Department of Finance Private Sector Merger Briefing Merger Implementation Group 26 September 2013 Merger of Synergy and Verve Energy © State of Western Australia

Merger Implementation Group Topics of discussion Overview  Rationale and transaction design  Key events in the merger process  Reform and market objectives  Merger process o Appointments o Consultation o Key dates Ring-fencing  Ring-fencing - structure  Information flows o Accessibility and ‘restricted information’  Methodology o Physical separation and secured access IT system o Use of ‘restricted information’ o Height of ring-fencing Transfer pricing  Mechanism o Non-discriminatory pricing o Standardised, and customised products  Methodology o Pricing o Risk allocation Compliance  Penalties  Auditing

Merger Implementation Group Merger Objectives  Reduce costs  Security of supply  Facilitate private sector investment A successful merger that meets these objectives needs to provide for transfer pricing and ring-fencing/information protocols

Merger Implementation Group Ring-fencing - structure Generation Activities Power stations (operations and maintenance) Wholesale Activities Nominations Fuel management Portfolio management Wholesale procurement Trading with the retail division and third parties Retail Activities Franchise Contestable Information + MWh Nominations for MWh Cost stack Transfer pricing Third Party generators PPAs Third party retailers ESCs STEM and the balancing market Daily Operating Activities Ancillary Activities Organisational development Non-energy procurement and facilities Corporate Shared Services Information technology Communications Human resources Corporate risk management Planning and strategy Legal Regulatory and compliance Industrial relations Accounting and finance Records and information * The above diagram is for illustrative purposes only and is not necessarily reflective of the final organisational design or structure for the purposes of accounts/records and financial reporting

Merger Implementation Group Ring-fencing – ‘restricted information’ InformationWho has access? Who does not? Reason for restrictionPotential structure of restriction Information provided by a third party generator pursuant to contract (pricing, volume, capacity credits) Wholesale Corporate Services Generation Retail Could provide the generation division an unfair advantage in future tender processes Could provide the retail division with access to information about competitor portfolio positions and costs Restrict the use of confidential information Physical separation of relevant staff (separate office floors with secured access) Information access controls within IT system Third party retailer volumes and prices Wholesale Corporate Services RetailCould provide the retail division with a means of undercutting third party retailers in the market The wholesale and retail divisions to have separate financial accounts Physical separation of relevant staff (separate office floors with secured access) Information access controls within IT system Third party generation procurement tenders Wholesale Corporate Services Generation Retail Could allow the generation division to submit tenders that are commercially better than third party generators Could provide the retail division with access to information about competitor portfolio positions and costs Physical separation of relevant staff (separate office floors with secured access) Restrictions on the use of confidential information Separation of wholesale and retail divisional decision makers

Merger Implementation Group Ring-fencing – key decisions Key decisionDecision maker Information the decision maker will not have access to Entering into a customer retail contract Retail Existing third party retailer contract prices and volumes held by the wholesale division Determining the retail price curve Retail Existing third party retail contract prices and volumes held by the wholesale division Pricing and tenders submitted by the generation division to the wholesale division as a part of the generator’s procurement process Generation Contractual information between the wholesale division and third party generators Any generation procurement tenders submitted by third party generators to the wholesale division  The purpose of the aforementioned restrictions is to ensure that certain information is not available to the decision maker when key decisions are made for example:

Merger Implementation Group Contractual relationship MWh and fuel costs Nominations for MWh Wholesale Activities Power generation cost stack Lowest Highest Retail Activities Franchise (cost plus) Contestable (mark-to-model) 3rd Parties Note:  All existing contracts with third parties will be honoured and minimum quantities will be nominated  All existing contractual arrangements between Verve Energy and Synergy will effectively fall away from a legal perspective o Existing contracts between Verve Energy and Synergy will be replaced by internal arrangements between the wholesale and retail divisions (these arrangements will have regard to the terms of existing contractual arrangements) Standardised/customised products Buy/sell spread Audit Penalties Generator 2 Generator 1 PPA Commitments & Verve “must-run” generation Generator 3

Merger Implementation Group Transfer pricing principles PrinciplePurposeIntended outcomes Non-discrimination Ensure prices and terms are on a non-discriminatory basis between third parties and the retail division (subject to credit) The wholesale division should be equally incentivised to deal with MergeCo’s retail division and third parties, but also to buy and sell (subject to risk policy requirements) Sustain competition in the market Does not hinder private sector investment Transparency Provide adequate information to third parties and broader market to evidence non-discrimination and enable price discovery Sustain competition in the market Cost and risk reflective Ensure that the wholesale division is able to recover costs (contractual and modelled) and risks to maximum extent possible Allows for transitional considerations for existing PPAs Fair value of State’s assets

Merger Implementation Group Transfer pricing principles (continued) PrinciplePurposeIntended outcomes Market reflective for the contestable market Ensure that the wholesale division’s prices are determined on a non-discriminatory and cost reflective basis May require a portion of portfolio benefits to be passed through in transfer price Sustain competition in market Does not hinder private sector investment Facilitate competition through equitable access to prices and products Ensure that the wholesale division provides prices in a timely manner and with other elements (volume, duration, product type etc) that meets market needs (subject to risk policy requirements) Ensures that the wholesale division provides market liquidity as required in wholesale market Sustain competition in the market Does not hinder private sector investment No cross subsidisation between franchise and contestable No cross subsidies between contestable and non- contestable customers Sustain competition in the market

Merger Implementation Group Core operational considerations  Take or pay requirements o Possible transitional adjustment relating to take or pay obligations between the wholesale and retail divisions to facilitate a smoother commencement and assist in alleviating broader market concerns  Energy Trading o There will be a single trading desk as of 1 January 2014 The wholesale division will manage the portfolio(s) Only the wholesale division will trade in the Wholesale Electricity Market The wholesale division will still be required to bid volume into the STEM The retail division will not provide nominations in the STEM o The wholesale division will provide nominations to its generation division and will have full control of its assets subject to operational and maintenance requirements The wholesale division bears all the risk and will use the generation division’s plant as required Plant outages to be managed between the wholesale and generation divisions

Merger Implementation Group The transfer pricing methodology Calculation  A transfer price is theoretically calculated as: o Underlying price + Shape premium + Risk premiums + Profit margin  Elements of a transfer price – price, volume, timeframes, terms & conditions, process  Potential for a segmented approach o Franchise: cost plus o Contestable: mark-to-model with management judgement

Merger Implementation Group Core components 1. Standardised/customised products 2. Buy/sell spread 3. Audit 4. Penalties

Merger Implementation Group Standardised Products  Electricity only – ‘bilateral contract style’  Priced in accordance with the transfer pricing methodology, risk assessment and management judgement  Buy/sell spread rationale o Incentivises MergeCo to determine prices on a reasonable basis  Standard types – for example flat and peak, up to 3 calendar and financial years – no very short term products  Fixed volume and increments – 100% take or pay, small parcel sizes, no nominations required from purchaser

Merger Implementation Group Customised Products  Electricity, capacity, gas and renewables – ‘bilateral contract style only’  Priced on the requirements and risk of the specific transaction  No buy/sell spread required  Obligation for the wholesale division to provide response within specific timeframes  Arrangements (including volume, timeframe and other idiosyncrasies) to be negotiated o These arrangements will allow for the formation of structured products (for example load-following products)  Within the first 12 months of operating there will be a positive obligation on MergeCo to investigate the potential to offer financial products

Merger Implementation Group 1 January 2014 o New entity in existence o Ring fencing o Non-discriminatory principle o Customised products - similar process and approach to Verve current offerings o Audit of compliance & penalties o The wholesale division is continuing to develop standard products and a new process for offering to market by 1 July 2014

Merger Implementation Group Merger implementation project phases Legislation Regulation Methodology Calculation Legislative instruments  Regulations o The segregation of functions and reporting of performance is made pursuant to s 62 of the Electricity Corporations Act 2005 (WA) o Prescribes the segmentation of MergeCo’s functions/operations o Provides the broad mechanics for ring-fencing and transfer pricing  Subsidiary instruments o Outlines the methodology for ring-fencing, transfer pricing and standard products o Setting of the capacity cap via Ministerial Directions Compliance Regime  External auditing o An independent authority will be responsible for independently auditing compliance with the regulatory regime  Penalties for non-compliance to regulation o An appeals mechanism will be established

Merger Implementation Group Objectives Achievement of objectives Cost reductions Corporate overhead savings Portfolio optimisation Maximisation of fuel purchasing and fuel aggregation opportunities Security of supply Maintained Private sector investment No discrimination or misuse of information No price shocks Structure Transition to new arrangements - Non-discrimination - Ring-fencing - Transfer pricing - Compliance regime

Merger Implementation Group Key messages 1. Start 1 January 2014: ring-fencing and non- discriminatory pricing in place o From 1 January to 1 July 2014 MergeCo will continue to offer wholesale products in the same manner as Verve did (prior to the merger) 2. 1 July 2014: standardised products with protocols 3. Buy/sell spread is not a market – it facilitates price discovery and keeps prices efficient 4. Standardised/customised products are not a market

Merger Implementation Group Feedback and consultation The Merger Implementation Group is open to feedback and to engage in consultations any time prior to COB 8 October 2013 Key contact people  Peter Oates o o Mobile:  Ray Challen o o Mobile:  Simon Middleton o o Mobile:

Merger Implementation Group Questions