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THIRD QUARTER 2010 Letter to clients

n one form or another, the government has always stricted market-based cap-and-trade programs to direct conguided resource planning. The last several years saw trol. In each instance, the current forms of the draft rules renewable power investors seeking an array of valuable introduce large bands of uncertainty for compliance costs. federal investment tax credits, cash grants, and loan guarantees. The result was an historic development boom in wind The courts will also have a say since lengthy legal battles turbines and solar panels. The subsidies also extended to typically follow major EPA rules like the ones proposed this carbon-free non-renewable sources, with even nuyear. States, busiclear developers considering new sites on the “Government is looking for regulatory nesses, public interest heels of the federal loan guarantees. But these organizations, and inalternatives with longer-lasting impacts” dustry groups have incentives are scheduled to expire, as early as the end of 2010 in the case for the federal cash grant. already challenged Rather than continuing to rely on short-term federal stimEPA’s recent proposals and many expect that this round of uli, the government is beginning to reach into its policy lawsuits will take several years to resolve. Some of these chaltoolbox for regulatory alternatives with longer-lasting imlenges have even been filed prior to knowing the final form pacts. of the regulation. Which of these proposed regulations will be vacated entirely (e.g., Clean Air Mercury Rule) or reThis regulatory effort began to grow last year at the EPA, manded back to the EPA (e.g., Clean Air Interstate Rule)? when it issued the draft endangerment Will these recent regulatory proposals sigfinding declaring greenhouse gases to be a nal the “last call” to Congress to pass a clipublic health threat and, as a result, the mate change bill? EPA’s clear intent to regulate carbon dioxide emissions. The EPA then followed its While these battles rage in the courts, delandmark finding with a series of proposed velopers are quickly coming to terms with a regulations targeting fossil fuel-fired generasignificant shift in the cost structure of tion, the most notable being the “Coal power production — a significant upward Ash” Rule, the Transport Rule, and the shift. Regardless of the policy vehicle (after Tailoring Rule. all, Congress can still pass legislative alternatives), there is agreement among market The unintended consequence of such a participants that generation costs will inrapid succession of proposals is an enorcrease for marginal price-setting generators mous cloud of uncertainty. It’s not simply the staggering under future emission and waste controls. Collectively, the breadth of these regulations, which cover everything from cost to comply with these policies will inevitably raise the coal ash disposal practices to emission reductions of SO2, long-term generation costs to coal-, oil-, and — albeit it to a NOX, and greenhouse gases (including CO2), that makes lesser extent — natural gas-fired generators. investors reluctant. There is still an open question about the specific approaches ultimately adopted under each proposed Since zero-emission technologies are not subject to these rule. costly compliance requirements, they capture higher long-term profit margins from operating “The unintended consequence is an in the power markets. The underlying economic For example, the proposed enormous cloud of uncertainty” question is whether these compliance-related Coal Ash Rule contains two distinct approaches, one of increases in energy prices will be high enough to which carries a very large stimulate the investment in low-emission sources without consequence for coal combustion byproducts disposed in the need for the array of financial incentives currently prolandfills. The proposed Tailoring Rule targets “large” vided. If CO2 emission reduction (and the corresponding sources first, but that threshold seems to be subject to compliance cost) is the biggest hammer in the policy toolchange. And the Transport Rule contains what is perhaps box, how high must allowance prices be to attract renewable the widest spectrum of approaches, ranging from unreresource additions without perpetual tax credits?

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DAI

PA 15017 — Appraisal & Valuation Market Analysis & Forecasting Independent Engineer — Phone (412) 220-8920 Facsimile (412) 220-8925 Internet www. but rather to study what those errors as well. Forecasting may many prediction errors have emerged from failures to fully grasp be thankless. Forecasts can be self-defeating tend that errors do not exist. of Energy Annual Energy Outlook . REC revenue.2010 FERC Order 836 $12. Many a bold prediction has been — and will continue to be — proven wrong.5 $0. negating the low prices and vice versa. The key is not to pregrowth in either demand or supply. the long-run effects of the Gulf Many prediction errors have emerged from truly spill. and the role that shale will have on supply a final thought random phenomena such as hurricanes.0 $0 Coal Natural Gas $0 Coal Natural Gas Wind Other (Non-Energy) Revenue can include capacity market revenue. A forecast of low prices may cause market participants to could be and incorporate that insight into your planning. Dept.S. and any state or federal incentive program revenue ERCOT $100 $100 Palo Verde $75 $/MWh $/MWh Coal Natural Gas Wind $75 $50 $50 $25 $25 $0 $0 Coal Natural Gas Wind Source of Forecasts: U. But will only add to the uncertainty.0 Henry Hub Spot Price $2. 1984 . but it is absolutely necessary.5 Hurricane Andrew Gulf War I Power Markets Deregulate California Energy Crisis Hurricane Katrina Gulf War II Global Recession $10. plan greater future consumption. New concerns such as the prolonged drop in natural gas demand.0 $/MMbtu $7.third QUARTER 2010 Letter to clients Non-Energy Revenue Required for Market Entry Over the Past Twelve Months ISO-NE $100 $100 PJM-West DAI $/MWh $75 Revenue Requirement Other Revenue Required Energy Revenue $75 $/MWh Wind $50 $50 $25 $25 DAI Management Consultants 1370 Washington Pike Bridgeville.0 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Natural gas prices are notoriously volatile.5 $5. Postscript .daimc.com $15. Events such as legislation and weather patterns contribute to a degree of uncertainty that frustrates industry planning.