1. UK electricity market was deregulated as per Electricity Act of 1983. As a result: It introduced competition at every stage of generation, transmission, distribution and supply. 12 REC’s were formed across the country for supplying electricity to consumers The National Grid Company forecasted daily demand based on historical data Cost of marginal generator was known as system marginal price (SMP) SMP + capacity payment gave Pool Purchase Price (PPP) PPP + Uplift (8% of PPP) gave Pool selling price (PSP) Price Determination by pool auction mechanism Power market: an overview

2. Reasons for price fluctuation: Cost of fuel Weather Plant failure Plant utilization rate Holidays Changes in generation Technology Long term economic growth rate Price volatility ranged from 200% (average weekly prices) to 1000% (intra day prices) However these volatilities failed to take into account extreme regularities in electric prices and the strong mean reversion in prices For hedging PPP fluctuations, participants adopted risk management contracts like forward and option contracts Price Volatility in Electricity

3. UK market had 50 major gas suppliers with a turnover of GBP 10 billion Gas prices were less volatile than electricity because they could be stored Short term correlation between electricity prices and gas prices was less than 10% There was OTC market for natural gas swap, forward contracts and options for a period less than a year Long term markets were relatively thin Natural Gas

4. Acquired by Hanson in 1995; it served customers both in natural gas as well as electricity Electricity business alone contributed 80% profits; Eastern wanted to diversify into deregulated businesses like natural gas Eastern had initial approval for power generation up to 850MW They acquired two coal based power plants having capacity up to 6000 MW due to forced divestiture mandated by OFFER. Thus it became 4th largest power generator As part of gas strategy, they signed several “take or pay” contracts and took positions in a number of North Sea fields Within a period of one year, Eastern became 2nd largest gas supplier in 1996 from being 6th largest in 1995 Eastern Group : A Brief Introduction

5. 700 MW power project near Sutton bridge, Lincolnshire As an IPP project, it created a separate project company and financed it on a non recourse basis to keep the asset off the balance sheet Goal was to eliminate market risk through long term fixed price contract The “contractual bundle” included Engineering, procurement and construction (EPC) Operating and maintenance Gas Supply Agreement Power Purchase Agreement Sutton Bridge

6. Because of steady income stream through IPP, it could have even sustained high leverage of 70-90% debt to total capitalization Power Purchase Agreement entailed demand of equity ownership by the utilities Drawbacks: Due to extensive risk mitigation, the plant could turn out to be a low risk, low return investment It did not utilize Enron’s risk management capability to the full capacity Cont..

7. As per alternative proposal, Eastern would have a contractual interest in a virtual power plant Eastern would have to bear the fixed cost , operating & maintenance, as well as the variable cost Each day, Eastern would decide how much power to purchase, based on the economics of prices of gas and electricity Eastern would exchange physical gas for power pool proceeds Eastern had Right to buy but no obligation in case of electricity Eastern had Right to sell but no obligation in case of natural gas Sutton Bridge: The alternative proposal

8. Capacity and Tolling Agreement Up front Payment Annual Fixed Payments Variable Payments Delivery of Gas Enron Europe (ECT) Eastern Group PPP x Nominated capacity

9. The company had a business model which is more extensive than merely distributing electricity and looked at becoming a diversified company with new generating capacity The firm’s goal was to have more than half of the profits come from the deregulated business which included the Power Generation Business The firm looked at creating additional generating capacity through acquisitions in order to enhance it’s competition in generation The firm also looked at additional generating capacity to complement its existing facilities Why is Eastern interested in getting additional generating capacity?

11. Different Pricing Scenario