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The New England Auction: Regional Strategy for Competitive Generation

Fortnightly Magazine - February 15 1998

capability, especially in the New England region, give it important insight into how the wholesale and retail markets will evolve. The company's ability to defer capital investment suggests the decision of when to build is associated with an options value. Because it enables USGen to reduce risk (uncertainties about the future market conditions) at low cost, the value is positive and probably significant.

While difficult to quantify the full potential of USGen's merchant capability and the options value of future plants, we nonetheless estimate an additional $150 million to $200 million as the potential value above the baseline estimate.

Retail marketing will prove critical. With its existing generating assets and its potential merchant capacity in the region, USGen can be expected to offer attractive terms to new power customers. New, lower-cost capacity can leverage the value of contracts and customer relationships tied to existing NEES generating assets. We conservatively estimate that USGen will enter new contracts with a net present value of $175 million to $225 million.

Portfolio Value:

Integrating Fuel, Power and Risk

The ability to manage fuel and power supply risks simultaneously will be the linchpin to operating in a competitive power market. Key requirements are commodity procurement, management and trading skills. In addition, access to gas supply, the future marginal fuel, and gas transportation services will figure prominently. PG&E Energy Trading and USGen's Natural Gas Services operations cover all these areas. USGen manages approximately 935 million cubic feet of Canadian natural gas imports per day, has an ownership interest in Iroquois Gas Pipeline, a major northeast interstate pipeline, and is a lead sponsor of a new gas storage facility under construction in New York. Before the sale, PG&E was already one of the largest importers of natural gas into New England.

Combining NEES' 18 generating plants and power contracts representing about 5,000 MW with PG&E/USGen's existing assets and trading capabilities can provide three important benefits:

PORTFOLIO SIZE. By managing an aggregate 9,000 MW, PG&E will become the fifth largest natural gas trader and the 14th largest electricity trader in the U.S. With 20 percent of the generating capacity in the region, the new combined entity will have much greater trading opportunities;

PORTFOLIO FUEL MIX. The fuel diversity of the NEES assets (em coal, gas, oil and hydro (em can provide an important hedge against price volatility in any one fuel. In addition, USGen is protected on the downside of the power purchase contracts it assumed because of the New England Power's payment for the above-market value of these contracts; and

FUEL STABILITY/POWER TRADING. The increased assurance of stable fuel supplies provided by USGen's natural gas pipeline and energy trading capabilities significantly increases the company's ability to minimize market risks and take advantage of arbitrage opportunities.

Stable fuel supply, diversified electric generating portfolio and experienced energy trading operations provide a solid foundation for operating in the deregulated New England power market. Several ancillary benefits may flow to USGen/PG&E's operations as well, such as increased gas sales. We conservatively estimate that these capabilities have the potential to enhance the value of