1. DAM and Nodal Collateral Requirements Concerns and Solutions December 7, 2009

2. 2 Market Concern  Some are concerned that the significant collateral requirements on QSEs will discourage market participants from participating in the DAM, which will create inefficiencies and additional volatility. Additionally, unhedged QSE load in the DAM will result in increased default risk in real time.

3. Agenda 1 – Review previous DAM collateral discussions 2 – Examine Nodal Protocols 3 – Determine a short-term solution for market open 4 – Identify a long-term collateralization solution 3

4. Previous Over Collateralization Examples Highlighted Netting Deficiency A) LSE Example Hedge Strategy: (1) Bilateral Supply from Hub (2) CRR from Hub to Zone Day Ahead Activity DAM Offer: Sell Hub Quantity DAM Bid: Buy Load Zone Quantity DAM Collateral = [ Bid Price x Q] + [95 th % (RT-DA) x Q] Default Risk <> [ Bid Price x Q] + [95 th % (RT-DA) x Q] B) Resource Example Hedge Strategy: (1) Sell Hub Bilaterally (2) Buy CRR from Node to Hub Day Ahead Activity DAM Offer: Sell Node Quantity DAM Bid: Buy Hub Quantity DAM Collateral = [ Bid Price x Q] + [95 th % (RT-DA) x Q] Default Risk <> [ Bid Price x Q] + [95 th % (RT-DA) x Q] 3-Part Offer Identification A) Out of the Money Units Penalty for not offering units in the DAM High heat rate units submit offers but are not lifted in the day ahead market Collateral required regardless of probability of offer being lifted B) In The Money Units Collateral required without regard to available portfolio capacity; Higher heat rate units within portfolio limit real time exposure Unit performance and probability of outage is ignored within credit requirement 4

5. Previous Nodal Collateral Discussions  Market Participants and ERCOT staff have recognized that the credit requirements require overcollateralization of situational risk  Proposed solutions have included but are not limited to: I.Identify physical bids and offers in an effort to reduce DAM overcollateralization i.Distinguish offers: Three-Part Offers versus Virtual a)Not require out of the money units to post for submitting offers day-ahead that are unlikely to be dispatched b)Reduce credit requirements for in the money units to operational performance risk c)Decrease posting requirement from the 95 th percentile ii.Differentiate physical bids from virtual bids i.Expand netting from the same Settlement Point to offsetting risk management strategies ii.Lower bid posting requirements to forecasted net settled risk or a percentile of day-ahead and real time settlement differences. 5

6. Identify Nodal Collateral Requirements  Section 4. Day Ahead Operations ̶ Credit Requirements for DAM Bids and Offers (4.4.10.6) i.DAM Energy Bid: Quantity multiplied by bid price ii.DAM Energy Offer: Quantity times 95 th % RT – DA Δ iii.Same Settlement Point: Max of Bid/Offer credit requirement iv.Ancillary Services not self arranged: Quantity * 95 th % MCPC v.PTP Obligation Bids: Quantity * Bid Price + 95 th % RT – DA Δ  Section 7. Congestion Revenue Rights ─ CRR Auction credit constraint (7.5.5.3) i.Lesser of self-imposed credit limit or 90% Available Credit Limit ii.Additional credit for PTP Obligations: [$A per MW + Bid] x Absolute Quantity 6

7. Identify Nodal Collateral Requirements  Section 16. Registration and Qualification of Market Particpants ̶ Total Potential Exposure (TPE) = Max [0, (IEL for the first 60 days), EAL, AIL, (EAL+AIL)] + Max [0, FCE] (16.11.4.1) ̶ Estimated Aggregate Liability (EAL) = Max [IEL during the first 60-day period, Max (ADTE during the previous 60-day period)] + OUT + PUL + DALE (16.11.4.3) ̶ Aggregate Incremental Liability = (RTL d) – Max [0, (ADTE / 40 * N * 0.9)] (16.11.4.4) ̶ Initial Estimated Liability (16.11.4.2) i.For ONLY Load-Serving Entities (LSE): IEL = DEL * Max [0.2, RTEFL] * RTAEP * 40 ii.For ONLY Resources: IEL = DEG * Max [0.2, RTEFG] * RTAEP * 40 iii.For BOTH LSE and Resources: IEL = DEL * Max [0.1, RTEFL] * RTAEP * 40 + DEG * Max [0.1, RTEFG] * RTAEP * 40 ̶ Future Credit Exposure = FCEOBL o + FCEOPT o + FCRFGR o (16.11.4.5) ̶ Available Credit Limit = Unsecured + Collateral – TPE (16.11.4.6) ̶ Day-Ahead Participation Incremental Collateral Requirement = 90% * [ACL – CRR Credit Limit] (16.11.4.6.2) 7

8. Solution For Overcollateralization Requesting MCWG and WMS to endorse the formation of a sub committee to: I. Interpret, determine application and quantify collateral requirements within the nodal protocol language II. Identify situational default risk III. Isolate over and under collateralization issues IV. Ascertain what solutions can be implemented by nodal inception to right size default and working capital risk V. Draft Nodal Protocol Revision Requests VI. Determine long-term solutions for optimizing collateral requirements 8