1. How Electricity Might Compete with Alternate Fuels for Certain End Uses Presented to: 2006 Business and Financial Workshop American Public Power Association Minneapolis, MN Presented by: Tim Miller, Senior Rate Analyst Missouri River Energy Services (MRES) Sioux Falls, SD September 19, 2006 Contact Information: Phone: 605-330-6960 Email: tmiller@mrenergy.com

2. Background Information MRES information: MRES information:  Joint action agency with long-term contracts  Serves 60 municipal utilities in Iowa, Minnesota, North Dakota, and South Dakota  Rate studies completed - 47 members plus others Members receive 50% of power from MRES, 50% from Western Area Power Administration (WAPA) Members receive 50% of power from MRES, 50% from Western Area Power Administration (WAPA) Wholesale power rates – traditional demand and energy rates; actual demand billed each month Wholesale power rates – traditional demand and energy rates; actual demand billed each month Presentation will focus on heating applications, but could be applied to other uses Presentation will focus on heating applications, but could be applied to other uses

3. Customer Viewpoints - Heating Natural gas and other fuel costs up 75% or more; volatile Natural gas and other fuel costs up 75% or more; volatile Forecasts indicate prices may not return to historical levels Forecasts indicate prices may not return to historical levels Many rural coops offer rebates and low off-peak rates Many rural coops offer rebates and low off-peak rates Customers asking municipals what rates are available for electric heating and water heating Customers asking municipals what rates are available for electric heating and water heating One utility – number of dual fuel customers jumped by 20% in just a few years after stable for many years One utility – number of dual fuel customers jumped by 20% in just a few years after stable for many years Should we as a municipal utility attempt to serve customers where possible, as long as we don’t subsidize? Should we as a municipal utility attempt to serve customers where possible, as long as we don’t subsidize?

4. Current Residential Heating Saturations 52% Natural Gas 52% Natural Gas 31% Electricity 31% Electricity 9% Heating Oil 9% Heating Oil 6% Propane 6% Propane 2% Other 2% Other 70% of new homes choosing gas or propane 70% of new homes choosing gas or propane Source: American Gas Association, 2003 Residential Natural Gas Market Survey

5. Factors Impacting Utility Rates Rising power costs and distribution materials costs; greater risk of serving new loads Rising power costs and distribution materials costs; greater risk of serving new loads Qualified distribution employees harder to find; salary and insurance cost pressures Qualified distribution employees harder to find; salary and insurance cost pressures Low sales growth rates due to: Low sales growth rates due to:  Flat or declining population in some cases  Service territory laws and disputes with coops Low growth rates lead to less contribution margins as fixed costs rise Low growth rates lead to less contribution margins as fixed costs rise In some cases, pressure from local government to provide additional funds through transfers In some cases, pressure from local government to provide additional funds through transfers

6. Considerations for a Competitive Rate 1. Comparison of electric to other fuels 2. Possible places to compete or not to compete 3. Cost considerations: On or off peak power costs On or off peak power costs Average or marginal costs Average or marginal costs Impact of transfers on rates Impact of transfers on rates 4. Rate concepts: Off-peak rate design Off-peak rate design Recovery of direct costs in rates Recovery of direct costs in rates Water heater credits Water heater credits Rebates and incentives Rebates and incentives Customer payback Customer payback

7. Comparison of Electric to Other Fuels – Residential Heating 90% Efficient Forced Air – recent price levels 90% Efficient Forced Air – recent price levels  $1.10 / therm gas = 4.2 cents / kWh electric  $2.25 / gallon heating oil = 6.2 cents  $1.50 / gallon propane = 6.2 cents 200% Efficient Heat Pump – recent price levels 200% Efficient Heat Pump – recent price levels  $1.10 / therm gas = 8.4 cents  $2.25 / gallon heating oil = 12.4 cents  $1.50 / gallon propane = 12.4 cents

8. Places to Compete In general, should be controlled or off-peak usage In general, should be controlled or off-peak usage For heating, areas with more heating degree days For heating, areas with more heating degree days Residential: Residential:  Forced air, dual fuel plenum heat  Off-peak storage heat – typically on 11 PM-7 AM  Heat pumps  Storage water heaters Commercial and Industrial: Commercial and Industrial:  Storage or slab heat  Dual Fuel – plenum or boilers  Some heat pumps

9. Places Not to Actively Compete In general, uncontrolled heating where the bulk of usage occurs during daytime, on-peak hours In general, uncontrolled heating where the bulk of usage occurs during daytime, on-peak hours  (If rates don’t match marginal costs) Many commercial and industrial uses would fit into this category Many commercial and industrial uses would fit into this category  In many cases, predominately on-peak demands  C & I might also have access to lower natural gas prices and/or interruptible rates

10. On or Off Peak Power Costs Must look at utility resource mix and characteristics: Must look at utility resource mix and characteristics:  Purchased power – short or long term contract  Owned generation  Market purchases  Utility load shape Identify marginal fuel and other variable costs for off-peak hours Identify marginal fuel and other variable costs for off-peak hours Many potentially lower cost hours – Mon-Fri. Many potentially lower cost hours – Mon-Fri. 10 PM-6 AM plus weekends equals 52% of hours Should regional market prices dictate your retail pricing? Should regional market prices dictate your retail pricing?

11. Average or Marginal Costs Covered at many previous APPA sessions Covered at many previous APPA sessions Which costs change as a result of this decision or action? Which costs change as a result of this decision or action? Should each kWh sold carry an equal “allocation” of fixed costs? Should each kWh sold carry an equal “allocation” of fixed costs? Most generation, distribution, administrative, and customer service costs are irrelevant when pricing off- peak services that directly compete with other fuels Most generation, distribution, administrative, and customer service costs are irrelevant when pricing off- peak services that directly compete with other fuels Transfers to other city funds may be relevant Transfers to other city funds may be relevant

12. Impact of Transfers on Rates MRES Study of 62 area utilities MRES Study of 62 area utilities  Median transfer is 9%  Range is 0% to 52% How transfer is assessed is key How transfer is assessed is key  If it varies by units sold or percentage of revenue, must consider in off-peak rate design  If flat amount or free services provided to city, not a factor Gas customers may pay franchise fee of perhaps 5% Gas customers may pay franchise fee of perhaps 5% High transfers may make electric utility less competitive High transfers may make electric utility less competitive  $0.034 marginal cost + 20% transfer = $0.041

13. Off-Peak Rate Design Upper Midwest – Typical Off-Peak Rates Upper Midwest – Typical Off-Peak Rates  Currently range from 3.2 to 3.7 cents for many utilities  Rate depends on whether cycled or off for several consecutive hours Separate meter or combined meter Separate meter or combined meter  If no time of use rates, better to separate the off-peak usage instead of combining all power in one meter Apply the power cost adjustment to off-peak rate? Apply the power cost adjustment to off-peak rate?  Calculation based on total power costs or just fuel  Make sure capacity costs aren’t rising faster than energy  Customers want stability – advantage over other fuels  But don’t guarantee the rate for a long time period!

14. Off-Peak Rate Design (Continued) Should only the controlled customers receive the benefit of not contributing to the peak? Or are we just giving them the rate that matches the costs? Should only the controlled customers receive the benefit of not contributing to the peak? Or are we just giving them the rate that matches the costs? Is a lower profit margin acceptable on off-peak sales? Is getting “something” better than “nothing”? Is a lower profit margin acceptable on off-peak sales? Is getting “something” better than “nothing”? Mandatory Time of Use Rates Mandatory Time of Use Rates  Would be good fit for these concepts  Automatic incentive to use power off-peak  Might be tougher to market – customer has to interpret rate schedule instead of flat discounted rate

15. Recovery of Direct Costs in Rates Direct costs of providing off-peak service Direct costs of providing off-peak service  Marginal power costs (energy rate)  Additional meter  Load management receiver  Load management system – portion of costs  Maybe some customer service costs Many utilities prefer flat energy rate with no additional customer charge Many utilities prefer flat energy rate with no additional customer charge  Example – direct costs billed as $0.003 vs. $2 / month  Disadvantage to higher volume users

16. Water Heater Credits Used for controlled water heaters not on separate meter Used for controlled water heaters not on separate meter Typical credits are $2 - $4 per month, depending on cycle times and avoided costs Typical credits are $2 - $4 per month, depending on cycle times and avoided costs Advantage of credit: Easy for customer to understand and see savings on bill Advantage of credit: Easy for customer to understand and see savings on bill Might specify a minimum usage per month to qualify for credit Might specify a minimum usage per month to qualify for credit

17. Rebates and Incentives Pay the customer to buy power from you? Pay the customer to buy power from you? Rebates are several hundred dollars in many cases Rebates are several hundred dollars in many cases Chips away at sales margin; calculate utility payback of rebate divided by additional annual margins Chips away at sales margin; calculate utility payback of rebate divided by additional annual margins In some states, utilities must spend money on efficiency - rebates targeted to efficient appliances In some states, utilities must spend money on efficiency - rebates targeted to efficient appliances  High efficiency water heaters  Heat pumps Low or no interest loans are another option Low or no interest loans are another option Make sure incentive isn’t a complete give-away – creates excess demand even if current appliance is working Make sure incentive isn’t a complete give-away – creates excess demand even if current appliance is working

18. Customer Payback Compare upfront costs of adding off-peak capability against annual savings to determine payback years Compare upfront costs of adding off-peak capability against annual savings to determine payback years Can help set ceiling for proposed rate Can help set ceiling for proposed rate Could shorten payback period if tied together with controlled water heating and/or air conditioning Could shorten payback period if tied together with controlled water heating and/or air conditioning Converting to dual fuel / electric plenum Converting to dual fuel / electric plenum  Payback shorter for fuel oil than natural gas  Some residential customers still switching despite relatively long paybacks (7 to 10 years)  Some gas companies charge for gas service line if not primary heating source

19. Conclusion Electricity can be competitive with alternate fuels for certain end uses Electricity can be competitive with alternate fuels for certain end uses Make sure off-peak rates aren’t subsidized by other customers Make sure off-peak rates aren’t subsidized by other customers Provide what the customer is asking for if you can! Provide what the customer is asking for if you can!