1. America’s Evolving Electricity Markets: Lessons Galore Dr. Branko Terzic Executive Director, Deloitte center for Energy Solutions and Regulatory Policy Leader, Energy & Resources Deloitte Services LP November 18, 2011 for HED 20 th Forum, Zagreb Croatia

2. Copyright © 2007 Deloitte Development LLC. All rights reserved. Primary Energy Consumption by Source and Sector, 2010 (quadrillion Btu)

3. Copyright © 2007 Deloitte Development LLC. All rights reserved. Regional reliability organizations

4. Copyright © 2007 Deloitte Development LLC. All rights reserved. National average retail price in 1999 was 6.66 cents/ kWh 0.499 5.00 – 5.99 6.00 – 6.99 Over 7.00 Cents per kWh WT 4.10 OR 4.87 CA 9.34 NV 5.93 UT 4.86 AZ 7.23 ID 3.98 WY 4.30 MT 5.01 CO 5.95 NM 6.58 TX 6.04 OK 5.37 KS 6.22 NE 5.31 SD 6.35 ND 5.49 MN 5.83 AK 9.78 HI 11.97 LA 5.81 AR 5.68 MO 6.07 IA 5.93 WI 5.53 IL 6.98 MS 5.65 AL 5.54 TN 5.63 KY 4.17 IN 5.29 MI 7.14 OH 6.40 WV 5.09 GA 6.24 FL 6.85 SC 5.57 NC 6.44 VA 5.86 PA 7.57 NY 10.4 ME 9.77 VT 10.28 NH 11.75 Source: Energy Information Agency MA 9.16 RI 9.02 CT 9.96 NJ 9.99 DE 7.12 MD 7.04 DC 7.45

5. Copyright © 2007 Deloitte Development LLC. All rights reserved. *Includes generation by agricultural waste, landfill gas recovery, municipal solid waste, wood, geothermal, non-wood waste, wind, and solar. ** Includes generation by tires, batteries, chemicals, hydrogen, pitch, purchased steam, sulfur, and miscellaneous technologies. Sum of components may not add to 100% due to independent rounding. Source: U.S. Department of Energy, Energy Information Administration, Power Plant Operations Report (EIA-923); 2009 preliminary generation data. May 2010 © 2010 by the Edison Electric Institute. All rights reserved. Fuel Mixes to Generate Electricity 4

6. Copyright © 2007 Deloitte Development LLC. All rights reserved. Status of restructuring Restructuring Active 1 Restructuring Delayed 2 Restructuring Suspended 3 Restructuring Not Active 4 DC

7. Copyright © 2007 Deloitte Development LLC. All rights reserved. States with Deregulated Generation 6 Source: Morgan Stanley, April 2010 Deregulated Regulated

8. Copyright © 2007 Deloitte Development LLC. All rights reserved. 29 States + DC and PR Have RPS (8 States Have Goals) Source: DSIRE, November 2011 7 Renewable portfolio standard Renewable portfolio goal * † Extra credit for solar or customer-sited renewables Includes non-renewable alternative resources U.S. RPS Policies

9. Copyright © 2007 Deloitte Development LLC. All rights reserved. Regional Transmission Organizations 8 Electric Reliability Council of Texas (ERCOT) ISO California ISO (CAISO) Alberta Electric System Operator (AESO) Southwest Power Pool (SPP) RTO Midwest ISO (MISO) Ontario Independent Electricity System Operator PJM Interconnection (PJM) New York ISO New England ISO New Brunswick System Operator (NBSO) Source: FERC October 2011

10. Copyright © 2007 Deloitte Development LLC. All rights reserved. Jurisdiction: state and federal Federal Energy Regulatory Commission (FERC) Wholesale electric rates setting “Market price” if not market dominant Electric transmission rates Cannot order retail access to consumers State Public Service (or Utility) Commission (PSC or PUC) Retail rate setting Can authorize sale of utility owned power plants Can authorize TPA, “retail access” to consumers

11. Copyright © 2007 Deloitte Development LLC. All rights reserved. A early view of the corporation “It is not because a corporation has a large capital or transacts a large and profitable business that it is an injury to community or a menace to prosperity. On the contrary, the development and growth of modern business have made large aggregations of capital absolutely necessary, and such capital is fairly entitled to a reasonable and legitimate profit. The wrong is done and the injury inflicted when such combination of capital are enabled, by means adopted for the purpose, to control prices, stifle competition and create a monopoly.” Source: La Follette edited by Robert S. Maxwell. Writings of “Fighting Bob” LaFollette

12. Copyright © 2007 Deloitte Development LLC. All rights reserved. 11 FERC: Independent Commission 5 Commissioners, 5-year terms, 3 from President’s political party (now Democratic), 2 from the opposition party (now Republican) or Independent President nominates, Senate confirms Commissioners Chairman Jon Wellinghoff (D) June 30, 2013 Commissioner Marc Spitzer (R) June 30, 2011 Commissioner Cheryl LaFleur (D) June 30, 2014 Commissioner John Norris (D) June 30, 2012 Commissioner Philip Moeller (R) June 30, 2015

13. Copyright © 2007 Deloitte Development LLC. All rights reserved. FERC electricity responsibilities Approval of rates for wholesale sales of electricity and transmission in interstate commerce for jurisdictional utilities, power marketers, power pools, power exchanges and independent system operators. Oversight of the issuance of certain stock and debt securities, assumption of obligations and liabilities, and mergers. Review of officer and director positions held between top officials at utility companies and certain firms with which they do business. Review of rates set by the federal power marketing administrations. Review of exempt wholesale generator status. Certification of qualifying small power production and cogeneration facilities.

14. Copyright © 2007 Deloitte Development LLC. All rights reserved. Old structure vs. new Production - monopoly Transmission - monopoly Distribution - monopoly Sales, marketing, services/ supply - monopoly Production - competitive Transmission - monopoly Distribution - monopoly Sales, marketing, services/ supply - competitive

15. Copyright © 2007 Deloitte Development LLC. All rights reserved. Regulation electric jurisdiction Electric generation – – if wholesale then regulated by FERC If monopoly the at cost of service rates If found competitive then at market based prices – If not selling at wholesale and in rate base then state regulated Power transmission – – Independent transmission company monopoly regulated by FERC – Transmission as part of utility with distribution (possibly generation too) Third party access –”wheeling” tariff from FERC In state costs for native load service in state retail rates Electricity distribution – – monopoly regulated by states Electricity supply, marketing and billing – – retail access subject to state by state determination – Some state have “unbundled”, marketers permitted or required – Others continue retail monopoly

16. Copyright © 2007 Deloitte Development LLC. All rights reserved. Aggregator PowerMarketer Power Exchange Scheduling Market Clearing Price ISO Transmission Security System Dispatch Ancillary Services MunicipalUtility ESP EMS SCADA GenCo UDC Scheduling Coordinator Bilateral Deals Commercial & Industrial Energy Bids Load Bids Balanced Schedules, Ancillary Bids IOU Non-Regulated California Market Structure California Dept. of Water Resources

17. Copyright © 2007 Deloitte Development LLC. All rights reserved. California Power Market “Crises” 2000 General causes Fundamental market structure problems Operational problems Competitive market forces Specific causes High demand growth, Supply deficiency, Fuel price increases, Government’s faulty market design Flaws in retail rate design

18. Copyright © 2007 Deloitte Development LLC. All rights reserved. California restrictions in law Law AB 1890 Investor owned utilities could not pursue a balanced portfolio of long term and intermediate contracts IOU’s were to buy only on day ahead spot market and only on California Power Exchange Competitive market failed to materialize

19. Copyright © 2007 Deloitte Development LLC. All rights reserved. California State Auditor Report “Energy Deregulation: The Benefits of Competition were undermined by Structural Flaws in the Market, Unsuccessful Oversight, and Uncontrollable Competitive Forces” www.bsa.ca.gov/bsa/ – March 22, 2001

20. Copyright © 2007 Deloitte Development LLC. All rights reserved. The FERC’S Goals after California 1.Reduce wholesale electric prices (FERC sets wholesale and transmission rates) 1.Make markets work 2.Not protect competitors 2.Incent investment in infrastructure 1.Transmission, 2.Generation, 3.Demand response 3.Incent development of technology 1.Demand response 2.Efficiency gains 4.Protect the environment 1.Encourage demand response 2.Use of more efficient generation

21. Copyright © 2007 Deloitte Development LLC. All rights reserved. FERC [All T] Formal State Role ITP (RTO, Other) Standards: Transmission (T) Trading Security New T Tariff NAS T Pricing for capital costs, Access Charges Regional Resource Planning, ATC, OASIS Existing Contracts LMP CRRs Spot Markets CRR Allocation & Auction Resource Adequacy Market Power Mitigation Market Monitors Regulators Independence Transmission Only Supplements Long Term 2-Party Contracts for Power Markets Customer Protection ROADMAP FOR FERC’S STANDARD MARKET DESIGN PROPOSAL

22. Copyright © 2007 Deloitte Development LLC. All rights reserved. FERC Standard Market Design proposal Same set of proposed rules for all users of the grid – Open access and flexible transmission service – Administered by fair and independent entity Market rules protect against market manipulation – Addresses Enron trading strategies Customer protection through market power mitigation measures and oversight Clear transmission pricing and planning policies for grid expansion

23. Copyright © 2007 Deloitte Development LLC. All rights reserved. Protect Reliability Resource adequacy requirement for load to be imposed on distribution electricity delivery providers Security constrained dispatch for day-to-day operations Encourages development of new infrastructure

24. Copyright © 2007 Deloitte Development LLC. All rights reserved. Coordination with States… Regional State Advisory Committees (RSAC) – Resource adequacy, transmission planning, rate design and revenue requirements, market power mitigation and market monitoring, demand response and load management, distributed generation and interconnection policies, energy efficiency and environmental issues and RTO management and budget review. – TO be formed in each region, no legal authority to make decisions. Multi-state Entities for planning, certification and siting at regional level – Compliments recommendation of the National Governors Association

25. Copyright © 2007 Deloitte Development LLC. All rights reserved. Elements of Standard Market Design Independent Transmission Provider (ITP) – Operates transmission facilities and administers tariff – Governance requirements are specified to include all major “stakeholders” – Every ITP becomes FERC-jurisdictional utility Network Access Service – Flexible transmission service with financially based “transmission rights” Tradable Congestion Revenue Rights (CRR) (4 Year transition provided) NEW MARKET!! Access charge (demand) to recover embedded cost based on % of load ratio share of transmission Revenue requirement to be collected from this charge (SFV type?) Open and transparent energy spot markets – Day ahead and real-time markets Congestion management through Locational Marginal Pricing (LMP)

26. Copyright © 2007 Deloitte Development LLC. All rights reserved. Elements of Standard Market Design Market mitigation and monitoring – Focus-local market power and lack of price responsive demand – Monitoring of markets and rules of conduct Resource adequacy requirement – Forward-looking requirement developed on a regional basis – Encourages long-term contracts for supply – Encourages development of price responsive demand Restructuring not deregulation Markets that work benefit customers Goal of SMD is to make wholesale electric markets for customers and develop infrastructure

27. Copyright © 2007 Deloitte Development LLC. All rights reserved. FERC Wholesale Market issues 2011 Electric – Compliance issues Are companies in compliance? Monitoring compliance – Regulating electric power markets Established regional transmission operator (RTO)/independent system operator (ISO) New RTO/ISO rules Pricing ancillary services & electric storage services (NOPR) Frequency response services (Final rule) Demand response (Final rule)

28. Copyright © 2007 Deloitte Development LLC. All rights reserved. Key FERC electric issues 2011 Electric – Smart Grid – Power markets Demand Response Integration of renewable generation Enhance market surveillance – Regulating electricity transmission Transmission tariffs – Incentives to build Reliability – Transmission planning and cost allocation –New principle is that costs will be allocated to “benefits” and no costs allocated outside of region, unless other region approves

29. Copyright © 2007 Deloitte Development LLC. All rights reserved. Purpose of the Transmission Planning and Cost Allocation NOPR FERC proposes regions, not interconnections, develop transmission plans and cost allocation methods that consider the benefits of new transmission facilities, including reliability, economics and complying with state/federal laws or regulations FERC also proposes to require each pair of neighboring regions to coordinate transmission planning and cost allocation

30. Copyright © 2007 Deloitte Development LLC. All rights reserved. Future federal regulatory issues Federal climate change legislation – New carbon dioxide legislation Federal energy legislation – Preemption of states Transmission Renewable portfolio standards Individual FERC rate case issues – Rate of return – Cost of service FERC power market regulation – Operating rules – Compliance

31. Copyright © 2007 Deloitte Development LLC. All rights reserved. John Kenneth Galbraith “One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom.” THE GREAT CRASH 1929 1954 Houghton Mifflin Harcourt, Boston, New York

32. Copyright © 2007 Deloitte Development LLC. All rights reserved. Management and regulation “When regulation is required it is management’s job to get the right regulation enacted.” “Management – and not only business management – has shunned this responsibility.” The Daily Drucker by Peter F. Drucker

33. Copyright © 2007 Deloitte Development LLC. All rights reserved. Classic References Deloitte Regulated Utilities Manual Accounting for Public Utilities by Robert Hahne and Gregory Aliff Hard Truths: Facing the Hard Truths About Energy by The National Petroleum Council Stern Review: The Economics of Climate Change Principles of Public Utility Rates by James C. Bonbright (1968), later with Albert L. Danielson, David R. Kamerschen (1988) The Regulation of Public Utilities by Charles Phillips The Age of Oil by Leonardo Maugeri The Economics of Regulation by Alfred Kahn

34. Copyright © 2007 Deloitte Development LLC. All rights reserved. Newer References Restructuring Electricity Markets by Charles J. Cicchetti and Colin M. long Smart Power by Peter Fox- Penner Energy Trading and Investing by Davis W. Edwards Fundamentals of Energy Regulation by Jonathan Lesser and Leonardo R. Giacchino GENERAL ENERGY Beyond The Age of Oil by Leonardo Maugeri Hot, Flat and Crowded by Thomas Friedman The Quest by Daniel Yergin

35. Thank you. Questions? Branko Terzic bterzic@deloitte.com +1 703 251 4350

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