Credit Exposure

Credit Working GroupBackground Information

Credit Aspects of Mass TransitionUpdate – February 3, 2006

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Credit Exposure

Credit Exposure – 3 primary components

Outstanding Invoices

Uninvoiced, historical activity

Expected forward liability

A great deal of work has been done in the past year to reduce credit exposure in all areas above

Additional work is needed (and in process)

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Credit exposure





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Credit exposure – Outstanding invoices

This credit exposure is well defined Known and measured Currently, there can be up to 3 invoices outstanding Collateral is held for outstanding invoices

PRR 638 is proposed to reduce this exposure

Impact on EAL / collateral is automatic

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PRR 638 - Summary

PRR 638 sponsored by COPS Proposes to change payment due date from 16 calendar

days after invoice date to 5 business days after invoice date (usually a Thurs)

Expected to go to the BOD this month (Feb 2006) Normally would implement Mar 1 (if passed) COPS will ask that implementation be delayed to April 1 so

as to not overlap implementation of PRR 568 Collateral requirements will automatically adjust since EAL

includes “outstanding unpaid transactions” Currently there can be up to 3 outstanding invoices When fully implemented, there will be 1 outstanding invoice

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PRR 638 Impact on Collateral during Transition Period

During the transition period, there will be two weeks when two invoices are due (one on Monday and one on Thursday)

During PRR 638 implementation,

After week 1, each QSE will have only two invoices outstanding

After week 2, each QSE will have only one invoice outstanding

All else being equal, A QSE’s EAL will decrease as the number of outstanding invoices decrease (by the amount of the invoice)

After week 1, EAL will reflect only two outstanding invoices

After week 2, EAL will reflect only one outstanding invoice

A QSE may request a refund of their posted credit.

The refund may be wired to the QSE or

held by ERCOT to apply toward the next invoice(s) due.

Going forward, QSE’s EAL will include only one invoice outstanding.

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Credit exposure





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Credit exposure – Uninvoiced, historical activity

Currently, at any point in time there can by 21 – 24 days of uninvoiced historical exposure Example: Invoice dated Feb 2 billed for operating days Jan 6 –

12 Operating days Jan 12 through Feb 6 (next payment date) are

uninvoiced, historical exposure This credit exposure is difficult to measure

First, we capture this exposure under the “40 day” portion of the EAL (weekly)

Second, we use the NLRI to test the adequacy of the collateral held (daily)

—Catches changes in scheduling activity, etc

PRR 568 has been approved to reduce this exposure

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PRR 568 - Summary

PRR 568 sponsored by COPS Reduces settlement date from 17 days after

operating day to 10 days after operating day COPS and ERCOT staff did an extensive review of

the implications of these changes Higher level of estimated data on invoices

Implementation will be phased-in PRR 568 will reduce credit exposure by 7 days Note: Reduced credit exposure does not

automatically translate to reduced collateral. A PRR would need to be processed. CWG will evaluate the overall credit risk in the market first.

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PRR 568 Impact on Collateral during Implementation

Beginning in Feb, invoices will include 8 settlement statements rather than 7 settlement statements It will take 7 weeks to complete the transition Transition should be complete by the end of March

Collateral is based on an average daily transaction amount over two invoices ERCOT credit staff will adjust to allow for 15 or 16 days to get

to the correct average daily transaction amount

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Credit exposure





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Credit exposure – Expected forward liability

Primary focus of Feb 3rd meeting Address “exit” scenarios

LSE no longer represented by a QSE QSE

There is currently unmitigated credit exposure in the market in this area

Even with current mitigation plans, there is still expected to be unmitigated credit exposure

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Credit exposure – Expected forward liability

Credit exposure related to a troubled entity generally centers around that entity’s use of the Balancing Energy Service (BES) A troubled entity that has been “cut off” for credit reasons

from its bilateral energy providers still serve its end users By default, energy requirements come from the BES, creating

liability for remaining market participants if that entity defaults

Credit exposure related to a QSE or LSE exists as long as end users are associated with that entity Energy continues to flow to end users

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Credit exposure – around Mass Transition

Credit exposure can only be eliminated by moving end users to another entity (e.g. the Mass Transition process)

Credit exposure is currently mitigated (although not fully) with Collateral (QSEs) or QSE notice period (LSEs) Mass Transition process

For QSEs, collateral currently covers approximately 2 weeks forward for “exit” process With the reduced credit exposure from PRR 568 and no

change to the EAL “40 day” calculation, there will be 3 weeks coverage

at historical levels of BES usage

For LSEs, QSE notice period covers 12 business days forward (approx 16-18 days) for “exit” process

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Credit exposure – Mitigation shortfalls

Based on recent experience, it takes approx 3 weeks for “exit” process Including notice periods and Mass Transition

Market losses have been experienced (and are

likely to continue) due to a combination of— How collateral is calculated per Protocols— How long it currently takes the market to

transition end users

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Credit exposure – Mitigation actions to date

Two PRRs have been approved and were effective Jan 1, 2006 to address some of the issues PRR 624 – Clarified language in the default section

—Sponsored by Mass Transition task force (WMS portion) PRR 643 – Shorten payment default timelines

—Sponsored by CWG—Changed due date for collateral calls from 5:00 pm to 3:00

pm on the second business day to allow default notice to go out on the second business day

—Changed the cure period from 3 business days to 2 business days

• New entrance to the market will sign contracts with the 2 day requirement

• Existing QSEs, LSEs and Resources will sign new contracts with the 2 day requirement by Mar 2006

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Credit exposure – 2 scenarios

Expected forward liability LSE no longer represented by a QSE QSE

Similarities Market exposure is directly impacted by how quickly a Mass

Transition (move customers away from the defaulted entity) occurs

Differences Market exposure “collateralization” is different for each

scenario—QSE – direct collateral held by ERCOT—LSE – notice period provided by QSE dropping the LSE provides

protection to the market

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Credit exposure – First scenario


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Credit exposure – LSEs

ERCOT does not 1) receive financials, 2) evaluate credit or 3) hold collateral for LSE s in the market, only QSE s (not required by Protocol)

The QSE that represents a LSE evaluates and collateralizes for the credit exposure The Protocols define how a QSE can “drop” an LSE in section 16.2.4.3 The Protocols define what the “dropped” LSE must do and the timeline

in which it must act in section 16.2.13 Emergency QSE

Market coverage (effectively collateral) is provided by the notice period required by the QSE before “dropping” an LSE Until Feb 1, notice period was 5 business days

PRR625 addresses several issues around this process and reduces market exposure PRR625 became effective Feb 1

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PRR 625 - Summary

PRR 625: Clarification of Emergency QSE Language Sponsored by Mass Transition task force (WMS portion) Strengthens or clarifies Protocol language that address when

and how Emergency QSEs may be used. In a default where an LSE is no longer represented by a QSE,

provides for use of a virtual QSE for tracking and scheduling of the LSE’s load at ERCOT.

Extends notification requirement to 12 Business Days for a QSE intending to terminate its relationship with an LSE.

—By noon on the 4th Business Day, LSE must either name a new QSE or qualify as an EQSE.

• If LSE does not meet either, then LSE is in breach of contract.• Notice provided on afternoon of 4th Business Day and cure period

begins on 5th Business Day. • If LSE does not cure, initiate mass transition of customers. • At end of 12th Business Day, current QSE/LSE relationship is terminated

and LSE is assigned to a virtual QSE for tracking purposes.

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PRR 625 Review

04 65 8 10

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QSE notice of intent to end

LSE relationship

QSE/LSE relationship ends

LSE must name new QSE or

post collateral

Notice of LSE Breach

End of cure period

Mass transition of ESI IDs begins

Last ESI ID transitions from Defaulting LSE

Notice of LSE Breach

LSE must name new QSE or

post collateral for EQSE

End of

cure

periodMass transition of

ESI IDs begins

Last ESI ID transitions from Defaulting LSE

EQSE Liability/Potential Market Exposure - Current

Potential Market Exposure – Post PRR625

*Current process above timeline.*Proposed process below timeline.*Dates in Business Days.

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QSE Liability extends to 12 Business Days

ERCOT notices EQSE of

collateral call

QSE Liability

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Credit exposure – Changing market dynamic

Market dynamics are just that – dynamic

Must prepare for the possibility that more LSEs will represent themselves directly as QSE s for credit purposes given the provisions of PRR 625

QSE collateralization issue remains

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Credit exposure – Second scenario


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Approx Timeline to Remove a Troubled QSE

Identify problem and make collateral call BDay 0

Notice periods (4 BDays, down from 6) Collateral due BDay 2 Notice of default given BDay 2 2 BDays to cure default BDay 4

Mass transition (9-11 BDays) Conference call to begin Mass Transition BDay 5 POLRs initiate switches (5 BDays allowed, switches to date have taken, on avg 3 BDays) BDay 8 Time until switch complete by TDSP BDay 14

(Note: 14 business days + 6 weekend days = 20 days of liability)

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Potential loss in exit scenario

Potential loss (simplified – w/3 weeks of collateral)

Collateral held1,000 MWh/day x $100/MWh x 10% x 21 days = $ 210,000

At default1,000 MWh/day x $100/MWh x 100% x 21 days = $ 2,100,000

Potential loss to the market $ 1,890,000

For 100 MWh/day $ 189,000For 10,000 MWh/day $ 18,900,000

Open question: Is 20 days a reasonable estimate if the MP is a larger entity?

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Potential loss range – w/ 3 weeks of collateral(assume MCPE = $100/MWh)

Collateralized based on BES 10% BES 100%

At Default BES 100% BES 100%

For 100 MWh/day $ 189,000 $ 0For 1,000 MWh/day $ 1,890,000 $ 0For 10,000 MWh/day $ 18,900,000 $ 0

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Potential loss range – w/ 2 weeks of collateral(assume MCPE = $100/MWh)

Collateralized based on BES 10% BES 100%

At Default BES 100% BES 100%

For 100 MWh/day $ 196,000 $ 70,000For 1,000 MWh/day $ 1,960,000 $ 700,000For 10,000 MWh/day $ 19,600,000 $ 7,000,000

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Market Statistics

# of LSEs by average daily MWh for August 2005 Potential

MWh/day CR NOIE Tot % Loss by cat

< 200 23 25 48 31% $ 200k ea

200-2,000 21 41 62 40% $ 2,000k ea

2,000-20,000 24 12 36 23% $20,000k ea

> 20,000 7 3 10 6% Total 75 81 156 100%

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Market Statistics

Average daily MWh for August 2005

MWh CR NOIE Total %

< 200 1,569 2,291 3,860 0.4%

200-2,000 16,504 27,828 44,3324.3%

2,000-20,000 182,528 76,488 259,016 25.1%> 20,000 578,401 148,377 726,778 70.3% Total 779,002 254,984 1,033,986

100.0%

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Credit Exposure – Mass Transitions 2005/2006

Entity Est MWh/day Est ESIDs Tot Est Exposure

LSE 1 350 3,000 $ 400,000QSE 1 50 500 $ 30,000QSE 2 65 550 $ 220,000LSE 2 3,500 12,250 $ 5,500,000LSE 3 1,500 10,000 $ 200,000QSE 3 125 2,500 $ 100,000

Total $ 6,450,000

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For today

Understand current status of changes to the Mass Transition process and the impact on credit exposure – updates next

Understand range of “residual credit exposure”

Begin addressing “residual credit exposure” Determine the level of acceptable unmitigated credit

exposure Identify possible ways to get to desired level of risk

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Questions ?

Documents

Credit Exposure