1. Credit Working Group Background Information Credit Aspects of Mass Transition Update – February 3, 2006

2. 2 Credit Exposure  Credit Exposure – 3 primary components  Outstanding Invoices  Uninvoiced, historical activity  Expected forward liability  A great deal of work has been done in the past year to reduce credit exposure in all areas above  Additional work is needed (and in process)

3. 3 Credit exposure  Credit Exposure – 3 primary components  Outstanding Invoices  Uninvoiced, historical activity  Expected forward liability

4. 4 Credit exposure – Outstanding invoices  This credit exposure is well defined  Known and measured  Currently, there can be up to 3 invoices outstanding  Collateral is held for outstanding invoices  PRR 638 is proposed to reduce this exposure  Impact on EAL / collateral is automatic

5. 5 PRR 638 - Summary  PRR 638 sponsored by COPS  Proposes to change payment due date from 16 calendar days after invoice date to 5 business days after invoice date (usually a Thurs)  Expected to go to the BOD this month (Feb 2006)  Normally would implement Mar 1 (if passed)  COPS will ask that implementation be delayed to April 1 so as to not overlap implementation of PRR 568  Collateral requirements will automatically adjust since EAL includes “outstanding unpaid transactions”  Currently there can be up to 3 outstanding invoices  When fully implemented, there will be 1 outstanding invoice

6. 6 PRR 638 Impact on Collateral during Transition Period  During the transition period, there will be two weeks when two invoices are due (one on Monday and one on Thursday)  During PRR 638 implementation,  After week 1, each QSE will have only two invoices outstanding  After week 2, each QSE will have only one invoice outstanding  All else being equal, A QSE’s EAL will decrease as the number of outstanding invoices decrease (by the amount of the invoice)  After week 1, EAL will reflect only two outstanding invoices  After week 2, EAL will reflect only one outstanding invoice  A QSE may request a refund of their posted credit.  The refund may be wired to the QSE or  held by ERCOT to apply toward the next invoice(s) due.  Going forward, QSE’s EAL will include only one invoice outstanding.

7. 7 Credit exposure  Credit Exposure – 3 primary components  Outstanding Invoices  Uninvoiced, historical activity  Expected forward liability

8. 8 Credit exposure – Uninvoiced, historical activity  Currently, at any point in time there can by 21 – 24 days of uninvoiced historical exposure  Example: Invoice dated Feb 2 billed for operating days Jan 6 – 12  Operating days Jan 12 through Feb 6 (next payment date) are uninvoiced, historical exposure  This credit exposure is difficult to measure  First, we capture this exposure under the “40 day” portion of the EAL (weekly)  Second, we use the NLRI to test the adequacy of the collateral held (daily) —Catches changes in scheduling activity, etc  PRR 568 has been approved to reduce this exposure

9. 9 PRR 568 - Summary  PRR 568 sponsored by COPS  Reduces settlement date from 17 days after operating day to 10 days after operating day  COPS and ERCOT staff did an extensive review of the implications of these changes  Higher level of estimated data on invoices  Implementation will be phased-in  PRR 568 will reduce credit exposure by 7 days  Note: Reduced credit exposure does not automatically translate to reduced collateral. A PRR would need to be processed. CWG will evaluate the overall credit risk in the market first.

10. 10 PRR 568 Impact on Collateral during Implementation  Beginning in Feb, invoices will include 8 settlement statements rather than 7 settlement statements  It will take 7 weeks to complete the transition  Transition should be complete by the end of March  Collateral is based on an average daily transaction amount over two invoices  ERCOT credit staff will adjust to allow for 15 or 16 days to get to the correct average daily transaction amount

11. 11 Credit exposure  Credit Exposure – 3 primary components  Outstanding Invoices  Uninvoiced, historical activity  Expected forward liability

12. 12 Credit exposure – Expected forward liability  Primary focus of Feb 3rd meeting  Address “exit” scenarios  LSE no longer represented by a QSE  QSE  There is currently unmitigated credit exposure in the market in this area  Even with current mitigation plans, there is still expected to be unmitigated credit exposure

13. 13 Credit exposure – Expected forward liability  Credit exposure related to a troubled entity generally centers around that entity’s use of the Balancing Energy Service (BES)  A troubled entity that has been “cut off” for credit reasons from its bilateral energy providers still serve its end users  By default, energy requirements come from the BES, creating liability for remaining market participants if that entity defaults  Credit exposure related to a QSE or LSE exists as long as end users are associated with that entity  Energy continues to flow to end users

14. 14 Credit exposure – around Mass Transition  Credit exposure can only be eliminated by moving end users to another entity (e.g. the Mass Transition process)  Credit exposure is currently mitigated (although not fully) with  Collateral (QSEs) or QSE notice period (LSEs)  Mass Transition process  For QSEs, collateral currently covers approximately 2 weeks forward for “exit” process  With the reduced credit exposure from PRR 568 and no change to the EAL “40 day” calculation, there will be 3 weeks coverage  at historical levels of BES usage  For LSEs, QSE notice period covers 12 business days forward (approx 16-18 days) for “exit” process

15. 15 Credit exposure – Mitigation shortfalls  Based on recent experience, it takes approx 3 weeks for “exit” process  Including notice periods and Mass Transition  Market losses have been experienced (and are likely to continue) due to a combination of —How collateral is calculated per Protocols —How long it currently takes the market to transition end users

16. 16 Credit exposure – Mitigation actions to date  Two PRRs have been approved and were effective Jan 1, 2006 to address some of the issues  PRR 624 – Clarified language in the default section —Sponsored by Mass Transition task force (WMS portion)  PRR 643 – Shorten payment default timelines —Sponsored by CWG —Changed due date for collateral calls from 5:00 pm to 3:00 pm on the second business day to allow default notice to go out on the second business day —Changed the cure period from 3 business days to 2 business days New entrance to the market will sign contracts with the 2 day requirement Existing QSEs, LSEs and Resources will sign new contracts with the 2 day requirement by Mar 2006

17. 17 Credit exposure – 2 scenarios  Expected forward liability  LSE no longer represented by a QSE  QSE  Similarities  Market exposure is directly impacted by how quickly a Mass Transition (move customers away from the defaulted entity) occurs  Differences  Market exposure “collateralization” is different for each scenario —QSE – direct collateral held by ERCOT —LSE – notice period provided by QSE dropping the LSE provides protection to the market

18. 18 Credit exposure – First scenario  Expected forward liability  LSE no longer represented by a QSE  QSE

19. 19 Credit exposure – LSEs  ERCOT does not 1) receive financials, 2) evaluate credit or 3) hold collateral for LSE s in the market, only QSE s (not required by Protocol)  The QSE that represents a LSE evaluates and collateralizes for the credit exposure  The Protocols define how a QSE can “drop” an LSE in section 16.2.4.3  The Protocols define what the “dropped” LSE must do and the timeline in which it must act in section 16.2.13 Emergency QSE  Market coverage (effectively collateral) is provided by the notice period required by the QSE before “dropping” an LSE  Until Feb 1, notice period was 5 business days  PRR625 addresses several issues around this process and reduces market exposure  PRR625 became effective Feb 1

20. 20 PRR 625 - Summary  PRR 625: Clarification of Emergency QSE Language  Sponsored by Mass Transition task force (WMS portion)  Strengthens or clarifies Protocol language that address when and how Emergency QSEs may be used.  In a default where an LSE is no longer represented by a QSE, provides for use of a virtual QSE for tracking and scheduling of the LSE’s load at ERCOT.  Extends notification requirement to 12 Business Days for a QSE intending to terminate its relationship with an LSE. —By noon on the 4 th Business Day, LSE must either name a new QSE or qualify as an EQSE. If LSE does not meet either, then LSE is in breach of contract. Notice provided on afternoon of 4 th Business Day and cure period begins on 5 th Business Day. If LSE does not cure, initiate mass transition of customers. At end of 12 th Business Day, current QSE/LSE relationship is terminated and LSE is assigned to a virtual QSE for tracking purposes.

21. 21 PRR 625 Review 0 465810 21 7 19 QSE notice of intent to end LSE relationship QSE/LSE relationship ends LSE must name new QSE or post collateral Notice of LSE Breach End of cure period Mass transition of ESI IDs begins Last ESI ID transitions from Defaulting LSE Notice of LSE Breach LSE must name new QSE or post collateral for EQSE End of cure period Mass transition of ESI IDs begins Last ESI ID transitions from Defaulting LSE EQSE Liability/Potential Market Exposure - Current Potential Market Exposure – Post PRR625 *Current process above timeline. *Proposed process below timeline. *Dates in Business Days. 92 QSE Liability extends to 12 Business Days ERCOT notices EQSE of collateral call QSE Liability 12

22. 22 Credit exposure – Changing market dynamic  Market dynamics are just that – dynamic  Must prepare for the possibility that more LSEs will represent themselves directly as QSE s for credit purposes given the provisions of PRR 625  QSE collateralization issue remains

23. 23 Credit exposure – Second scenario  Expected forward liability  LSE no longer represented by a QSE  QSE

24. 24 Approx Timeline to Remove a Troubled QSE Identify problem and make collateral callBDay 0 Notice periods (4 BDays, down from 6)  Collateral dueBDay 2  Notice of default givenBDay 2  2 BDays to cure defaultBDay 4 Mass transition (9-11 BDays)  Conference call to begin Mass TransitionBDay 5  POLRs initiate switches (5 BDays allowed, switches to date have taken, on avg 3 BDays)BDay 8  Time until switch complete by TDSPBDay 14 (Note: 14 business days + 6 weekend days = 20 days of liability)

25. 25 Potential loss in exit scenario Potential loss (simplified – w/3 weeks of collateral) Collateral held 1,000 MWh/day x $100/MWh x 10% x 21 days = $ 210,000 At default 1,000 MWh/day x $100/MWh x 100% x 21 days = $ 2,100,000 Potential loss to the market $ 1,890,000 For 100 MWh/day $ 189,000 For 10,000 MWh/day $ 18,900,000 Open question: Is 20 days a reasonable estimate if the MP is a larger entity?

26. 26 Potential loss in exit scenario Potential loss range – w/ 3 weeks of collateral (assume MCPE = $100/MWh) Collateralized based onBES 10% BES 100% At Default BES 100% BES 100% For 100 MWh/day $ 189,000$ 0 For 1,000 MWh/day$ 1,890,000$ 0 For 10,000 MWh/day $ 18,900,000$ 0

27. 27 Potential loss in exit scenario Potential loss range – w/ 2 weeks of collateral (assume MCPE = $100/MWh) Collateralized based onBES 10% BES 100% At Default BES 100% BES 100% For 100 MWh/day $ 196,000$ 70,000 For 1,000 MWh/day$ 1,960,000$ 700,000 For 10,000 MWh/day $ 19,600,000$ 7,000,000

28. 28 Market Statistics # of LSEs by average daily MWh for August 2005 Potential MWh/day CRNOIE Tot % Loss by cat < 200 23 25 48 31% $ 200k ea 200-2,000 21 41 62 40% $ 2,000k ea 2,000-20,000 24 12 36 23% $20,000k ea > 20,000 7 3 10 6% Total 75 81 156 100%

29. 29 Market Statistics Average daily MWh for August 2005 MWh CRNOIETotal% < 200 1,569 2,291 3,860 0.4% 200-2,000 16,504 27,828 44,3324.3% 2,000-20,000 182,528 76,488 259,016 25.1% > 20,000 578,401 148,377 726,778 70.3% Total 779,002 254,984 1,033,986 100.0%

30. 30 Credit Exposure – Mass Transitions 2005/2006 Entity Est MWh/dayEst ESIDs Tot Est Exposure LSE 1350 3,000$ 400,000 QSE 1 50 500$ 30,000 QSE 2 65 550$ 220,000 LSE 2 3,500 12,250$ 5,500,000 LSE 3 1,500 10,000$ 200,000 QSE 3 125 2,500$ 100,000 Total$ 6,450,000

31. 31 For today  Understand current status of changes to the Mass Transition process and the impact on credit exposure – updates next  Understand range of “residual credit exposure”  Begin addressing “residual credit exposure”  Determine the level of acceptable unmitigated credit exposure  Identify possible ways to get to desired level of risk

32. 32 Questions ?