Strategic Support Services for Participants in the Post-Restructuring
                                Electric Industry

                  "Real-Time Optimization and Market Modeling"

Introduction:

Policy Analysis Corporation (PAC) and Perot Systems Corporation (PSC) have
teamed to assist companies (electric utilities, energy service providers, power
marketers, etc.) who must learn to operate in the restructured electric
industry. Companies operating in this market will face considerable uncertainty
as they enter this new phase. California is just at the start of the process of
deregulating its electric industry. The industry structure as of 1/1/98 will not
be the final, steady-state structure. The market's rules as well as the
participants in the market will evolve over time. Consequently, the nature of
the challenges these companies face will continue to change over time, as will
the learning process.

Experience in other markets (U.K. Electric Pool, U.S. airlines, U.S. gas
industry, U.S. telecommunications industry) shows that deregulation and the
accompanying restructuring of these industries proceeds in phases. We expect
that the deregulation of the electric energy market will follow a similar path.

Broadly speaking, the steps in the de-regulation path are:

1.       Transition from a regulated market to a structured market (vertical
         utilities are unbundled and market entities such as Power Exchanges and
         Independent System Operators (PX/ISO) are created)

2.       Further accelerated deregulation of the market due to economic and
         political pressure

3.       System divestiture (further efforts to move generation, transmission,
         distribution, and energy-marketing into separate companies)

4.       Strategic and tactical maneuvering by the participants in the market

5.       Reregulation to control market behavior as reality deviates from
         theoretical expectations

6.       Massive consolidation of market participants through mergers and
         acquisitions

Experience indicates that the process should take five to six years from start
to finish.

Throughout each of the above phases, the participants in the electric market
will be presented with different threats and opportunities. A company must
anticipate these changes and position itself properly for each phase if it to
survive, let alone prosper. This "prediction" requires an understanding of the
way the market will operate in each phase and the likely actions of its
competition. PAC and PSC bring together unique capabilities to help a company
consider its position within each stage of deregulation and to develop
strategies for operating successfully.

PAC's study of the deregulation process in many industries and several countries
has led to the development of a model that simulates the dynamics of
deregulation and which has been used to predict accurately market behavior
through the various phases of deregulation. PAC is actively engaged in studies
of the deregulation of the electric utility industry in the U.S., which analysis
has provided insights into the likely opportunities and threats that will occur
in many states, including California.

PAC's model possesses analytical capabilities and goes beyond that of simply
simulating the behavior of the market on a macro-level. It can also be used to
assess the competitive position of an individual company in these markets and to
develop strategies for that company. The model can then serve to evaluate the
return and risk associated within each of a possible range of "gaming"
strategies which a company may wish to consider in deciding on its market
position.

Important lessons can be drawn from these theoretical studies, the "what if?"
capabilities delivered by these tools, and from the actual market experience:

*        A company must develop its operating strategies taking into account the
         range of strategies available to it as well as its competitors. It must
         seek to balance return with risk.

*        A company must change its mind-set from operating "optimally" as a
         stand-alone entity. This leads to predictable behavior and gives
         competitors information that they can use to devise strategies to
         improve their return at the expense of the company.






Illustrating the above statements, we can examine the behavior of generators
bidding into the U.K. Pool. The generators employ bidding strategies to earn
returns that balance associated risks while considering the likely range of bids
by the other participants. For example, the U.K. generators do not simply bid
their true costs and availabilities. Examining the behavior of the participants
in the U.K. Pool and other electricity markets, one can derive insights that
will be useful in devising strategies for participants in the U.S. electricity
market.

California Electricity Market:

Experience in other deregulated electricity markets, combined with simulation
models of these markets, are useful for gaining insights which may suggest
strategies for companies operating in California. However, the restructured
market in California differs from other markets in several important respects.
Therefore, these experiences must be customized to address California's unique
requirements

A thorough examination of the protocols that govern the California ISO/PX is the
first step in devising strategies that balance returns with associated risks.
The descriptions of these protocols are in the public domain. PSC has an
excellent foundation for this work since it has been intensively studying the
business protocols that govern the ISO and PX since 1994, and understands how
these components of the market interact.

To illustrate this point, the California market design is based on two
theoretical models: a supply curve/demand curve economic model of a market with
a single commodity, and a non-repeated auction for a single commodity. Theory
shows that for such a market, in which each participant is relatively small, the
optimal strategy is to bid its "true cost." However, a review of the protocols
shows that the actual California market structure deviates from its theoretical
underpinnings for practical reasons.

The California electric market actually consists of several markets that
interact in complex ways:

*  A progression of forward and spot markets

   - Day-ahead forward markets, hour-ahead forward markets, and
     real-time spot markets

* Markets for different commodities run by several different parties

   - Forward energy markets run by the PX

   - Forward energy markets run by other Scheduling Coordinators (SCs)

   - Real-time imbalance energy market run by the ISO

   - Forward transmission markets run by the ISO

   - Markets for ancillary services such as reserves run by the ISO

   - Ability to opt out of the ISO ancillary service markets through
     self-provision of ancillary services.

These are also not one-time auctions, rather these markets are frequently
repeated (daily or hourly). All of these factors will significantly affect a
participant's best strategy.

A participant in the California energy market will therefore face several
high-level strategic decisions. These include:

* Whether to buy and sell energy in the PX forward energy markets or in some
  other SC's forward energy markets?

* How to balance risk due to uncertainty in its forecasts of demands and market
  prices by bidding into the day-ahead market vs. the hour-ahead markets?

* Where and how to bid a generator's capacity (the same capacity could be used
  for several mutually exclusive purposes, e.g. to sell energy into an energy
  market, to sell one or more ancillary services to the ISO's ancillary services
  markets, to self-provide ancillary service requirements)?.

PAC & PSC's "Real-time Optimization and Market Modeling" Service Offering:

Our comprehensive service offering includes:

*   Review & Analysis of the California market ISO/PX business protocols
*   Assessing competitive positions
*   Developing and simulating strategies





    Monitoring and tracking market behavior

We will first review the ISO and PX public domain protocols on a detailed level
to identify the risks to which a participant may be exposed, as well as to
identify potential opportunities. Based on this review, we will then work with
the participant to identify potential strategies that it may choose to use as
well as the strategies which its competitors may use against it. For example,
our initial evaluation of the published protocols for the real-time energy
market indicates that the behavior of this market may potentially expose a large
net buyer of energy to substantial risk. We would aid such a participant in
developing its strategies to detect and guard against such occurrences.

Reviewing the public domain protocols provides the basic foundation for
developing a range of potential strategies. Developing workable strategies
requires the further ability to perform detailed "what if?" simulations of the
market's response as well as the ability to examine other participants'
responses to these strategies. PAC's simulation models provide the foundation
for this effort. PSC and PAC will work with the participant to refine the
candidate's strategies using the simulation tools to determine its optimal
strategies for the California market.

In order to continue to refine and adjust strategies to market conditions,
participants must monitor and evaluate the behavior of the markets. Participants
will be able to take advantage of the information available and published by the
ISO and PX, but they should also assimilate and analyze the information arising
from its own experience in structuring appropriate bids, and tracking the bids
which are accepted and rejected. By evaluating this information, a participant
will determine whether other participants' strategies are damaging its economic
position and can develop counter strategies to preclude harmful actions by
others in a timely fashion. We would work with the participant to implement such
a monitoring effort.