CEO Report Thomas F. Schrader

ERCOT Board of DirectorsJanuary 18, 2005

2

CEO Report

• Interim CFO – Ray Bowman• CFO Priorities• Audit Response• 2004 Accomplishments• 2005 Challenges• Reserve Margins

3

CFO Priorities

Audit Response- Fixed Assets (inventory and process)- Internal Controls Management Plan- Policies and Procedure

Fiscal Management- Cost reductions- Expense and time tracking- Justification requirements- Zero Base (activity based) Budgeting

Compensation and Benefit Study Annual Financial Audit

4

Audit Response

Tracking Tool Populated- Responsibility- Milestones

Internal Control Management Program- Proposals received- Work starting in early February

Security- Lost Chander, seeking permanent SD- Progress on organization and plan for 1Q

5

2004 Accomplishments

Despite Difficulties- Rogue employee scheme- Time and resources for audits

A tremendous amount was accomplished- Projects in Board Materials- Goals

ERCOT 2004 Goals Update

Fourth Quarter Results Through 12/31/04

7

1. Reliability & Congestion Mgmt1. Reliability & Congestion Mgmt

• Implementation of EMMS Release 3 provided enhanced functionality that improves grid operations, including elimination of some resource specific deployments that have cost the market over $50M in 2003.

• Completed exit strategies for RMR generation at Laredo, Bates and Eagle Mountain. Once transmission improvements are completed, RMR uplifts will be reduced by $46 Million per year.

• Approved additional (non-RMR) transmission planning projects to relieve congestion resulting in $58 Million per year savings to the market.

• Implementation of Remedial Action Plans (RAPS) and Special Protection Schemes to reduce congestion cost to the market by over $70M.

• Achieved overall compliance with NERC standards with only one violation in 2004.

• The number of lost intervals on the EMMS system has been reduced by 75%, reducing market interruptions.

• Implementation of dynamic transmission equipment ratings in spring 2004 that have reduced congestion management actions and associated costs in the range of $30-40M.

• Creation of a Congestion Management Analysis and Mitigation Department in September 2004 whose focus is on improving congestion management processes for future savings.

8

2. Retail Transaction Processing 2. Retail Transaction Processing SuccessSuccess

• Successful implementation Texas set 2.0/MIMO, most complex business process/system improvement since Market Open. Improved market-wide operations by reducing rejects by 54%, 66% reduction in back dated move ins. Estimated market savings of $40M in first 3 months.

• Completed retail market test flight 0504 ahead of schedule, largest integrated flight to date and certified 32 new market reps in 3 test flights during 2004.

• Implemented Retail testing improvements including automation and test defect tracking reporting.

• Market Metrics “In Protocol %” for Switch transactions (99.9%) and Move-In transactions (96.4%) reported to the PUCT was an all time high in 2004.

• Continuous Service Agreements (CSA) initial reporting delivered to the market fulfilling SCR 734 requirements without a system change.

• Comprehensive Market Participant survey conducted, confirming high performance perceptions in most areas and other areas needing improvement.

• Improvement actions based on market survey include: ERCOT.com enhancements, MP meeting management/support project, cost tracking and reporting project, TML improvement projects, and business process improvement efforts.

9

3. Wholesale Access Settlement and 3. Wholesale Access Settlement and BillingBilling

• Successfully completed SAS 70 II audit of Settlements and Billing with no qualifications to internal controls.

• Met Board Directive of resettling True-ups for 2002 and 2003 and getting back on Settlement Calendar by year end.

• Met timeliness requirement of posting of Settlement Statements 99.5% on time despite additional Settlement runs from Board directive.

• Completed all settlement runs with less than 1% Re-run rate (resettlement due to errors).

• Implemented system changes to improve settlement performance by 10%. Performance includes added efficiencies in automated controls and reduced manual work-arounds.

• Successfully resolved and settled 4000 settlement disputes and ADRs within protocols.

• All TRC Auctions conducted on time with no errors identified in tracking of ownership. All TCR Invoices collected and revenues distributed according to Protocol.

10

4. Management Systems and 4. Management Systems and Business PracticesBusiness Practices

• Achieved NERC 1200 Security compliance and remediated security related SAS 70 issues resulting in unqualified second period opinion.

• Implemented 35 internal process improvements and 5 external transaction reports in EDIM department, improving transaction processing, reports and related systems.

• Resolved 15,535 Fas Trak issues in 2004, a 99.5% completion rate resolving 224.482 transactional issues.

• Received 4,259 Data Extract Variances in 2004, completed 94.5% by year end resolving 134,437 variances.

• Lawson Procurement system used in 2004 to automate and track purchases and establish control improvements

• Began process of responding to SAS 70 and management audits to address control concerns and improve effectiveness

• Implemented MS Project Server to provide ERCOT wide resource planning for projects and improved project controls and reporting.

• Completed standardized job descriptions for every position within the organization.

11

5. Financial Management and 5. Financial Management and Cost EffectivenessCost Effectiveness

• Deployed Aperture Data Center management application that improves capacity planning accuracy and provides asset management capability.

• Completed the Data Center Consolidation project deferring the need for expansion by at least 24 months.

• Completed construction (temporary CO issued) of the TCC II facility on schedule and budget. Move in scheduled for January.

• Implemented Altiris client management solution improving service performance, automating backups, validating license compliance and saving $120k annually.

• Renegotiated communications contracts saving ERCOT $1.2MM on an annual basis.

• Negotiated software license and maintenance cost reductions saving $2.3 M annually.

• Implemented automated test capability for portal applications improving test capabilities and reducing time and cost for testing.

• Revised relocation policy resulting in a savings of over $500,000.

• Reduced property tax liability over the last two years by nearly $700,000.

12

6. External Affairs6. External Affairs

• Implemented a more robust process for Protocol revision requests (section 21 )to include better impact analysis, requiring additional market benefit information and a revised review timeline.

• Deployed enterprise data warehouse solution and new market monitoring system to PUCT MOD improving ability for timely market oversight.

• Enhance the existing Texas Renewable Energy Credit Trading program to facilitate market improvements to comply with changes in PUCT rules.

• 1,319 Market Participants employees reached by Retail Client Services through education and site visits in 2004.

• Creation of business plan to support improvements for Market Education.

• Continued participation with ISO council (hosted ‘compare best practice’ ISO meeting in 2004).

13

7. Organizational Readiness7. Organizational Readiness

• Implemented corporate goal setting process, updating ERCOT mission statement, establishing corporate goals and building division and manager goals in support of major corporate goals.

• Implemented Lawson HRIS system allowing employees online access to information, improving tracking and reporting for ERCOT resources.

• Hired over 200 people during 2004 with minimal outside recruiting assistance.

• Reduced reliance on outside services by 25% in 2004, replacing contractors with ERCOT employees, resulting in over $1.8M savings annually.

14

2005 Challenges

Management Action Plan- Internal Controls- Process Improvement- Management Practices- Fiscal Constraints

Texas Nodal/Market Redesign Legislative Oversight

- Jurisdictional Committees - PUC Sunset/Reauthorization Legislation

Issues - Congestion Management- Transmission Planning- Resource Adequacy

Reserve Margin Considerations

Currently, 8,386 MW of generation is mothballed in ERCOT

Total does not include RMR generation

An additional 1,628 MW may be mothballed

Reserve Margin calculation is dependent on the definitions and/or assumptions used for the calculation

Current ERCOT Reserve Projection

Year 2005 2006 2007

TAC-approved definition

17.4% 28.8% 25.8%

If mothballed units are not operational in future years

17.4% 13.8% 11.1%

If additional 1,638 MW is mothballed

14.8% 11.2% 8.6%

Current ERCOT reserve requirement is 12.5%