September 2012

Proposed CRR Auction Credit Changes: Summary of Draft

NPRR

Draft -Confidential – Not for Distribution

Objectives of CRR Collateral Methodology Changes

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1) Proposal primarily focuses on modifying the way collateral is calculated for the “Future Exposure” related to holding a CRR where “Future Exposure” is defined as the potential payment that would need to be made by a CRR holder if the reference DAM price settles at a negative number. The key elements of the proposal are:

a) Replace the auction collateral adder “A” ($0.75/MWh) and the post-auction FCE calculations with an adder based on the credit exposure risk associated with owning individual CRR obligations on a source-sink basis

b) Given the lack of a liquid forward CRR market, historic settled DAM prices represent the best available data. Proposal uses P99-P100 historical sink-source DAM prices, broken up by TOU, as a proxy for a monthly price, e.g. 18 days for 5*16, 8 days for 2*16, 28 days for 7*8

c) For CRRs held for current month delivery, the Path Specific DAM Based Adder will not roll-off until the last day of the delivery month

d) Applies a “Portfolio Benefit” to post auction FCE calculation e) Gives ERCOT the ability to increase collateral on a specific path due to “State Change”f) Allows price history to be excluded if no longer relevant

2) This proposal would allow Market Participants to post collateral for the notional value of awarded CRRs for “Forward Months” in lieu of pre-paying:

a) A “Forward Month” is defined as any month further out than the prompt delivery month i.e. if an auction is held in Nov ’12, Forward Periods would be defined as any months beyond Dec ’12

b) The full notional value of all CRRs bid on will continue to be collateralized during the pre-auction process

c) Note - CRRs awarded for the prompt month will continue to be paid for in full before the month begins

Draft -Confidential – Not for Distribution

Calculation of Auction Collateral Requirements

3

[(Bid MW X (Max(0,Bid Price) - Min(99th Percentile A1,ACP) + S2)]

minus

[Offer MW X (Min(0,Offer Price)]

• Credit risk exposure for Obligation Bids is equal to: a) the payment that the CRR holder would have to make to

ERCOT if awarded the CRR, plus b) the potential payment the CRR holder would be required

to make to ERCOT based on the reference source-sink DAM settlement price i.e. if price settled at a negative number

• Credit risk exposure for Obligation Offers exists when the Offer Price is negative i.e. the CRR holder is willing to pay ERCOT in order to close their existing CRR position.

• Under this proposal collateral requirements for Bids or Offers that would result in ERCOT making a payment to the CRR holder would be set to $0

CommentsCalculation

Note - In all cases, calculation is summed by source-sink path, time of use, and month

• (1) where A is the Path Specific Adder and is either 0 or a negative number

• (2) where S is the State Change Adder and is set to $0/MWh as a default

[Bid MW X Max(0,Bid Price)]

minus

[Offer MW X Min(0,Offer Price)]

• Credit risk exposure for Option/FGR Bids is equal to the payment that the CRR holder would have to make to ERCOT if awarded the CRR. With an Option/FGR there is no delivery month risk

• Credit risk exposure for Option/FGR Offers exists when the Offer Price is negative i.e. the CRR holder is willing to pay ERCOT in order to close their existing CRR position.

• Under this proposal collateral requirements for Bids or Offers that would result in ERCOT making a payment to the CRR holder would be set to $0

ObligationsObligations

Options /FGRs

Options /FGRs

Draft -Confidential – Not for Distribution

Calculation of Future Exposure Collateral Requirements

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• Credit risk exposure for awarded Obligation Bids is equal to: a) the payment that the CRR holder has to make to ERCOT for

awarded CRRs in the forward months (invoice payment is only required for Prompt Month CRRs), plus

b) the potential payment the CRR holder would be required to make to ERCOT based on the reference source-sink DAM settlement price i.e. if price settled at a negative number

• Credit risk exposure for Obligation Offers exists when the awarded Offer cleared at a negative price i.e. the CRR holder has to pay ERCOT in order to close their existing CRR position.

• Under this proposal awarded Bids or Offers that would result in ERCOT making a payment to the CRR holder provide a credit benefit

CommentsCalculation

Note - In all cases, calculation is summed by source-sink path and time of use

• (1) where PWA is the Portfolio Weighted Adder and is either 0 or a negative number

• (2) where PWACP is the Portfolio Weighted Auction Clearing Price• (3) where S is the State Change Adder and is set to $0/MWh as a default

[Fwd Mth Purchased MW X Awarded Price]

minus

[Fwd Mth Sold MW X Awarded Price]

• Credit risk exposure for Option/FGR Bids is equal to the payment that the CRR holder has to make to ERCOT for awarded CRRs in the forward months (invoice payment is only required for Prompt Month CRRs) . With an Option/FGR there is no delivery month risk

• Credit risk exposure for Option Offers exists when the awarded Offer cleared at a negative price i.e. the CRR holder has to pay ERCOT in order to close their existing CRR position.

• Under this proposal awarded Bids or Offers that would result in ERCOT making a payment to the CRR holder provide a credit benefit

ObligationsObligations

Options /FGRs

Options /FGRs

[Fwd Mth Purchased MW X Award Price]

minus

[Fwd Mth Sold MW X Award Price]

plus

[Net MW X – ((Min(100th percentile PWA1,PWACP2) + S3)]

Delivery Mth Option Offset

Delivery Mth Option Offset

• A credit offset is given for the expected payout of prompt month MW owned which is equal to notional MW X 99th percentile Portfolio Adder

[Delivery Mth MW X 99th percentile A1]

• (1) where A is the Path Specific Adder and is either 0 or a positive number

Draft -Confidential – Not for Distribution

Key Elements of Proposal

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Path Specific Adder

Path Specific Adder

• The current $0.75/MWh auction adder does not take into account the difference in “riskiness” of owning different paths

• The intention of the Path Specific Adder is to mitigate credit exposure associated with potential payments that CRR obligation holders have to make during the delivery month should the reference DAM prices for a particular source-sink path settle at a negative price

• By using the 99th percentile of a rolling average “monthly” price data set for each source-sink pair the majority of historical events should be captured

• Collateral is posted for each path owned, regardless of “Portfolio” benefit

• Methodology:- Using the rolling average “monthly” price data set for each source-sink pair, select the value that

represents a P99 confidence level. - Collateral posted is then equal to the P99 value for each source-sink path applied to the total

volumes bid on each path- Note – specific historic DAM settled prices for source-sink paths can be excluded from the

calculation if deemed no longer relevant following TAC review and ERCOT Board approval

Portfolio Weighted

Adder

Portfolio Weighted

Adder

• Owning a number of CRR paths is likely to provide some degree of correlation benefit i.e. in the event of default, the holder of a portfolio of CRRs would have some paths that require payments to ERCOT, while others would require payment from ERCOT to the CRR holder.

• The Portfolio Weighted Adder takes this into account by calculating an adder based on current volumes owned applied to historical source-sink pair price data at a P100 confidence interval

• Methodology:- To determine the Portfolio Weighted Adder use awarded volumes for each source-sink path and

calculate a new data set that represents a volume weighted rolling “monthly” average prices of the portfolio of awarded volumes

- From this new data set select the value that represents a P100 confidence level. This represents the worst case scenario that a particular portfolio of volumes would have settled at historically

- Collateral posted is equal to the P100 value applied to total awarded volumes by month - Note – specific historic DAM settled prices for source-sink paths can be excluded from the

calculation if deemed no longer relevant following TAC review and ERCOT Board approval

Draft -Confidential – Not for Distribution

Key Elements of Proposal (continued)

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Incorporation of Current Mkt View via ACP

Incorporation of Current Mkt View via ACP

• Given the lack of a forward liquid CRR market, the Path Specific and Portfolio Weighted Adders are based on historical DAM settled prices. Given that a P99/P100 confidence interval is being used, this is likely to mitigate the majority of potential credit exposure.

• However, recognizing that historical prices may not always represent the future, incorporating the most recent auction clearing price (either on a path specific or portfolio basis) in the collateral calculations will ensure that the current market view of congestion is taken into account

• Methodology:- To the extent that the most recent Auction Clearing Price for a particular source-sink path is lower

than the current Path Specific Adder it will replace the Path Specific Adder in the Auction Collateral calculation – applies to relevant path, month, and time of use

- To the extent that the Portfolio Weighted Auction Clearing Price (calculated based on awarded volumes) is lower than the current Portfolio Weighted Adder it will replace the Portfolio Weighted Adder in the Post Auction Collateral calculation – applies to relevant path, month, and time of use

Incorporation of “State Change”

Incorporation of “State Change”

• There may be a circumstance where the “riskiness” of a particular source-sink path has not been captured by either historical DAM settled prices, or the most recent Auction Clearing Price

• While this period of time is likely to be relatively short i.e. between the Adder calculation “catching up” with current prices or a new auction taking place, the “State Change Adder” gives ERCOT the ability to increase collateral on a particular path by month, and time of use. In order for this increase to stay in place for more than 60 days, ERCOT would require TAC approval

• The default by path, month and time of use for the State Change Adder will be set to $0/MWh