QA Natural Gas Prices and Electricity

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					                                                                                                                             July 8, 2002




                        Q&A: Natural Gas Prices and Electricity
On average, the cost of fuel makes up roughly one-third the cost of electricity. In
ERCOT, the price of electricity is predominantly set based on electricity produced by
natural gas fired generation. Therefore, changes in natural gas prices impact the price
of electricity consumed by customers.

The 1999 Texas Electric Choice Act allows retail electric providers (REPs) affiliated with
former investor-owned utilities to adjust their electric prices twice per year, based on
natural gas prices. This process benefits customers and the competitive market by
adhering to the legislative intent of the 1999 Texas Electric Choice Act to allow the
price-to-beat to reflect market conditions. And now, customers can select a new REP if
they’re unhappy with their electric prices.

How is the price-to-beat fuel factor changed?
•    A composite natural gas                      4.500
     price is calculated from
     the NYMEX Henry-Hub                          4.000

     natural gas index,                           3.500
     averaging the closing
     forward 12-month prices                      3.000
     for each business day of a
                                                  2.500
     10 day period.
                                                  2.000
•    If this composite price is
     more than four percent                       1.500
     higher than the natural
                                                  1.000
     gas price used to set the
     existing fuel factor, a REP                  0.500
     may file for an increase.                                                    Data from NYMEX Henry-Hub Natural Gas Index
     The graph to the right                       0.000
                                                      3/2/02   3/9/02   3/16/02    3/23/02   3/30/02   4/6/02   4/13/02   4/20/02   4/27/02
     serves as an example of
                                                               Avg 12-month Gas Price $/MMBtu            10-Calendar Day Mov. Avg. $/MMBtu
     this.                                                     $3.11/MMBtu Gas                           $3.11/MMBtu * 1.04


•    The percentage increase in the natural gas price is applied to the current fuel factor
     to calculate a new fuel factor, utilizing rules developed by the Public Utility
     Commission of Texas (PUCT).

•    PUCT rules also specify that the new factors will become effective within 20 or 45
     days, depending on whether a hearing is requested.
                                                                                     (more)

    Association of Electric Companies of Texas, Inc.                             American Electric Power • El Paso Electric Co.
       1005 Congress, Suite 600 • Austin, TX 78701                                        Entergy • Reliant Energy
phone 512-474-6725 • fax 512-474-9670 • http://www.aect.net                 Texas-New Mexico Power Company • TXU • Xcel Energy
                                                                                                   July 8, 2002



Why is the price of natural gas used to determine the fuel factor?
When the PUCT collected comments and data from stakeholders in Texas’ market, there
was extensive discussion on how to determine the fuel factor (Project No. 21409 Final
Order; Substantive Rule §25.41). The PUCT ultimately decided to use changes in the
price of natural gas as the sole basis for fuel factor adjustments, concluding that it
would be sufficient to ensure that affiliated REPs can remain solvent, while
appropriately adjusting the price-to-beat so other REPs are able to compete. Some of the
reasons are below:

•    Gas prices are an acceptable proxy for the marketplace. In the preamble to the
     price-to-beat rule (Substantive Rule §25.41), the PUCT notes that “[After electric
     competition begins,] the market prices of generation will likely be set by gas-fired
     generation, and as such, it is appropriate to apply the changes in the market price of
     natural gas to the entire fuel factor in order to maintain the level of headroom in the
     price to beat.” This means that, because the cost of natural gas determines the
     market price of purchased power, changes in natural gas costs are a suitable
     approximation for changes in the fuel factors.

•    Using the NYMEX natural gas index is relatively straightforward. In Texas’ old
     regulated market, fuel costs were treated as a pass-through. Utilities were allowed to
     file to adjust their fuel rates twice per year and were allowed to recover their
     unbilled fuel charges accrued since the last fuel reconciliation. In the new
     competitive market, fuel is not a pass-through. While affiliated REPs are allowed to
     file adjustments twice per year, they are not able to recover any fuel charges from
     any prior periods. So the PUCT shortened the period of time in which a decision can
     be reached by simply using an established natural gas index as the proxy. This helps
     to ensure that the price of electricity is appropriate to the market, and that affiliated
     REPs are not forced to sell electricity below cost.

•    There is no reliable electricity index at this time. Without an electricity index that
     can be relied on to be indicative and accurate of the wholesale, purchased-energy
     market, some other proxy must be used to set the fuel factor.

•    A REP’s energy portfolio is competitively sensitive information. The energy
     purchases that affiliated REPs make are based on highly confidential, highly
     competitive business agreements. Disclosing these purchases would seriously harm
     affiliated REPs’ abilities to compete outside their traditional service areas.

•    REPs don’t purchase fuel separately. In the new market, REPs generally do not
     know the fuel mix of the electricity they purchase from suppliers. Thus, it would not
     be practical to apply different increases to the different components of the fuel mix.




    Association of Electric Companies of Texas, Inc.               American Electric Power • El Paso Electric Co.
       1005 Congress, Suite 600 • Austin, TX 78701                          Entergy • Reliant Energy
phone 512-474-6725 • fax 512-474-9670 • http://www.aect.net   Texas-New Mexico Power Company • TXU • Xcel Energy