John,

Sorry for the delay in getting back to you; the EPA work is more tedious than
planned.

As we discussed, much of my work is in "gaming" both in helping energy companies
play and in providing regulatory surveillance to keep the games from getting out
of hand. I am working with one of the large CA utilities and am in contact with
the other plus the PX and ISO. I also have a 12 client deregulation project that
looks at the "rules' throughout the country to determine where those clients
should "play" next. Ten of these twelve want to do whatever it takes to be in
the top five; the other two are just deathly afraid of the other ten. We are
also working with utilities and the government in Brazil on deregulation gaming.

The US EPA work on climate change rules add another new set of features to the
games in the US. These do lead to bankruptcies as best we can tell and I believe
the UK may have to deal with some of these implications as well. From my UK
experience, I am also designing stealth games that the competitor can't follow
and the regulators can't stop. Of course, on the reverse side, I design better
methods to detect tactics in-play and to make counter moves. Most of the energy
suppliers and regulators, other than the big desperate utilities, understand the
inevitability and, essentially, the need for gaming dynamics in the market
place. It is part of standard business in all other commodities. It is just that
the transition regulations make the games a bit nastier than they would be under
stable conditions. I would also think that the presence of American companies
like yourselves have cause some financial-instrument-based gaming to occur in
the UK that were not evident during my tenure.

As you may remember, our work comes from the original efforts with the Carter
Administration on oil and gas deregulation. (The FOSSIL2/IDEAS model I
co-authored is still the US National Energy Policy model.) Our first electric
deregulation model was built in 1986 (really, 86), to look at alternatives to
the nuclear rate shock issues. The model worked fine but nobody could understand
why we needed to include mergers, acquisitions and bankruptcies into the model
to allow it to simulate a ways into the future.

I spent 1994/1995 in the UK working on European Union energy and environmental
issues. But by being housed in Cambridge, I was surrounded by the UK events. The
UK models could not simulate the gaming, the re-regulation and the M&A activity.
We simply took our 1986 US model and parameterized it to the UK ... and it
worked!. We reproduced the games, we predicted the re-regulation (both the caps
and the windfall tax), and the M&A activity. We then saw that the dynamics
appeared to be universal. We checked 2000 industries (clear back from the 16th
century to the present) and found the same repeating phenomena.

For electricity deregulation dynamics, we predicted events in Australia and
South America, such as price volatility, excessive ill-timed outages and zero
cost bids. The timing and size of the events occurred as predicted. We then
looked at the US in local

markets and found the games the model indicated - some of them, 2 months before
they happened. We then took the decision parts of the model out, leaving in only
SEC rules and the laws of physics . We took the model to utility management and
commissions to let them play "deregulation." Despite their best efforts at
setting rules and proving me wrong, they could not change the sequence and
magnitude of the 6 dynamics I discuss in the report I sent you.

Our standard model now has every gas and electric energy supplier in North
America in it, simulated in detail - financial, demand, physical, the works. We
run the model from 1989 to ensure we can simulate what did happen as well as
what will happen. We have a confidence/validity package we "stole" from Los
Alamos (with their blessing) that was used for nuclear weapons safety. We can
test essentially ALL the options available to the future in real time on a PC.
That is how we know that in the US, Southern Company Services has to really make
multiple mistakes to lose, that Enron can make only one big mistake and still
win, and that, for instance, AEP has basically no chance to win.

Essentially everyone else in the US is using optimization models to determine
what will happens and what to do. I can show, as can others, that during the
transition time from a regulated to a "stable" deregulated environment, that I
can ALWAYS win against an optimal plan. An optimal plan is the WORST thing a
company can do. The simple reason: in the "plan" you assumed, for example, that
I would do something. If I do something really dumb and different, I can make
your plan very sup-optimal, by definition. I can then make a portfolio of
options and hedges that guarantee I get 90% of everything you lose. Ten percent
goes to our mutual competition, but such is life in the game of deregulation. In
the UK the games have gotten a bit more sophisticated, but I can still find the
games, play the games, and make a portfolio where I benefit from the games.

As others were trained to find how to make things work, I was trained (nuclear
safety and economic policy) to see if things can be broken and if so how badly,
and then how to make a system that limits the breakability. However, the "tough"
system I would build weeds out the strong from the weak quickly and the old weak
guys want their protection. In the US, I have only found one other person
outside of my companies (from Perot Systems Corporation -PSC) who can think
about these issues. In the UK there are several people versed in gaming but they
are all on the government side and academic. PSC is currently working with East
Midlands but is available as of April 1. I do not need to use them, but they do
have both the UK and US experience in deregulation and gaming. They also have
the detailed systems/information software that allows my software to perform
accurate real-time gaming.

We do large amounts of utility management and staff training in deregulation
dynamics. We work with SMG, Inc. (WWW.SMGINC.COM). They (we) will probably be
presenting a training session to Scottish Power in spring but I have no
commitment to provide Scottish Power a model and am open to an exclusive
arrangement with you for UK efforts.

I previously catalogued something like 500 games it the UK two years ago. From,
our telephone discussion, I am sure I have new ones to learn. We have found over
a thousand loop-holes in the CA system. For a few years, playing at the edge of
the rules will be the name of the game. I think of it as being like multiple
simultaneous games of chess. You can't make the same move over and over and for
every move there is a counter move. One can also recognize that the badly
distorted rules look like tax deductions; one would feel very foolish not taking
advantage of the "easy" money.

We know of "problems" in all the deregulation protocols, world-wide, to date.
All of them simply try to protect some one's past rights plus promote a new
market by entangling it in conflicting rules that distort the market. By
definition, a market distortion gives different advantage to some and not to
others. These economic advantages are describe in terms of potential dollars.
The rules can almost always be used in reverse to move the money in the opposite
direction of the intent. In other words, the market will find a way to be more
efficient, one way or the other. (In the extreme, a black market forms, but in
the present case of a fairly capitalistic country with a parliamentary
democracy, the existing market is a fine place to play.)

We can provide strategic and tactical planning with a relatively inexpensive
off-the-shelf model. - for North America. The model can be modified for other
parts of the world. (We now spend more time in Eastern Europe, South American
and Canada than we do in the US.) We can also provide a more expensive real-time
system that adds artificial intelligence (think Deep Blue versus Kasparov) and
hourly detail/uncertainty analysis while hooked up to instant weather and energy
system information systems. We can see if your competitors are playing out a
strategy of if they see your strategy.

As you and we have discovered, it takes many months to change a protocol or rule
- - from review committee to software testing. In the interim the game remains
"legitimate." In the CA instance, the interim rules of the PX/ISO are causing $
B/year loop-holes. Previously the rules were in favor of the IOUs. During this
transition without the hour- ahead market and the day-ahead price discovery, the
non-IOU schedule coordinators (SCs) now have significant advantages. After the
"system" goes to full implementation, the IOUs can again play, by their own
design, very nasty congestion games (even when there is no congestion) with the
SCs.

In summary, we are very confident that we understand how deregulation evolves,
as opposed to how politics and idealized economics would like it to evolve. We
can simulate the full range of uncertainty in real time (we are sure no one else
can), can simulate all the gaming tactics, and can find the portfolio of
tactics, hedges, and options that maximize the minimum rate of return no matter
what happens. (Note that I did not say maximize the rate of return because
anyone can stop that strategy.) And in regard to the uncertainty, our work
indicates that you can play the game to have large and growing profit margins -
on average. Are you still interested in what we do?



George