1. September 15, 2006 Mending the Fractured Value Chain Through Functional Use of Demand Response

2. Demand Response in a Fractured Value Chain

3. Risk Elements With DR DR risk elements include the following:  Marketing, customer acquisition, and customer churn  Hardware and equipment (warranty)  Software upgrades and customer call center  Operations and maintenance  Measurement & verification  Performance – dispatchable MWs when called upon  Stranded investment (if not used)

4. Demand Side Benefits Across the Value Chain Demand response can reduce costs and investment:  Long- and short-term generation costs – reduce dispatchable, low-capacity-factor, peaking resources  Transmission investment and congestion (redispatch)  Distribution investment, maintenance, and reconductoring  Environmental emissions (SOx, NOx, CO2) Demand response over the longer term has the potential to capture all of these benefits Unbundled market structure, however, strands many of these benefits – leaves benefits untapped

5. Retail Choice Creates Churn, While Demand Response Equipment Does Not Migrate For customers that seek retail choice some churn -- change of retail provider -- is expected Given churn, demand response equipment cannot be easily “changed-out” or reinstalled in a different local Customer choice means demand response equipment will be stranded investment Retail choice and unbundled functions fracture the value chain How to capture the full set of retail and wholesale benefits?

6. Proposal for Demand Response to Mend the Fractured Value Chain

7. How DR May be Best Used During declared emergency conditions, ERCOT may have first priority to dispatch DR for reliability (if DR is not already dispatched by the REP) The REP may dispatch for economics to lower peak power costs (absent emergency conditions), if customer chooses DR If DR is not used by ERCOT or the REP, the distribution wires company may dispatch the DR if needed Place limits on the number of hours of dispatchable DR that are available? Alternative schemes for DR priority?

8. Optional Uses of Demand Response Option 1: the retail customer does not choose to have DR, so ERCOT uses DR during limited grid emergencies Option 2: the retail customer has the REP using DR, and REP pays customer an incentive – more customer choice Option 3: the distribution wires company uses the DR if needed and it is not used by ERCOT or the REP Option 4: a priority scheme allows REP to use DR if the customer chooses, ERCOT to use it under emergencies (if not previously used by REP), and distribution wires company uses DR (if not used by REP or ERCOT)

9. Use Neutral Demand Response Provider Use a demand response (DR) provider that is neutral to all parties involved, e.g., retail energy providers Roles of the DR provider may be  1) marketing under the prevailing REPs logo and terms  2) installation of equipment for customers that choose DR  3) Operations, measurement & verification of DR program  4) Migration of DR capabilities to the current customer REP DR provider does not migrate, but changes marketing to match the prevailing REP’s approach and logo

10. Who Benefits from DR: Matching Functions and Costs All customers benefit from DR dispatched by ERCOT during emergencies – less outage and lower costs REPs and their customers benefit from DR when it is dispatched for economics/congestion to lower costs Distribution wires companies benefit from reliable operations and greater kWH sales from customers Instead of “cost-of-service” DR cost allocation, use functional allocation of DR responsibilities/costs

11. Functional Proposal to Allocate DR Costs & Responsibilities #1: Share costs across value-chain elements-- use logical functions consistent with DR benefits #2: Provide consistent incentives that reduce conflicts  Rate-base DR equipment costs – allocate to the distribution wires company who is neutral and does not change  Allocate DR operations (dispatching), maintenance, and communications costs to REPs – they net peaking benefits  Allocate DR measurement, verification, and settlement responsibilities to ERCOT, paid for by all customers  Use a fully-outsourced third party DR provider for all functions, under a long-term contract (e.g., 10 to 12 years)

12. Outsourcing Achieves Multiple Goals (e.g., neutrality) and Mends Fractured Value Chain Distribution wires company has DR equipment installed so it is available – neutral agent REPs dispatch DR if the customer chooses to lower overall costs – operations agent ERCOT uses DR if emergency reliability is needed – reliability and settlement agent Fully-outsourced third party DR provider facilitates all functions across multiple entities – services agent

13. Q&A & Answers