International Swaps & Derivatives Association

Transforming the Derivatives Business

The Emerging Ontario Electricity Market

July 11, 2001

1Meg Timberg Solicitor

Historically, Ontario Hydro was an integrated utility, generating and transmitting electricity. Electricity was sold at regulated rates:

no electricity derivatives market existed in Ontario.

Emerging Electricity Market

In 1998, the Province created the Market Design Committee (oversees design, creates rules etc. for the New Ontario Market) and the market restructuring legislation, the Energy Competition Act, 1998 was enacted: Ontario embarked on the course of deregulating the

electricity sector and creating a New Market for electricity.

Emerging Electricity Market

April 1, 1999, business of Ontario Hydro transferred to separate entities: Ontario Power Generation Inc. (generation business)

Hydro One Inc. (transmission, rural distribution and retail energy services businesses)

Independent Electricity Market Operator (“IMO”) (centralized independent electricity system coordinator and independent market operator)

Emerging Electricity Market

Electrical Safety Authority (electrical equipment and electrical wiring installation inspection functions)

Ontario Electricity Financial Corporation (“OEFC”) (manages retirement of Ontario Hydro’s outstanding debt and other obligations for non-utility generator contracts)

Emerging Electricity Market

Market Rules are being developed.

Market testing is in process.

OPG continues to sell electricity at regulated rates.

Market Participants are developing strategies, products etc. for New Market.

Current Status

Province has indicated Open Access should be achieved by May 1, 2002 subject to four conditions being met: protecting consumers and offering more choice;

creating a strong business climate with a reliable supply of electricity;

protecting our environment; and

encouraging new ways of doing business and supporting the search for alternative sources of power.

Date of Market Opening

OPG’s generating license has two market power mitigation provisions, intended to help create framework for a competitive marketplace.

1. Rebate Mechanism (hedges against price increases): majority of OPG’s expected Ontario energy sales will be subject

to an average annual price threshold of 3.8 cents per kWh;

OPG rebates any excess earned to Ontario energy consumers via the IMO (creates automatic hedge for Ontario consumers).

Market Power Mitigation

2. OPG relinquishing effective control of generating capacity (thereby creating competition in generation of electricity): First target: decontrol at least 4,000 MW of fossil generating

capacity (1,000 MW of which can be substituted with hydroelectric generating capacity) within 42 months after Open Access.

Second target: reduce effective control over electricity supply options to 35% or less of total electricity supply options in Ontario within 10 years of Open Access.

Market Power Mitigation

Generators may submit to the IMO offers to sell electricity and consumers (i.e. ‘load’) may bid to purchase electricity from the IMO.

Generators and load who do not submit an offer or bid will be “non-dispatchable” (i.e. will automatically sell or purchase at floating price).

Price will be established and electricity will be dispatched based on offers and bids received by IMO to sell (and purchase) energy and operating reserve.

New Market - Establishes a Floating Price for Electricity

Generally speaking, generators will receive the IMO 5-minute price and load will pay the IMO hourly market clearing price: price paid/received will be a floating price, not the amount

offered/bid;

creates incentive for generators and load to enter into OTC derivative contracts to fix the price of electricity.

An energy forward market will not be established as of Open Access, but may be introduced at a later date.

New Market Lends Itself to Price Management

Can either fix price of electricity by contracting with a competitive retailer, or purchase energy from current distributor (“standard supply service” or “SSS”).

Generally, distributors of SSS will charge customers with demand greater than 50 kW the hourly spot price directly, while consumers with less demand will be charged a fixed annual rate based on a forecast spot price, subject to adjustment at the end of each year against the actual spot price.

Retail Consumers

Status of Emerging OTC Derivatives Market

Various market participants are developing products to meet customers price management needs following Open Access.

Products and opportunities will develop over time as market develops.