Dominion East Ohio Merchant Function Exit Transition Plan

1. Dominion East Ohio Merchant Function Exit Transition Plan Working Draft

2. Plan Outline • Fundamental Issues • Transition Approach • Operational Features

3. Fundamental Issues

4. Fundamental Issues • Why exit the merchant function? • What are the objectives? • What are the “guiding principles”? • How should we approach the task? • What does the end state look like? • What issues do we need to address: • Up front • At some point

5. Why Exit The Merchant Function? • Groundwork for an exit has been laid by a successful transition out of the GCR business for nearly 60% of DEO’s customers • Although it has responded well to unpredictable market erosion thus far, DEO would prefer to exit its remaining GCR business in an orderly manner • GCR rates that are affected by large unrecovered gas cost distort the competitive market • By law, DEO cannot make a profit on its GCR service • Why remain in a business that at best breaks even? • Strategically, DEO recognizes that its fundamental role is to provide distribution service, not commodity service

6. Objectives • Foster a competitive market in which customers can make informed choices among expanded alternatives while ensuring reliable commodity service by suppliers • Address the commodity service needs of those customers that cannot or will not choose among those alternatives without disrupting the competitive marketplace

7. “Guiding Principles” • Leave no one worse off than before • Promote competitive yet reliable commodity service • Minimize customer confusion • Avoid damage to Energy Choice program • Minimize duplicative capacity costs • Appropriately allocate assets and costs • Support end state objectives Make it “workable,” not theoretical

8. General Approach Take a methodical and incremental approach that: • Builds on successful features of the current program • Identifies and resolves up front those issues that are absolutely essential to a merchant function exit • Doesn’t try to address every conceivable end state issue before implementation Phases I and II - Described in considerable detail Phase III - Provides direction with fewer details End State - Outlined in intentionally broad terms • Keeps objectives and “guiding principles” in mind, yet recognizes that trade-offs may be needed • Strives for stakeholder consensus where possible

9. Ideal End State • A highly competitive market attracts suppliers that offer a wide range of pricing and service options • Customers experience no degradation of reliability • DEO’s only regulated commodity service role is to act as short-term back-up for default • All existing LDC services that can be unbundled are unbundled and offered competitively • The class of customers that cannot or will not choose is nonexistent or extremely small • Customers understand their options, the implications of their choices and the consumer protections that are available

10. Issues To Be Addressed: UP FRONT • How to maintain reliable commodity service • Transition from GCR to Standard Service Offer • Implications of disappearing GCR class • Nonpayment of unregulated commodity service • Customer communications AT SOME POINT • Eliminating/minimizing “default customer” class • Revenue cycle services (metering, billing, A/R risk, …) • Expanded unbundling beyond revenue cycle services

11. Customer Communications Intend to make use of lessons learned from Energy Choice expansion • Involve Staff and OCC up-front • Conduct market research • Review materials in draft form • Extensive employee training (call centers critical) • Key topics: • Communicate nature and rationale for change • Address safety and service concerns • Assist customer decision-making process • Refer to PUCO and OCC resources

12. Transition Approach

13. Provider-of-Last-Resort Timeline Discussed at 3/30/04 Meeting STANDARD SERVICE OFFER DEO RESPONSIBILITIES Hourly Daily <1 Cycle Monthly <2 Cycles • Intra-Day Balancing >2 Cycles • Daily Balancing • Single-Day Underdelivery • Multi-Day Underdelivery • Supplier Default • Monthly Balancing • Interim Commodity Service

14. Incremental Transition ApproachDiscussed at 3/30/04 Meeting Phase I Phase II Phase III • Less insulation of GCR customers from market prices • Implement MBSSO for returning customers (EGC?) • Change handling of delinquent Choice customers – disconnect for nonpayment of supplier $ and return to prior supplier • Customer communication - Educate and motivate • CBP for initial service offer (fixed or variable rate) and MBSSO(*) (variable rate only) • Wholesale relationship between supplier & customer • Implement as 12 or 24-month pilot with intent to make permanent • Customer communication – Educate, motivate and comfort • (*) DEO for < 2 cycles? Single or multiple supplier? • CBP for more limited group(*) and MBSSO • Retail relationship between supplier & customer • Make transition permanent • Customer communication – Educate, comfort, consequences • (*) Intent may be to minimize pool size

15. Transitional Issues Discussed at 3/30/04 Meeting

16. Transitional Issue Decisions(*) (*) Bold-faced type reflect preliminary decisions

17. Rationale for Transition Decisions

18. Transitional Issue Thoughts SSO Customer Qualifications • No fundamental reason to treat PIPP customers as separate pool (could be continued if desired) • GCR customers that don’t choose should be included • Need to minimize reversion of Energy Choice customers still under contract to a marketer • Traditional transportation customers should only be provided access to a market-based SSO (MBSSO) • Customer qualifications may also depend on the nature of SSO service to be offered

19. Transitional Issue Thoughts Pilot Program or Permanent Change • DEO prefers to make transition as a permanent change but recognizes that other stakeholders may prefer a pilot approach • DEO willing to conduct program as a pilot – preferably lasting no more than 2 years - with expectation that it be made permanent • In other words, DEO would approach a pilot as if it were exiting the merchant function on a permanent basis • If transition is undertaken as a pilot, a decision about permanency must be made in second year of a 2-year pilot • DEO will perform a review in the second year to determine what additional changes may be warranted and will file that report • Decisions about specifics of Phase III approach will have to await the review of Phase II results • Unlikely to reach consensus about thresholds that must be reached before advancing to next phase

20. Standard Service Offer Structure • Presents the biggest challenge of all • No strong preference regarding wholesale or retail approach, but want multiple suppliers in either case Wholesale: Supply responsibilities for SSO customers outsourced via an RFP or auction process, DEO still shown as the commodity provider on the bill (similar to PIPP) Retail: Customers are provided SSO by supplier(s) identified on the bill who obtain random customers in bulk (i.e., not one at a time) via an RFP or auction process • Major Objective: Ensuring a smooth transition

21. Desired SSO Attributes • Must be highly reliable service backed by 100% comparable capacity throughout entire year • Primary role is to replace GCR service, not compete with Choice supplier offers • Price must be market based, uniformly applied and initially subject to PUCO approval: • If Fixed: Reflect NYMEX strip and basis at time (*) • If Variable: Tied to relevant and verifiable index • Must anticipate inaction by large # of customers • Returning customers not necessarily entitled to receive fixed price SSO (if offered) unless determined otherwise • Must be clearly communicated in advance of asking customers to choose (*) Could be fixed for quarterly, seasonal or annual period

22. Wholesale Comparable to PIP outsourcing, but on larger scale Minimizes change from GCR service Could be used as a stepping stone to retail approach May not diminish size of SSO pool by much Continues Gross Receipts Tax vs. Sales Tax disparity Retail Gets closer to end state result by minimizing size of SSO pool Moves customers more effectively to “full retail mode” Some form of opt-out process could be used to address concerns about allocation of customers Less chance of damage to Energy Choice program May entice more suppliers Wholesale vs. Retail Approach Desired SSO attributes could be achieved by either approach, although in different ways

23. DEO vs. SSO Responsibilities • DEO is responsible for: • System dispatching and balancing • Back-up POLR service lasting less than two billing cycles using operational balancing assets: • Defaulting supplier’s on-system storage allocation also available • Curtailment plan execution (no fundamental changes needed) • Standard Service Offer is: • Treated much like any other Energy Choice pool • Responsible for deliveries into constrained areas (e.g., Cochranton, Woodsfield/Powhatan Point) • Subjected to 100% comparable capacity requirements all year • Will not count capacity if released on unrecallable basis • Provided by several suppliers through RFP or auction • Provided for an entire billing cycle

24. Capacity Contracting Implications • To date, DEO has decontracted aggressively to eliminate stranded cost • Cannot sacrifice future reliability by premature/excessive decontracting or by leaving SSO supplier(s) ill-equipped to serve customers • ROFR issues important where capacity can be readily sold into other markets Recommended Approach: Recontract as if DEO were to remain in merchant function for remaining GCR customers and release capacity not needed for operational balancing to SSO supplier(s) at point of transition: • Reduces ROFR-related risks • DEO experience with capacity provides greater assurance of performance • Maintains ability to serve isolated areas (may need modification in Phase III) • Lack of on-system storage means reserve margin may be needed at West Ohio

25. Revenue Cycle Issues • Enrollment sequence, file transfer process and billing options remain largely unchanged • DEO will establish marketer sub-group to address those issues, no changes required at transition point • Remittance of $ to suppliers to occur closer to bill due date than bill issue date • DEO considering prorated calendar month billing to accelerate enrollment process and synchronize billing & supply periods • Supplier consolidated billing issue put in “parking lot” • DEO given waiver to shut-off for non-payment of supplier commodity $ (No change in payment priority needed) • Marketer has option to take back customer under prior contract terms, otherwise customer must be reacquired as new enrollment • DEO continues to purchase A/R • 1% receivable discount revisited in light of shut-off option and bad debt tracker

26. 3-Tier Wholesale Approach • Initial Service Offer (fixed or variable price) provided by several suppliers selected via RFP and offered only to GCR customers(*) at the point of transition, price includes unrecovered gas cost (UGC) • No minimum stay obligation or true-up to actual price • If fixed, price will be adjusted at beginning of year 2 ISO • Market-Based Standard Service Offer (variable price based on first-of-month DTI-IF index + basis) offered by one or more suppliers and offered only to returning customers, with no UGC • MBSSO customers at beginning of year 2 can migrate to ISO MBSSO • Provider of Last Resort for customers of defaulting supplier • MBSSO supplier(s) given option to serve immediately, with DEO as back-up for current and next billing cycle only using predetermined index-based pricing method POLR (*) New customers could be served by ISO or MBSSO

27. 2-Tier Wholesale Approach • Market-Based Standard Service Offer (variable price only) offered by several suppliers to: • GCR customersat the point of transition, price includes unrecovered gas cost (UGC) • Returning customers, with no UGC • New customers, with no UGC • Pricing likely to reflect value of storage for transitioning GCR customers due to greater certainty of requirements (unlike uncertainty associated with new and returning customers) • No true-up to actual price MBSSO • Provider of Last Resort for customers of defaulting supplier • MBSSO supplier(s) given option to serve immediately, with DEO as back-up for current and next billing cycle only using predetermined index-based pricing method POLR

28. Retail Variant • Initial Service Offer (fixed or variable price) provided by several suppliers that successfully bid for GCR customers(*) at the point of transition, price includes unrecovered gas cost (UGC) • Customers provided opportunity to opt-out of service from selected supplier and receive MBSSO service instead • No minimum stay obligation or true-up to actual price ISO • Market-Based Standard Service Offer (variable price only) offered on wholesale basis by one or more suppliers to: • GCR customers opting out of ISO, with UGC • Returning customers, with no UGC MBSSO • Provider of Last Resort for customers of defaulting supplier • MBSSO supplier(s) given option to serve immediately, with DEO as back-up for current and next billing cycle only using predetermined index-based pricing method POLR (*) New customers could be served by ISO or MBSSO

29. Recommendation: Wholesale vs. Retail • If stakeholders prefer incremental approach, wholesale model minimizes change from existing GCR service • Should recognize that retail model gets us closer to desired end state where suppliers have the customer, not merely the load • If wholesale model chosen, plan must include a date certain for the transition to a retail model • Avoids leaving the market with impression that GCR is simply being replaced with another LDC-supplied commodity service • 2-year time frame for wholesale approach preferred • Permits “tweaking” after year 1 prior to next transition phase • Gives suppliers greater certainty about progress toward end state • Retail variant could serve as potential Phase III approach if MBSSO pool doesn’t appreciably shrink by that time

30. Recommendation: 2-Tier vs. 3-Tier • 2-Tier approach preferred over 3-Tier • Reduces complexity of transition for customers • Does not introduce another competitor into market • Single MBSSO less disruptive to Choice market • Smoother transition from GCR/EGC pricing • Issues/Challenges of single MBSSO approach • Consistency of CBP bids • Could use 1st of Month DTI Appalachian price as reference price • No fixed “price to compare” • Exposure to market volatility No different than today’s GCR

31. Possible RFP Process • Process could be similar to that used to outsource PIPP supply for last four years: • RFP terms and conditions developed in conjunction with Staff and OCC • Bid term could be for both one and two years • RFPs sent to both Choice and non-Choice marketers • DEO reserves right to reject any and all bids • Bids provided to Staff and OCC along with DEO recommendation • Selection of supplier(s) subject to PUCO approval • Electric CBP rules provide good starting point • If 2-tier wholesale approach taken, there would be no fixed-price offer

32. Possible Auction Process • DEO considering combination of PIPP Supply RFP and NJ BGS Auction processes as follows: • Use single-round PIPP-style RFP to solicit bids for full requirements slices or “tranches” of MBSSO load (EOG & WOG) • PIPP load - 10 Bcf (break into 2 tranches of 5 Bcf each) • GCR load - 80 Bcf (break into 16 tranches of 5 Bcf each) • Cap # of tranches awarded any one supplier (one-third of total or 6) • No need to treat PIPP class separately, but could award bid for first 10 Bcf to lowest price supplier(s) if desired • Could bid out half of load for 1-year term and other half for 2-year term to spread pricing risk • Specify reference index price and request bids in form of index-to-burner-tip basis with no true-up • Refresh bid for half of load prior to second year • Award in form of X% of remaining SSO load • Uniform price set at the market-clearing level • Migration and pricing risk borne entirely by supplier

33. Background Information: New Jersey Auction Process • NJ “reverse clock” auction for basic generation service (BGS) cited as possible approach for DEO exit process • Pre-qualified bidders compete to sell slices of full requirements SSO load or “tranches” • Maximum # of tranches per supplier specified in advance • Multiple-round auction begins at high end of price range as specified by regulator • As the price descends in subsequent rounds, # of tranches bid by suppliers decline (the lower the price, the lower the # of tranches bidders are willing to supply) • Auction ends when there are just enough bids remaining to supply entire SSO market at the going price for that round • Uniform price paid by SSO customers equals the final market-clearing price

34. Rates and Charges • Current operational balancing capacity cost $0.08-$0.10/Mcf • Compares to $0.099/Mcf for non-Choice transport • Offset by 91.75% comparable capacity requirement • Retention of year-round FTNN to make firm injections would increase rate by $0.02-$0.03/Mcf • Will have to reinstate Transportation Migration Rider at $0.021 level for estimated 12-24 months to cover customer education, computer system modifications and other costs • Will charge standard service offer supplier(s) $0.035/Mcf pooling fee and $5 switching fee after initial “switch” like other Energy Choice suppliers • Uncertain coverage of operational balancing inventory cost by cash outs, storage sales, etc. makes it impossible to estimate additional cost – net figure could be a credit after those offsets

35. Cost Recovery Issues

36. Operationally Oriented Timeline(*) (*) Process could be stretched out until 2005-Q4 at the latest

37. Communications Oriented Timeline(*) (*) Process could be stretched out until 2005-Q4 at the latest

38. Timing Issues • Operationally oriented timeline would target April 1 exit to coincide with beginning of storage injection season • Communications oriented timeline would consider ability of call centers to handle customer inquiries • Would avoid customer communications during winter months, leading to Q2 or Q3 communications effort prior to actual exit 90-120 days later • Recommend communications oriented timeline to ensure ability to handle customer inquiries • Storage issues can be addressed in same manner as done for system-wide expansion of Energy Choice that occurred in 2000 Q4

39. Operational Features

40. Operational Issues • Current State Summary • Future State Issues • Proposed Operation

41. Current State Summary

42. Current State - Supply Timing • Monthly enrollment deadline is 14th • Customer confirmation file posted next day • Comparable capacity requirements e-mailed following day • Comparable capacity assessed last few days of Oct-Feb (for Nov-Mar period) • Supply targets posted 2-4 days before 1st of next month (standard time frame) • Bills rendered beginning with Cycle 1 of the month following supply • Imbalance trading occurs 15-17th of following month

43. Current State - Supply Sources

44. Current State - Comparable Capacity • DEO verifies 91.75% comparable capacity • Assessed monthly during Nov-Mar period • Adjusted each month based on supplier’s enrollments • Sources include: • Interstate (DEO primary delivery point) • Only examine DEO city gate capacity • Non-recallable releases or FT-backed supply • Storage (ECPS allocation + any purchased) • Adjusted based on storage inventory • Local production (Dedicated or LPPS)

45. Current State - Balancing • Choice pools are daily balanced • Targets posted 2-4 days in advance, less if OFOs • Targets based on equations developed for each pool’s customers • DEO open to supplier forecasting suggestions • Annual true-up if comparing supply to billed use • Monthly true-up available using “unbilled volumes” • Long/short positions available for imbalance trading with ECPS and FRPS pools • Adjust storage inventory within contractual limits • Cash out using DTI South Point plus variable cost

46. Current State - Cost Recovery

47. Current State - Default Protection • DEO does not retain a reserve margin in anticipation of potential default • DEO’s on-system storage enables it to quickly react to supply shortfalls, but within limits • In event of supplier default, DEO can utilize: • On-system storage assigned to that supplier • Operational balancing capacity held for that supplier’s customers • Operational balancing capacity held for other pools/customers • Idle GCR capacity (if any) • DEO views OFO as measure of last resort

48. Current State - Balancing Assets (*) 15.5% of design day usage, 25% on-system/75% GSS/FSS Potential storage overrun commitment equals 110 MDt/d

49. Future State Issues

50. Operational Issues • How do we maintain system reliability with DEO no longer in the GCR business? • What capacity does DEO need to retain in its role as system operator? • Is a reserve margin needed? • Does anything change in Energy Choice? • How does DEO recover the costs it incurs as system operator? • Operational balancing capacity, Storage inventory, UFG, Unrecovered gas costs, Cash outs