1. ENERGY FUTURES MARKET

2. ASPECTS OF PRICE VOLATILITY  PRICE ADJUSTMENTS SUPPLY/DEMAND CHANGES. The obscure period of oncoming growth of power consumption, which reduction was caused by conditions of the economic crisis. INFRASTRUCTURAL LIMITATIONS (structure of generating equipment, repairs, power lines). The time needed for structural changes in power sector which will help to cut the price volatility, is significantly longer. OPERATING TROUBLES. Annually growth of accident risks. FUEL. Uncertainty of fuel prices, beginning of gas exchange trading. CLIMATE. Climate variability.

3. Risks of market members PLANNING.  PRODUCERS GUARANTEE OF FIXED INCOME (execution of an actual business-plan). Day-ahead market price is variable. It affects the income statement, an essential document for stockholders, creditors and prospective investors. LONG-TERM CONTRACTS (FORM OF PRICE).  CONSUMERS GUARANTEE OF FIXED PRICE. Reducing the risk of cash deficiency. 100% market pricing along with keeping the current system of translation for guaranteed supply companies, will cause the end- consumer to pay for all the price variations for a fully liberalized volume. LONG-TERM CONTRACTS (FORM OF PRICE).

4. The purpose of hedge Decrease of energy price variation risk, that offends : 1.The price of capacity in NECC (СДЭМ) (Non-regulated Electricity & Capacity Contract). 2.The buy/sell price at the day-ahead market. Organization of predictable money flows. On all markets worldwide hedge is operating by signing a financial contracts which do not intend material delivery/consuming of energy, negotiated at the exchange or on bilateral basis, in combination with buying/selling the same volumes of energy on a spot market. The lack of mechanisms & practice of price risks insurance leads to situations when in case of unpredicted natural disasters or global accidents on a crucial energy objects, a government has to interfere in pricing for solution of a social problems. In countries where financial contracts are well-developed, a consumers have a lot more protection and problems are solved using a market methods.

5. What can you achieve? A producer of energy will be able to: Stabilize the money flow of income from selling electricity & capacity. Make a perfect forecast of volume of future money income from selling electricity regardless of price variations on a day-ahead market. A consumer of energy will be able to : Decrease the dependence of payments for energy from variations on day- ahead market. Execute business-plans in a part of energy costs regardless of price variations. Sales company will be able to: Offer to its clients a new products with fixed prices on electricity for schedule dates. Receive an additional income from difference between futures price and sale price.

6. Instruments for hedging your risks Non-regulated Bilateral Contract (СДД). Its disadvantages: 1. Non-payment risk. 2. Distribution of imbalance of the market. 3. There’s no possibility to close a position in case of negative price change. 4. Tax risks (particle 40 Tax Codex of RF) Futures. Advantages: Standardization. Liquidity. A market basis of prices. Guaranteed payments. The only disadvantage is a need of partial deposition of money (initial margin) for contract execution. However this is a guarantee of payments.

7. Practical application of futures 1. Fixation of capacity price on exchange for NECC. A members of exchange, negotiating a NECC contract, form a NECC with 2 parts : electricity & capacity. In that way they fix a needed price of capacity and forecast an electricity price for month of delivery. An actual price of capacity on NECC is a difference between the price level of NECC and cost of electricity, which is part of NECC, on a day- ahead market in a period of delivery. The way the price of electricity offends the real price of capacity can be seen on a next slide.

8. Practical application of futures A change of capacity price in exchange NECC related to price of electricity on a day-ahead market

9. Practical application of futures Example for buyer: In July of 2009 he negotiates a NECC on August of 2009 for 232 095 RUR. NECC consists of 1 MWT of capacity and 147 MWH of electricity in peak hours. At the same time buyer plans to buy a capacity at KOM1(initial average) price – 102 000 RUR and forecasts the electricity price at 885 RUR / 1 MWH, predicting its seasonal growing. So for the date NECC has been signed, the prices do fit both – a consumer and a producer. To fix a price of a capacity (102 000 RUR) a buyer sells futures for 147 MWH at the price of 885 RUR. He has an option of making a two-sided deal with the same producer. In August of 2009 a price for electricity instead of growing, has a downward trend and it is 740 RUR. Therefore an actual price of capacity gone up to 123 220 RUR. However buying futures a consumer receives an income of 21 315 RUR : (885-740)*147 – so the total price of buying a capacity is 102 000 RUR.

10. Practical application of futures An example for a producer: In November a producer negotiates a NECC for December of 2009 for 252 000 r. NECC consists of 1 MWT of capacity and 156 MWH of electricity in peak hours. Let’s assume that he wishes to sell his capacity on KOM-1 price (133 440 RUR) and predicts the price of electricity at the level of 760 RUR fo 1 MWH, forecasting its growing. So for the date NECC has been signed, the prices do fit both – a consumer and a producer. To fix the capacity price of 133 400 RUR he buys futures on 156 MWH at the price of 760 RUR. He has an option of making a two-sided deal with the same consumer. In December of 2009 a price has gone up ( 907 RUR). Therefore an actual capacity price is 110 500 RUR. But selling futures a producer receive an income of 22 932 : (907-760)*156 and the final capacity price is 133 440 RUR.

11. Practical application of futures 2. Electric power spot price hedging

12. Practical application of futures Electric power spot price hedging by consumer January 2010

13. Example. Assume that consumer plans to buy 744 MWH (1 MWH for every hour of January) at the price not above 720 RUR/MWH. Total contract value – 535 680 RUR. Prices at GTP of buyer correlates to the «Ural» hub index. Average electric power price in December 2009 – 750 руб. Consumer risks: Spot market price in January will rise above 720 RUR/MWH. (consumer will have to buy at higher price). To hedge (insure) the risk of price rise at spot market, consumer buys 10 EUBM-1.10 future contracts that will settle in January 2010г. Exchange transaction date – 30 th of December, 2009 Contract price – 715 RUR/MWH Total contracts value – 531 960 RUR Practical application of futures

14. At the time of this calculations the spot price in January in «Ural» hub is 854 RUR/MWH Financial result: Without hedging: Spot market expenditure = 854*744=635 376 RUR, that is 99 696 RUR (535 680- 635 376) more than planned expenditure. With hedging: Spot market expenditure = 854*744=635 376 RUR. Variation margin payouts = (854-715)*74,4*10= + 103 416 RUR. Actual expenditure including variation margin = 635 376 – 103 416= 531 960 RUR. Actual value of 1 MWh including variation margin = 531 960/744= 715 RUR/MWH Practical application of futures

15. Electricity spot price hedging by producer October 2009 г.

16. Example. Power producer plans to sell 3720 MWH at price not lower than 700 RUR/MWH in October 2009. Total contract value – 2 604 000 RUR. The price at GTP (group of delivery points) of the producer correlates to the «Ural» hub index. Average electricity price in September – 768 RUR. Producer risks: Producer forecasts seasonal drop in price, but not less than 700 RUR/MWH. The risk is that spot price will drop lower 700 RUR/MWH. To hedge (insure) the risk of price decline at spot market, producer sells 50 EUBM-10.09 futures that will settle in October 2009. Exchange transaction date – 25 th of September, 2009 Contract price – 710 RUR/MWH Total contracts value – 2 641 200 RUR Practical application of futures

17. At the time of this calculations the spot price in «Ural» hub is 693 RUR/MWH. Financial result: Without hedging: Spot market revenue = 693*3720=2 577 960 RUR., that is 26 040 RUR less than the revenue objective. With hedging: Spot market revenue = 693*3720=2 577 960 RUR. Variation margin payouts = (710-693)*74,4*50= + 63 240 RUR. Total revenue including variation margin = 2 577 960 + 63 240 = 2 641 200 RUR Actual value of 1 MWh including variation margin = 2 641 200/3 720= 710 RUR/MWH Practical application of futures

18. EXCHANGE INFRASTRUCTURE  TRADING ORGANIZER. EXCHANGE «АРЕНА» EXCHANGE  CLEARING CENTER FUNCTIONS CENTRAL COUNTERPARTY, TRADE SETTLEMENT GUARANTEE  BROKERS ENERGY COMPANIES FINANCIAL INSTITUTIONS  PARTICIPANTS (BROKERS’ CLIENTS) ENERGY COMPANIES PHYSICAL PARTIES

19. BROKERS Brokers are companies holding a license of exchange intermediary that gives authorization to conclude transactions on the exchange Broker’s clients – individuals and organizations Broker’s services: –Portfolio management, –Assets controlling, –Reporting results for clients, –Trading systems providing, –Analytics.

20. INSTRUMENTS AND TECHNOLOGY Financial, non-deliverable future is the financial contract that is settles by paying variance margin – difference between the contract price and the price of the underlying asset. Underlying asset for futures is the average price of electric power in Center and Ural hubs of the first price zone and Kuzbas hub of the second price zone on certain delivery hours (base-load hours and peak hours). Why hub index is used? Close to 99% correlation of the hub index to the price of the GTP (group of delivery points) included in hub index. The trading technology is similar to the EEX exchange technology that makes the trading mechanism multipurpose for the Russian and foreign participants.

21. PRICE FORMATION  A METHOD OF PRICE FORMATION – CONTINIOUS TWO WAY AUCTION.  SUBMISSION OF ORDERS TO THE EXCHANGE SYSTEM. ANONIMOUS ORDERS: AT MARKET PRICE. AT SPECIFIC PRICE. ADDRESS LIMIT ORDERS: AT SPECIFIC PRICE.  TRADING HOURS 10:30-23:50 (MOSCOW TIME)  CLEARING – SYSTEM OF THE PARTIES’ OBLIGATIONS DEFINITION UNDER TRANSACTIONS: CLEARING TIME: 14-00, 18-45. VARIATION MARGIN RECALCULATION. SETTLEMENT PRICE DETERMINATION (TWICE A DAY).