1. © UH Institute for Energy, Law & Enterprise 1 Energy, Inc. Natural Gas/Electric Power Overview U.S./Canada Case

2. © UH Institute for Energy, Law & Enterprise 2 U.S. Gas Issues Energy Inc. business perspective: Long run production and deliverability Demand/supply balances and price impacts Market oversight and mitigation U.S. energy policy considerations: Alaska pipeline routes (Canadian considerations) Conflicts over public lands surface management with increased drilling U.S. energy legislation (specific coalbed methane, CBM, issues deserve consideration) Market oversight and mitigation

3. © UH Institute for Energy, Law & Enterprise 3 Natural Gas Value Chain Oil and Gas Field Production Processing (If Needed) Pipeline Transportation Local Distribution Liquefaction (LNG) LNG Tanker Shipment to Markets Re-gasification Liquids Transportation (pipeline, truck, tanker or petrochem stream for butanes+) Marketing and Distribution (propane, butane) Gas Separation, Gathering Residential Commercial Industrial (Direct Use) Electric Power Generation (Utilities, IPP, Industrial) Electric Power Transmission Electric Power Distribution Direct Use (eg., vehicle transport)* Oil Refining Gas Liquids Extraction Liquids (LPG) stream (propane, butanes, etc.) Power stream Methane stream *Note that compressed methane and LPG are also used for vehicle transport.

4. © UH Institute for Energy, Law & Enterprise 4 U.S. (Canada) Natural Gas Value Chains Industrial Electric (fuel, bulk market for power) Residential, Small Commercial Physical Bypass Natural Gas: Production Gathering* Processing* Intrastate Pipelines * Often vertically integrated Interstate Pipelines “City Gate” “LDC” Transportation (pipe)Sales (commodity) “Unbundling” involves the separation of transportation from sales to allow third party marketing with pipelines providing “open access” and comparable service to all shippers. Most CompetitiveCompetitiveLeast Competitive Commercial

5. © UH Institute for Energy, Law & Enterprise 5 U.S. Natural Gas Restructuring Competitive LDC Industry State Public Utility Regulatory Commissions, 1800s-1927 Development of Interstate Transportation Federal Regulation of Interstate Transportation (PUHCA/FPA ‘35) Federal Regulation of Wellhead Prices (Phillips Decision ‘54) Decontrol of Wellhead Prices (NGPA ‘78) First Stage Open Access for Pipelines (Order 436 ‘85) Final Stage of Open Access (Order 636 ‘92) LDC Unbundling Era?

6. © UH Institute for Energy, Law & Enterprise 6 Market Design Issues, 2003 Marketing affiliates of federally-regulated (interstate) pipelines –Market power and reporting Price transparency and market gaming –California investigations –Rules for market oversight without reducing market liquidity Deterioration in market liquidity –Price volatility impacts

7. © UH Institute for Energy, Law & Enterprise 7 Natural Gas Price Change Over Time Source: U.S. EIA

8. © UH Institute for Energy, Law & Enterprise 8 U.S. Gas Resource Development Source: U.S. EIA. Through July 2002

9. © UH Institute for Energy, Law & Enterprise 9 Demand: A Fall Can be Hard Consumption, bcfAvg. Wellhead, cents/mcf Source: U.S. EIA

10. © UH Institute for Energy, Law & Enterprise 10 Gas Demand by Segment Gas consumption by customer group Source: U.S. EIA

11. © UH Institute for Energy, Law & Enterprise 11 U.S. Natural Gas Prices (Real) Source: U.S. EIA Electric utilities is YTD

12. © UH Institute for Energy, Law & Enterprise 12 U.S. Value Chain Issues Source: U.S. EIA Price differentials, $/mcf Note- Wellhead to electric excluded for 2000

13. © UH Institute for Energy, Law & Enterprise 13 Market Geography with Pipe De-bottlenecking, 1995-99 Spot prices, $/mmBtu, beginning of month Source: World Gas Intelligence

14. © UH Institute for Energy, Law & Enterprise 14 U.S. Gas Price Convergence Source: Natural Gas Week $/mcf across all U.S. and Canada market centers, hubs and major city gates

15. © UH Institute for Energy, Law & Enterprise 15 Japan 223 105 12 75 3544 LNG 66 United Arab Emirates 3 Trinidad and Tobago 99 6 Australia Algeria 44 10 Oman Nigeria 13 Indonesia 3 46 Qatar Natural Gas Imports, Exports in 2000 U.S. DOE – Office of Fossil Energy, bcf Total U.S. Consumption 22.7 tcf

16. © UH Institute for Energy, Law & Enterprise 16 Prices Are Converging $/mmbtu Oil indexed LNG v. Henry Hub Source: BP Gas and Power

17. © UH Institute for Energy, Law & Enterprise 17 Henry Hub Does Rule 1998199920002001 Canada$1.91$2.18$3.90$4.36 LNG Imports* 2.31 – 2.842.15 – 2.692.73 – 3.933.29 – 5.00 Domestic/ Henry Hub** 2.082.274.323.98 Natural Gas Prices, $/mmBtu (U.S. DOE – OFE) * Includes both landed and tailgate prices; lower price is generally landed price. ** Mean, daily spot prices.

18. © UH Institute for Energy, Law & Enterprise 18 U.S. Power Issues Energy Inc. business perspective: Financial health of electric power industry Demand/supply balances and price impacts Market oversight and mitigation U.S. energy policy considerations: Fuels for power generation Market design issues and market performance Financial health of electric power industry Market oversight and mitigation

19. © UH Institute for Energy, Law & Enterprise 19 Application of Principles: Electricity Restructuring Early Electric Utilities Samuel Insull and state regulation, early 1900s Development of Interstate Transmission Federal Regulation of Wholesale and Interstate Commerce (PUHCA,FPA ‘35) North American Reliability Council, ‘68 Conflicts on Natural Gas Use (PIFUA & PURPA ‘78) Commitment to Bulk Market Competition (EPAct ‘92) Open Access Begins (CPUC ‘94, Orders 888/889 ‘96) Retail Wheeling Era?

20. © UH Institute for Energy, Law & Enterprise 20 Electricity Demand Source: BP Nonutility generation = 30% of total industry

21. © UH Institute for Energy, Law & Enterprise 21 Natural Gas Consumption for Power Generation Source: BP

22. © UH Institute for Energy, Law & Enterprise 22 Electricity Price Change Over Time

23. © UH Institute for Energy, Law & Enterprise 23 What Is a Public Utility? Old Concepts: –Technical economies of scale –Essential services –Capital intensive –Lack of storage –Variable costs and load factors –Exclusive franchise New Concepts: –Technology is not static –Essential services provided by competition –Changing ratio of capital to labor –New storage technologies –Pricing for specific customer needs –Borderless service areas “Public utilities are public only by law, with limited property rights endowed by their creator (Bonbright, p. 8)”

24. © UH Institute for Energy, Law & Enterprise 24 Summary: A History of Ideas, 1800s-Today “Regulated monopoly” as a substitute for competition Emerging ideas about competition –Minimize monopoly component –“Contestability” (potential competition) as substitute for pure competition Initiation of the “Deregulation Movement”-- Fred Kahn and the “Saturday night stay” for airlines

25. © UH Institute for Energy, Law & Enterprise 25 Principles of Deregulation for Energy Utilities Separate the commodities--natural gas and electricity--from the infrastructure (“pipes and wire”): unbundling Contract carriage and nondiscriminatory open access Third party marketing Risk management to hedge against commodity price volatility

26. © UH Institute for Energy, Law & Enterprise 26 Based on Comparative Research - Market Design: What Is the Role of Regulation? Can regulators act as “market facilitators”? Can regulators design markets? Should the U.S. have regional regulatory authorities (“how many regulators do we need?”) Is harmonization good or bad? Should there be a “uniform code” for North America? How does Mexico fit in to the North American regulatory scheme? – Stage of development

27. © UH Institute for Energy, Law & Enterprise 27 Electric Power Driver It’s Stormy Out There! Real Time Pricing Does choice matter? Load Management & Reliability Retail Competition? Competitive Electricity Markets (Restructuring) Market Structure Measurement Aaagghh!

28. © UH Institute for Energy, Law & Enterprise 28 U.S. Restructuring: Gas vs. Electricity Natural gas was both a driver, for and set a precedent for, electricity –Increasing integration is the “logic driver” for electric restructuring Gas can be stored, electricity cannot (yet) Gas is cheapest when used directly –For electricity, fuel cost of gas is higher -- but capital cost, O&M are less -- than coal or nuclear, thus far Seasonal/daily demand, balancing, reliability are challenges for both

29. © UH Institute for Energy, Law & Enterprise 29 Issues for Electricity Restructuring in the U.S. Size and complexity of U.S. market Market design -- How? Who? Individual state approaches vs. federal interstate commerce T&D constraints and development –Generation capacity installed at load sites Permitting and siting for gen, T&D

30. © UH Institute for Energy, Law & Enterprise 30 The Texas Approach: Highlights In 1995, wholesale market deregulated In 1999, SB 7 passed for retail restructuring –Retail choice date: January 1, 2002 –Munis and co-ops opted in as of December, 2000 –Utilities must separate businesses - no forced divestiture Gencos - limited to 20% across power region REPs - affiliates can only offer price to be in traditional service area for 36 months or until 40% of customer load is lost; 3.5 % or 2,000MW of delivered power from renewables by 2009 Transcos/Discos - open access, nondiscriminatory, PUCT regulated with postage stamp wholesale transmission services –50% NO x, 25% SO 2 reductions for grandfathered plants Pilot beginning June 1, 2001for 5% of market

31. © UH Institute for Energy, Law & Enterprise 31 The Texas Approach: Key Conditions PUCT must: –Conduct market monitoring –Certify REPs –Establish reliability standards –Protect customers ERCOT ISO: –Must manage information and settlement –May provide nondiscriminatory gen-related ancillary services to all REPs “Gas is Green”: –Railroad Commission charged with encouraging performance standards for gas-fired megawatts

32. © UH Institute for Energy, Law & Enterprise 32 How We Differ from California Us –Market-based –No mandated pool –Allow LT contracts –Price caps only until December 2001 –10 month avg for new powerplants –Risk management at discretion of market participants Them –Government-based –Cal PX –FERC instituted! –5-year price caps (original law) –3-year avg for new powerplants –No allowances for risk management