1. Integration of Physical and Financial risk in Australia’s National Electricity Market Les Hosking Managing Director and CEO NEMMCO

2. 2 Presentation – Overview  NEM design- gross pool and contract market  Settlement inefficiencies  Risk management processes  Reallocation- offset spot with  contract payments  Futures payments  Central clearing- Objectives/Issues

3. 3 Pool R R G GGG NEM Design – Gross Pool All prices via pool Compulsory Competing generators Energy only Marginal price setting Volatile $-1k to $10k Competing retail

4. NEM Design – Contract Market  Risk management for Retailers requires  Contracting around compulsory gross pool spot market  Direct generation investment (vertical integration - gentailer)  Demand side control  Contracts can take the form of contracts for differences, hedges, swaps or futures  Via bilateral, brokers and exchange traded futures  Concerns over financial market liquidity  Vertical integration (gentailers)  Beyond Q2 2010 climate change uncertainty  Futures contracts strong but not in all locations 4

5. Contract at $40/MWh = ($100 – $40) x 100MW = $6,000 per hour RetailerGenerator NEMMCO Gross Pool / Contract Market- Settlements Energy $10,000 NEMMCO Retailer buys 100MWh Generator supplies 100MWh Spot price determined as $100/MWh Settlement = $100x100 =$10,000 per hour via NEMMCO $6,000 Banking System

6. NEMMCO  Circular cash flows  Volatile cash flows  33 day settlement  High prudential requirements  Credit default risks  One retailer has failed Gross Pool – financial inefficiencies Retailer Generator NEMMCO Energy $10,000 $6,000 Banking System

7. 7 Prudential Management  Risks from large volatility in price  Risks from rapid payment obligations  Largest retailer (20% of NEM) with spot price at $10,000/MWh will increase exposure to NEMMCO at $1Million per minute  Risk of non payment covered by bank guarantees with NEMMCO  NEMMCO typically holds $1.5Billion to $3.5Billion in bank guarantees  Level of guarantee (Max Credit Limit) driven by energy traded, average price and price volatility  Daily review of participant exposures  Rapid payment requirements when near limits  Default then suspend if obligation not met  Rapid retailer of last resort required

8. NEM Outstandings History 8

9. Reallocation- Offset spot with contract payments  Option to offset the credit from one party (generator) in MW or $ against the debit from another (Retailer) - in line with their financial contract position  Slow to be taken up by participants  Confidentially concerns  Counterparty credit issues 9

10. NEMMCO Mechanics of Reallocation Reallocate $10,000 Energy $10,000 Retailer buys 100MWh Generator supplies 100MWh Spot price determined as $100/MWh Settlement = $100x100 =$10,000 per hour via NEMMCO Reallocation of 100MW between Generator and Retailer which is valued at $10,000 RetailerGenerator $4,000 Contract at $40/MWh Strike value paid direct = $4,000 per hour Banking System NEMMCO

11. Growth in Reallocations - MWh 11

12. Reallocation by Formula  NEMMCO is moving towards reallocation by formula  Effectively allows parties to settle derivatives via NEMMCO and net against physical spot settlement  Requires licence/exemption from Securities Regulator ASIC 12

13. RetailerGenerator NEMMCO Reallocation by Formula Reallocate $6,000 Energy $10,000 Retailer buys 100MWh Generator supplies 100MWh Spot price determined as $100/MWh Settlement = $100x100 =$10,000 per hour via NEMMCO Reallocation of 100MW swap between Generator and Retailer which is valued at $6,000 Contract at $40/MWh = ($100 – $40) x 100MW = $6,000 per hour

14. Futures Offset Arrangement  Investigations into using positive margins from futures contracts flowing to NEMMCO  Has strong upside price stablising effect for retailers  Risks need to be understood  Complex under insolvency  Complex in segregation of accounts in clearing participant and potentially clearing house 14

15. Retailer Generator NEMMCO Futures Offset Arrangement Energy $10,000 Energy $4,000 Futures Exchange Clearing Participant Positive margins $6,000 Futures Contract

16. Central Clearing – Objectives/Issues  Shorten settlement cycle in the NEM  Align settlement times of all products  Data on amounts owing and to be paid fed to Central Clearer  A single party takes responsibility to clear all products  All payments made to Central Clearer  Prudential regime managed by Central Clearer  Central Clearer to be responsible to address defaults and “remove” defaulting parties  Synergy with market operation functions  Acceptance of compulsory central clearer by participants 16

17. 17 Conclusion ISSUES Gross Pool Challenges –vertical integration –liquid Financial markets Settlement Inefficiencies –offset spot/forward difficulties –protracted settlement cycle –credit squeeze Central Clearing –outsourcing issues