Texas Deregulation – A Success Story

The ERCOT Market Framework Has Been A Success

Implementation Bilateral Contracts - Participants contract up to

100% of energy needs in lieu of a centrallymanaged market

Balancing Energy Market - ERCOT operates thin balancing energy pool to balance real-time supply and demand

Out of Merit - ERCOT can order plants on/off to maintain grid reliability

Retail Price to Beat (PTB) - Default service rate mandated for incumbent retailers until January 1, 2007 – may offer different prices starting in 05

Market Objectives Leverage market solutions wherever possible and

encourage competition Minimize ERCOT intervention Establish tools to maintain grid reliability

Positive impact Large infusion of capital Intense retail competition

Competitive rates for end-users High system reliability

ERCOT

ERCOT supply curve; Implied heat rate04; MMBtu/MWh

ERCOT’s Robust Competitive Wholesale Market Led To A Large Capital Infusion…

Cumulative capacity MW

Deregulation led to investment of over $15 billion and the addition of 22GWof low-cost CCGT capacity

Deregulation led to investment of over $15 billion and the addition of 22GWof low-cost CCGT capacity

0

3

6

9

12

15

18

21

24

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

22 GW

Internal combustion

NuclearCoal

CCGT

Gas/oil

…And A Reduction In Market Heat Rates

ERCOT heat rate cycle98-04; MMBtu/MWh

0

2

4

6

8

10

12

14

16

98 99 00 01 02 03 04

CCGT marginal heat rate

CCGT reinvestment economics

Lower market heat rates have mitigated the effectsof higher gas prices for consumers

Lower market heat rates have mitigated the effectsof higher gas prices for consumers

The ERCOT Regulatory Framework Has Led To StrongRetail Competition…

Source: KEMA

ERCOT has the most active de-regulated retail market in the USERCOT has the most active de-regulated retail market in the US

11223

67

10

1920

TX OH DC NY PA MD MA CT ME CA

Residential Customer Switching04; percent

1 2

3 4

Texas Deregulation – A Success Story

…With Customer Switching In Line With Other Successful Deregulated Markets…

Incumbent market share1

Years since deregulation; Percent

50%

60%

70%

80%

90%

100%

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1 Market share estimates based on customer count2 Estimates for 2003 and 2004Source: PUC; OFGEM

Wireline

South Texas residential

North Texas residential

UK residential2

…Giving End Use Customers Access To Lower Prices

25%

12%11%

33%

2002 2003 2004 Long TermScenario

13%

7%

15%

21%

2002 2003 2004 Long TermScenario

Competitive residential price1 vs. regulated rate 02-04; Percent savings

Competitive large business price vs. regulated rate 02-04; Percent

Customers have benefited from access to lower electricity prices than they would have experienced under a regulated rate regime

Customers have benefited from access to lower electricity prices than they would have experienced under a regulated rate regime

1 Competitive Residential price based on 15% discount to TXU PTB as currently offered by market competitors, e.g., Utility Choice (14.6%), Cirro (14.6%) andGexa (16.6%); Regulated world assumes 7.8 GW added capacity in the rate base at a cost of $600/kw, O&M costs approximately 20/kw-yr resulting in anaverage cost of $93/kw-yr average cost in the rate base

2 Based on 2004 with the following assumptions: Competitive prices assume $4.07/MMBtu Henry Hub gas price, 24X7 heat rate of 7.3 MWh/MMBtu, andincumbent residential gross margins of 30% and LC&I gross margins of 5%

2 2

There Is Still Room For Improvement In ERCOT…

1 Estimated cost of bad debt for key ERCOT retailers in 2003; TXU retail bad debt in 2003 was $120 MM2 OOME down cost to the system 3 Reduction of “ask” price to energy retailers of 0.2 cents / KWh on 300 TWh4 Unaccounted for energy costs at 1% of load at $40 / MWh on 300 TWh (Line loss can represent an additional 5% of load cost)5 Based on 6 month RMR costs for delay at La Palma of $15 million and 12 month RMR costs on delay at Davis of $30 MM6 ERCOT requires approximately 2 GW of new capacity per year; better siting reduces transmission cost by $10,000 per MW

Market design and governance Example inefficiency

Est. annual system cost ($millions) Potential solution

Retail market Bad debt 2501

Eliminate switchingfor customers with outstanding balances

Wholesale market design

Out of Merit production 702

Send generators price signals to back down or up

Load balancing between market participants 603

Create a day-aheadmarket for energy and ancillary services

Unaccounted for Energy 1204 System data and reporting

Delivery regulation

Slow build of transmission forRMR exit 455

Additional incentives or mandates for TDSPs to construct transmission

Poor siting of generation raises transmission costs 206

Require plant siting approval to consider transmission costs

Market inefficiencies drive significant costs to market participantsacross the ERCOT system

Market inefficiencies drive significant costs to market participantsacross the ERCOT system

…As Key Milestones Approach

Milestone Effective Date

Affiliate Retailers may offer other price structures in addition to PTB January 1, 2005

Sunset Review recommendations are considered by Texas Legislature Session begins January 11, 2005

PTB is no longer a required offering January 1, 2007

Sunset Review1

The Sunset Advisory Commission reviews performance of The Public Utility Commission of Texas (PUC) and the Office of Public Utility Counsel (OPUC) every 12 years

The next review should be completed during the 2005 session Key recommendations of the Sunset Advisory Commission include:

– Changes to ERCOT/PUC governance structure– Extension of the PUC for 6 years

The competitive market in Texas is functioning well andTXU does not anticipate any major structural changes in the marketplace

The competitive market in Texas is functioning well andTXU does not anticipate any major structural changes in the marketplace

1 The Sunset process is guided by a 12-member body of legislators and public members appointed by the Lieutenant Governor and the Speaker of the House of Representatives.

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