1. The Effect of Environmental Regulation upon the Electric Power Industry: A Rating Agency Perspective 23rd February 2005 At the California Public Utility Commission

2. Regulation of Pollutants >Four major pollutants >SO 2, NO x, Mercury, CO 2 >Regulation is fragmented >Regulation to-date of SO 2 and NO x under the Clean Air Act >Clean Air Interstate Rule: Proposed rule for further reductions in SO 2 and NO x emissions >SO 2 : 70% below 2002 levels by 2015 >NO X : 65% below 2002 levels by 2015

3. The Effect on Credit Profiles >Increasing CapEx >Rising allowance credit prices >Leading to >Higher energy costs >Increased leverage and >Lower profit margins

4. Lessons Learned from SO 2 >Complying? >Pollution control devises, fuel switching or buying credits. >Best solution was probably a combination. >Buying credits buys time >Fuel switching was feasible because of the abundance of low sulfur coal

5. Lessons Learned from SO 2 >Building/switching to gas-fired capacity was not always optimal >Volatile natural gas prices >Limited supply of natural gas >Avoiding the installation of pollution control devises may be costly >The recent run up in prices for SO 2 credits has generally caused the building of scrubbers to be more economic than buying allowance credits Purchase Allowances for 2003 Purchase Allowances 2005 Scrubber 3 10.236.625.1 Compliance Costs Comparission ($ millions) 1 CAIR: Clean Air Interstate Rule; requires a 70% reduction in SO2 emissions by 2015. 2 SO2 emission allowance costs: Jan 2003 = $150/ton, 2005 est = $540/ton. 3 Based on a plant with 1,880 MW capacity and scrubber cost of $200/kw. Number represents annual depreciation of total cost based on a useful life of 15 years. Source: EPA, Fitch Ratings.

6. NOx SIP Call >Covers 22 states including DC and affects 35 investor owned electric utilities >The top five NOx emitting utilities include*: AEP, Southern Company, Xcel, Cinergy, First Energy >Seen in the market: NIPSCO, Exelon, CMS, and First Energy. * Ceres. Benchmarking Air Emissions report, April 2004.

7. CO2 Regulation: Not if but when >Fitch believes that there will be a carbon law at the federal level however it may be a number of years off. >Other States currently regulating carbon: Massachusetts, New Hampshire, Oregon, and Washington >RGGI >Law suits from eastern states >Investor requests for additional information >McCain-Lieberman and Carper

8. Anticipation of a Carbon Constrained Environment: Current Industry Response >Participate in the development and/or construction of clean coal technology >Buy Carbon Credits – Chicago Climate Exchange >Estimate and inform Investors as to possible costs (for example studies done by AEP and Cinergy)

9. U.S. CO2 Emissions >Aggregate electric power sector CO2 emissions expected in 2004 = 2,257 million metric tons 1 >A 5% reduction could range from $.7 billion to $4.2 billion 2 in costs per annum. >Top five CO2 emitting utilities include: AEP, Southern Company, Xcel, Cinergy and Progress Energy >AEP’s costs to reduce CO2 emissions by 2020 range from $0.5 billion to $6.4 billion 3 1 Source: Energy Information Administration. 2 Information Based on prices of CO2 emissions ranging from $6 per metric ton to $37 per metric ton. 3 Cost estimates based upon McCain Leibermann and the Carper proposals.

10. Challenges for CO2 >The Power Industry will need economically feasible CO 2 emission control technology >The development of these devises will be challenged by: >A realistic estimate for the price of “carbon” >The time horizon for investors and developers >The time horizon for electric power generators

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