervene. Because of recent electric industry restructuring, it’s natural to consider the potential link between these changes and recent price increases.

4. 44 Why this study? To decode what’s going on with prices Lots of debate, interest in electricity prices. Purpose – review the literature, analyze trends. Caveat – speak for own self, not EPSA, nor for AG. To comment on what should — and can — be done about it

5. 55 What’s happening? The bottom line: Relatively high electricity prices are likely to be the “new normal” in the electric industry Based on fundamental economic forces No region is likely to escape these realities: No satisfyingly simple storyline on these issues. “10 Points in the Prism”

6. 66 1. Electricity is not ‘too cheap to meter’ The continuing view — (electricity should be cheap, and there’s someone to blame when it’s not) — is not reality-based. U.S. Retail Electricity Prices: Average Annual Electricity Prices Relative to Prices in 1996 (1996 Average Retail Electricity Price: 6.64 cents/kWh)

7. 77 1. Electricity is not ‘too cheap to meter’ (cont’d) Prices have risen in almost every state since 1995. Price increases: 70% to -8%

8. 88 1. Electricity is not ‘too cheap to meter’ (cont’d) Central reason: Fossil fuel price increases – in global markets Prices of Electricity, Natural Gas and Petroleum — 1987-200

9. 99 1. Electricity is not ‘too cheap to meter’ (cont’d) Price impacts vary by regions and their fuel mix. Coal has kept prices low in certain regions. Mix of Fuel Used to Generate Electricity in Different U.S. Regions

10. 10 1. Electricity is not ‘too cheap to meter’ (cont’d) Significant recent investments in power facilities: Generation investment: – Meeting demand growth (~Texas-sized increment added since 2000). – 210,000 MW added from 2000-2007.  ~ one power plant a week; ~$99 b. – Air pollution controls - $21 b. (from 2000-2005) Transmission: – 2,500 miles added in 2005 – $24.5 b. in 2006 (up from $10.4 b in 1995)

11. 11 1. Electricity is not ‘too cheap to meter’ (cont’d) New investments on the horizon Power resource requirements – 258,000 MW needed by 2030 (EIA) Meeting new clean air regulations – $2.7 - 4.4 b. per year in upcoming years New investments relating to carbon controls New transmission New demand meters and energy efficiency investments

12. 12 2.Although prices are rising, electricity still provides value Electricity is still cheaper today than in the past: Price today (inflation-adjusted) is 2/3 of what it in the 1980s Average all-in retail price of electricity Price of Electricity (inflation-adjusted) Price of Electricity (real dollars)

13. 13 2.Although prices are rising, electricity still provides value Electric expenditure as % of GDP

14. 14 2.Although prices are rising, electricity still provides value Electric prices

15. 15 2.Although prices are rising, electricity still provides value % of Household Median Income – same as a decade ago

16. 16 2.Although prices are rising, electricity still provides value Americans use 25% more power than two decades ago.

17. 17 3.Electricity prices are rising everywhere; it’s too simple to assign it to “regulation” or competition” Restructured states Non- Restructured states

18. 18 3.Electricity prices are rising everywhere; it’s too simple to assign it to “regulation” or competition” Non- Restructured regions Restructured regions

19. 19 3.Electricity prices are rising everywhere. It’s too simple assign prices increases to “restructured states” or “competitive regions” versus traditionally regulated states or regions. The states that restructured a decade ago were mainly the ones with high electricity prices; The gap has narrowed between the high-priced states that restructured and those that didn't; The states with more coal in their power generation mix a decade ago have lower prices today; The states that restructured ended up adding new gas-fired generation – because they had markets, had prices high enough to induce investment, and had a variety of economic and environmental policies favoring gas.

20. 20 4.Restructured electric markets have provided benefits This is despite some new costs and slow development of retail choice for small customers. Part of the rationale for restructuring was sending better incentives for efficient operations and investment in the industry. Results have shown that these have the results: Many consumers are better managing their electric use Power production efficiencies – Improvements in heat rates, availability, O&M costs, dispatch – Newer power production technologies – improved fleet averages

21. 21 4.Despite some new costs and slow development of retail choice for small customers, restructured markets have provided benefits Newer, cleaner power generation technology Recent Improvements in Power Plant Efficiency & Emissions: New England Example Heat Rate (MBtu per MWh) ’99-’05 Emissions of CO2 (lb. per MWh) ’93-’05 Less energy used to produce power Lower emissions for power produced

22. 22 4.Despite some new costs and slow development of retail choice for small customers, restructured markets have provided benefits Newer, cleaner power generation technology Total Installed U.S. Wind Energy Capacity (MW in each state as of June 2007 More wind in areas with RTOs

23. 23 5.Consumers and suppliers have both seen benefits. Very difficult to assign benefits among consumers and producers. Large industrial customers have benefited – many examples of gains derived from managing own costs (including demand response) Small customers have had the benefits of: Efficiency gains (e.g., availability of nuclear plants) At-risk investment by investors (e.g., risk of surplus capacity) Utility and Non-Utility Generating Capacity Additions, 1995-2004

24. 24 6.It’s not harmful to consumers to have investors seeking adequate returns in the electric industry. Electric industry is extremely capital-intensive. Most electric capital in the U.S.: private investment 80% of generating capacity is privately owned (½ utilities, ½ IPPs) Estimated new capital requirement for energy/capacity – Over $412 billion by 2030 (EIA) – More in carbon-constrained economy – More at current prices of materials Additional investment will be required for T&D, metering, energy efficiency, carbon reduction For consumers to get the benefit of a reliable/clean electric supply, it will require the opportunity for adequate returns True in all regions

25. 25 7.Neither regulation nor competition is perfect. Investment will be attracted to places where there is a stable regulatory framework. Restructuring the power industry in 1990s was motivated by problems in the traditional model: High capital costs borne by ratepayers Inappropriate signals for investment and O&M and risk The transition to competitive markets has also not led to perfectly functioning markets Both retail and wholesale market designs have ended up with hybrid features. Debate today too often holds up the perfect standard – with complaints that “if only” the markets were pure. Yet investment opportunities may be most enhanced by stable market designs, rather than “if only” thinking.

26. 26 8.Market design actually matters, and is still evolving. If neither model is perfect, there are opportunities to improve the industry on whichever path a region or state has adopted. Restructured markets, including – Forward markets for capacity – Long-term transmission rights – Demand response – Improved price signals to retail customers – Improved energy efficiency delivery models Traditional markets – opportunities to improve include: – Improved market-based competitive procurements – Non-discriminatory access to transmission – Improved regional transmission planning – Improved price signals to retail customers – Energy efficiency and demand-response delivery models Both require care in the “fixes” applied

27. 27 9.Technology doesn’t just happen in the electric industry without the incentives embedded in market and regulatory rules. The industry is inherently technology-based. Complex systems of machines, controls, technologies – for supply, delivery, operations, demand-management. The challenges for the future are significant. Business-as-usual technologies will not be enough to meet the nation’s needs – Especially in a carbon- constrained economy.

28. 28 10.Consumers will be better able to realize the full benefits of competitive wholesale markets if they are brought out of the dark. Most Americans see only average monthly prices in their electricity bills. Given the “new normal” of higher electricity prices, consumers would benefit from greater information about prices – to help them manage their bills. Lessons from large customers that “see” time-of-use prices. – Demand response resources in NYISO, PJM, NE – 1000’s of MW – Cambridge energy efficiency alliance Empowering consumers with the tools to understand and control electricity use is one of the most important “fixes” in all regions of the U.S.

29. 29 Susan F. Tierney, Ph.D. Managing Principal Analysis Group, Inc. 111 Huntington Ave., 10 th Floor Boston, MA 02199 ph: 617-425-8114 fax: 617-425-8001 stierney@analysisgroup.com www.analysisgroup.com