Responsive Demand – The Opportunity in California

1. LAN020315003-24972-853 CONFIDENTIAL Responsive Demand –The Opportunity in California March 15, 2002 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

2. 118 • 271%increase • 271%increase • 50%reduction • 50%reduction 32 LAN020315003-24972-853 CALIFORNIA ENERGY CRISIS DROVE PRICES SKY HIGH $/MWh • 2001 Q1/Q2 prices exceeded $200/MWh • Almost 16GWh of load went unserved 60-65 • 1994 utility blended average • 1999 Cal ISO average • 2000 Cal ISO average • 1994 utility blended average • 1999 Cal ISO average • 2000 Cal ISO average

3. Structure of supply (35-45%) • Steep supply curve • Highly dependent on gas (with no alternative) • High gas prices and costs for environmental externalities • Large amounts of "unreliable" capacity (e.g., hydro, imports) • Market dynamics (55-65%) • Capacity additions not timely • Demand unresponsive to price • Bidding rules/procurement requirements magnified generator market power • Price caps distorted market signals and made matters worse LAN020315003-24972-853 MICROECONOMIC ROOTS OF THE CRISIS

4. Gas fired • Summer loads • Winter loads LAN020315003-24972-853 PRICE IS VERY SENSITIVE TO SMALL CHANGES IN DEMAND California power and load duration cost curves 2000 • Marginal generation costs • $/MWh • Actual load • Hours • 900 400 4,000 350 3,500 300 3,000 250 2,500 200 2,000 150 1,500 100 1,000 50 500 0 0 0 15,000 30,000 45,000 • CaISO generation capacity • MW

5. San Diego monthly residential bill (including wires) • Dollars/month • Hypothetical impact on reserve margins • Percent • 1999 summer • 2000 summer • -5% • San Diego electric usage • Index • Reserve margin 12/08/00 • Gain from 5% demand decrease • Estimated reserve margin with demand increase • 1999 summer • 2000 summer LAN020315003-24972-853 DEMAND COULD HAVE RESPONDED • ESTIMATE

6. Still reflects tight supply at wellabove $100/MWh • 2001 Q1/Q2 would represent additional potential savings – almost 16GWh of blackouts prevented • $0.2 billion-0.6 billion in economic costs avoided LAN020315003-24972-853 ESTIMATED TOTAL OPPORTUNITY COST – CALIFORNIA 2000 • ESTIMATE $ Billions • Cal PX power spend • DSM/RTP savings opportunity • Net power spend with DSM/RTP in place

7. Residential • Small C&I • Large C&I • Total • Percent of total value • 53 • 10 • 37 • 100 • Percent of total load • 40 • 10 • 50 • 100 LAN020315003-24972-853 ECONOMIC BENEFITS NATIONWIDEFROM DYNAMIC PRICING • ESTIMATE $ Billions • 5 • 15 • 2 • 8 Note: Assumes customers shift 5-8% of peak load to off-peak hours and curtail an additional 4-7% of resulting peak load; savings based on actual prices and load for PJM power pool in Year 2000 extrapolated to national load; peak hours defined as highest 10% of daily and annual prices Source: PJM ISO; McKinsey analysis

8. LAN020315003-24972-853 NATIONAL ECONOMIC BENEFITS FROM DYNAMIC PRICING IN MASS MARKET • ESTIMATE $ Billions Demand Curve shifts – lower prices for everyone • 12 • 10 Direct benefit from curtailing or shifting loads • 2 • Total • Collective benefit • Individually measurable benefit Source: McKinsey analysis

9. ~250 "peaker" plants not built • Power infrastructure for peaks reduced by 31,000 MW, saving $16 billion in capital costs (one-time) • 31,000 tons of NOx not emitted (per annum) • Reduction in water used for hydro electric generation • Gas demand reduced by 680 bcf/year • Gas transmission reduced by 2 bcf/day • Other environmental benefits, e.g., • Cleaner water • Thermal pollution • Hydro power impact on ecosystems • Enough saved electricity to supply 7 million new homes annually • Significant benefits for avoiding blackouts (lost productivity) • Other system benefits • Avoided transmission and distribution investment • Reduced meter reading costs LAN020315003-24972-853 INDIRECT BENEFITS OF BROADLY DEPLOYED NATIONAL DYNAMIC PRICING SOLUTION • ESTIMATE Note: Assumes 125 MW peaking plant, $500/kW capital cost, 25% load factor, 10,000 heatrate, 0.9 lb NOx/MWh Source: Department of Energy; EIA Power Annual Volume II; BAEF Report; EIA RECS 1997; McKinsey analysis

10. LAN020315003-24972-853 NEED FOR AN INSTITUTIONAL SOLUTION • "Free rider" challenge • 80% of benefit stems from collective actions • 50% plus adoption required • Voluntary program will not work • Capital intensive – estimated at up to $1-3 billion • Utilities must be involved • Metering savings alone will not justify investment • Some form of guaranteed return necessary • Comes down to ensuring a public good

11. LAN020315003-24972-853 CONFIDENTIAL Responsive Demand –The Opportunity in California March 15, 2002 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.