Summary of IMM Function and Monthly Report for September 2008

1. Summary of IMM Function and Monthly Report for September 2008 Presented to: Organization of Midwest ISO States Annual Meeting David B. Patton, Ph.D. Independent Market Monitor October 14, 2008

2. The Role of Market Monitoring • Deregulation is premised on the benefits of replacing price regulation with competitive forces to guide generation and transmission usage in the short-term and investment decisions in the long-term. • To help ensure that these benefits are realized, market monitoring is designed to identify: • Flaws in market rules that create inefficient incentives or gaming opportunities; • Potential efficiency improvements in the operation of the market; • Market power; • The monitoring function includes: • Real-time screening and analysis to identify circumstances that require further investigation. • Investigations of market operations or conduct identified through the daily screening or complaint processes. • Periodic analysis and reporting; - 2 -

3. Effective real-time monitoring requires a highly automated software system to continuously receive data and screen the market results for: Attempts to exercise market power by withholding resources; Running a generator uneconomically and causing a transmission line to become overloaded; Other inefficient conduct that may indicate potential market design flaws; Operator actions or actions of control area operators that may undermine the efficiency of the market; The market monitoring system generates automated alerts sent to the beepers and emails of IMM staff to ensure real-time monitoring is effective on a 24-7 basis. The real-time market monitoring also includes the implementation of prospective mitigation of economic withholding. Real-Time Market Monitoring - 3 -

4. Investigations are most often triggered by the real-time monitoring, but can be initiated in response to requests from the States, FERC, market participants, or the MISO staff or Board of Directors. Investigations are often necessary to evaluate certain conduct that may or may not be anticompetitive. For example, we conduct physical audits of certain generator or transmission outages to identify physical withholding; Although we consult with participants to gather information, we do not attempt to compel participants to change their conduct. Investigations that indicate anticompetitive conduct or gaming will result in referrals to FERC under a) the sanction provisions of the MISO tariff or b) enforcement provisions of the Energy Policy Act. Investigations and Complaints - 4 -

5. The primary product of the periodic reporting is an annual State of the Market report that contains: An assessment of the overall performance of the RTO markets; Recommendations for changes in the market rules or other provisions to improve the efficiency of the market; and An evaluation of the conduct of market participants and recommendations regarding changes to the mitigation measures. We also report on the performance of the market to: To FERC staff in regular weekly and monthly meetings; The States on a quarterly basis and on specific topics as needed; The MISO Board on a monthly basis; and Market participant committees as requested; Periodic Reporting on Market Performance - 5 -

6. We have developed mitigation software that runs as part of the MISO’s real-time production system. The mitigation software automatically performs the conduct and impact tests that determine when mitigation will be imposed. This system ensures that mitigation to limit economic withholding is imposed within 10 minutes of the conduct and impact tests being satisfied. On a daily basis, we compute the competitive reference levels against which suppliers’ offers are compared. The impact test utilizes the real-time energy market software, run in parallel to determine the price effects of conduct that fails the economic withholding tests. Real-Time Mitigation Software - 6 -

7. In the Midwest, States and participants designed the market monitoring function to be independent of the ISO – performed by an independent entity (i.e., the independent market monitor or IMM). Independence of the Market Monitor from the RTO is important due to its role in monitoring the RTO’s rules, procedures, and operations. The actions of a market operator generally have a larger impact on the market outcomes than any single participant. Manual actions taken to maintain reliability can distort the market outcomes -- the rules and operating procedures can often be modified to improve the consistency of the market and reliability requirements. The IMM is also required to be independent of any Market Participant by adhering to conflict of interest restrictions that prevent the IMM from having any relationships with an MP. Independence of Market Monitoring - 7 -

8. The market monitoring function requires an interdisciplinary team of experts, including: Economists, Power system engineers; Generation engineers; Software developers; and Other professionals with math and statistics . Potomac Economics currently has 20 staff to perform market monitoring. The market monitoring function also requires an extensive market monitoring software system and data interfaces with the ISO. Market Monitoring Resources - 8 -

9. Monthly Report for September 2008

10. Peak loads continued to be very low in September due to mild weather. Average load in September was 10 percent lower than in August 2008 and 4.7 percent lower than September 2007. Load exceeded 90 GWs in only 5 hours on one day and 80 GWs in 25 hours. In addition to the mild load, continued reductions in fuel prices contributed to a significant reduction in energy prices. Average energy prices in September at Cinergy, Minnesota and WUMS decreased roughly 20 percent from August. Tropical Depression Ike had significant operational impacts on MISO. Over a million customers were without power at its peak, as well as a significant number of transmission and unit outages and deratings. There were two minimum generation events in the early mornings of September 1st and 21st. There were 5 ARC events caused by a combination of generation deviations, outages, load volatility and NSI changes. Midwest ISO Energy Prices - 10 -

11. Real-Time Midwest ISO Energy Prices September 2008 - 11 -

12. Day-Ahead Midwest ISO Energy Prices September 2008 - 12 -

13. The next figure shows the day-ahead to real-time price convergence at the Cinergy Hub (the table shows other locations). September continued to generally show the usual day-ahead price premium at most of the hubs. In general, the market has tended to exhibit day-ahead price premiums due to the lower price volatility in the day-ahead market and the higher RSG allocations to real-time purchases. The average day-ahead premiums were slightly lower in September than in August, although price volatility was somewhat higher in September. The increase in price volatility relative to August and July were generally due to unusually low load (contributing minimum generation issues) and the storm conditions affected MISO for several days. Volatility remained much lower than experienced in June. Day-Ahead to Real-Time Price Differences - 13 -

14. Average Absolute Day-Ahead and Real-Time Price Convergence - 14 -

15. The next figure shows coal, natural gas, and oil prices from January 2007 through September 2008. Natural gas prices in continued the decline that began in July, which ended an 18 month period of steady increases. Gas prices averaged $6.81 per MMBTU in September compared to $8.20 in August. Prices have generally continued a downward trend into October, trading around $6.50. Illinois basin coal prices, which had risen substantially in 2008, decreased roughly 10 percent in September. Oil prices decreased modestly during the month. Despite the decline in gas prices in September, fuel prices overall remain substantially higher then the same period last summer. Midwest ISO Fuel Prices - 15 -

16. Midwest ISO Fuel Prices - 16 -

17. The following figures show variation of the net load scheduling metric during the daily peak hour. The net load scheduled day ahead is a key driver of RSG because low levels can compel MISO to commit peaking resources to satisfy the increased load in real-time. The figure shows that over the past 12 months, the net day-ahead load scheduling levels in peak hours have remained steady between 95 and 98 percent. Net load scheduling in September in the peak hours continued to be reasonably high at 96.3 percent. This significantly reduces the need to commit peaking resources in the real time to satisfy the peak load. This high level of net load scheduling during peak hours contributed to continued very low RSG levels in September. Average load scheduling in all hours was 97.4 percent. Net Load Scheduled in the Day-Ahead Market - 17 -

18. Net Load Scheduled in the Day-Ahead Market - 18 -

19. Net Load Scheduled in the Day-Ahead MarketPeak Daily Hour, September 2008 - 19 -

20. The following figure shows the real-time dispatch of peaking resources, separately indicating the share of these peaking resources that were out-of-merit (offer price higher than the LMP). Dispatch of peaking resources in September was lower than August 2008 and substantially lower than in September 2007. The decrease in utilization of peaking resources was largely due to the decrease in peak load levels and modest congestion. High load-scheduling in the peak hours also contributed to the moderate dispatch levels for the peaking resources. 48 percent of peaking resources dispatched were in-merit, which is relatively typical for moderate load conditions. Real-Time Dispatch of Peaking Resources - 20 -

21. Peaking Unit Real-Time Merit Status - 21 -

22. The next two figures show RSG payments made to peaking units and other units on a nominal basis, and adjusted for changes in fuel prices. The first figure shows RSG payments in the real-time market. RSG payments in September were among the lowest for any month since market start and slightly lower than August on a fuel-adjusted basis. In September, the share of real-time RSG paid to peaking resources was very high, which is consistent with historical patterns. The second figure shows day-ahead RSG levels for September, which continued to be much lower than in the real-time market. The third figure shows daily real-time RSG costs incurred by region. Compared to prior months, RSG payments in WUMS and the West regions were modest. This reflects continued modest congestion into those areas in September. There were no significant periods with reliability issues resulting in large RSG payments in any region during September. Real-Time RSG Payments - 22 -

23. Monthly Real-Time RSG Payments - 23 -

24. Monthly Day-Ahead RSG Payments - 24 -

25. Regional Daily Real-Time RSG PaymentsSeptember 2008 - 25 -

26. The next two figures show the output gap levels used to screen for economic withholding. The first figure shows the output gap under two thresholds (mitigation threshold, one-half of mitigation threshold). The output gap levels in September increased slightly at the lower threshold, and were nearly unchanged at the higher threshold compared to August. The increase in output gap levels compared to 2006 is primarily due to the introduction of the Minnesota NCA in early 2007 and the reduction in NCA thresholds in February 2008 Lower mitigation thresholds cause more resources to fail the output gap screen. No significant changes in participant offer conduct has occurred in recent months. The second figure shows output gap by day. While there is a steady baseline level, some days show elevated levels that we routinely investigate. Our monitoring of the output gap levels on an hourly basis has not raised significant competitive concerns. Potential Economic Withholding: Output Gap - 26 -

27. Monthly Output Gap - 27 -

28. Peak Hour Output GapSeptember 2008 - 28 -

29. Submittals to External Entities Responded to FERC data request related to our referral regarding transaction scheduling around Lake Erie and participated in additional teleconferences with FERC staff regarding these issues. Met with both the OMS staff and the state Commissioners regarding market monitoring issues in early to mid-October. Other Issues We have continued to work with MISO in reviewing results of the operations testing of the ASM software and evaluating the ramp rate modeling assumptions. Submittals to External Entities and Other Issues - 29 -