Global Energy Horizons Scenarios of the Energy Future

Scenario analysis is a proven technique to anticipate, rehearse and respond to market uncertainty, future risks and strategic opportunities. Global Energy adds value to the traditional scenario planning process by leveraging its analytic software tools, data and market expertise to provide actionable quantifiable results to complement the qualitative power of scenario analysis to help our clients manage uncertainty and turn their energy strategies into actionable results. Global Energy Horizons 2007 has been expanded to include broad consideration of the uncertainties associates with CO2 regulation and the growing pressure for greenhouse gas reductions worldwide.

Scenario analysis offers a credible check to tunnel vision and the tendency to base

strategy on one view of the future—especially if the scenario impacts are

quantified to provide actionable results. Combining scenario analysis with Global

Energy’s advanced analytic software, risk expertise and data creates realistic and

measurable alternative futures. Simulating the impact on market fundamentals of

the distinct economic, regulatory, and technological parameters that underlie

each distinct possible future takes scenario planning to the next level.

It works by iteratively building plausible alternative views of the future given

different economic, regulatory, and technological driving forces. Properly

implemented, the process should challenge participants’ mental maps, check

over-optimism, provide strategic insights, engender a common strategy language,

and lead to better decision-making.

Scenario analysis is a proven strategy for managing uncertainty. The process

acknowledges that both today and tomorrow’s business environment are

increasingly complex and unpredictable. Unexpected events, shocks, and

inevitable surprises will drastically change the marketplace. This has never been

truer than it is today, when fuel price, regulatory, environmental, and competitive

risks are growing.

Scenario analysis provides the framework for critically and systematically testing

strategy options for the future. The framework is the broad set of possible future

business environments or scenarios developed. While a set of rigorous scenarios

is a chief output, as equally important benefit is the iterative and interactive

process of putting forth and challenging ideas about how the future may unfold.

Global Energy Horizons is the perfect balance of the qualitative power of scenario

analysis and the quantitative precisions of advanced analytics.

Figure 2-1 Scenario Planning Process

SOURCE: Global Energy.

The Global Energy Horizons Process

The scenario building process begins with a detailed assessment of the key

strategic questions from the perspective of future pre-determined elements and

key uncertainties (see Figure 2-1). Generally, two to four distinct major themes or

patterns are identified in which key uncertainties are played out. These become

the scenarios—the distinct, equally plausible, and internally consistent views on

how the future may evolve.

1. Global Turmoil: Global impact on disrupted petroleum and natural gas

supply imports and economic growth;

2. Technology Evolution: Broader application of environmental controls

including second generation nuclear, mandated CO2 reductions drive

technological advances in utility industry;

3. Global Economy: Shift of major industry in the U.S. to overseas drives

formation of Atlantic Rim Pact and global consolidation of energy

infrastructure;

4. Return to Reliability: Reliability standards adopted after growing concern

of electricity reliability due to brownouts and increased outages drives a lack

in consumer confidence.

Through an iterative process of re-thinking and testing, the scenarios gain rigor

and credibility. Developing internally consistent storylines for each scenario is an

essential part of the thought process since they highlight the connections among

the various forces and events driving a scenario. Timelines are created to identify

important milestones that define each scenario. Signposts are identified to signal

which scenario is unfolding. An important consideration is whether the scenarios

capture all the critical uncertainties. Are there any emerging trends and future

events that will shape the business environment but have not been taken into

account? Have the scenarios sufficiently stretched the mental maps of the

participants?

The Quantitative Process - Global Energy’s Analytic Approach

Electric Markets Modeling

Global Energy uses a fundamentals-based methodology to forecast power prices

in each region. Based on its STRATEGIC PLANNING™ powered by MIDAS

Gold®—a proven data management and production simulation model—Global

Energy simulates the operation of each region of North America.1 Strategic

Planning is an integrated, fast, multi-scenario zonal market model capable of

capturing many aspects of regional electricity market pricing, resource operation,

and asset and customer value.

Strategic Planning generates zonal electric market price forecasts for single and

multi-area systems by hour and is chronologically correct for 30 years. Prices

may be generated for energy only or bid- or ICAP-based bidding processes. Prices

generated reflect trading between transaction groups where transaction group

may be best defined as NERC subregions. Trading is limited by transmission

paths and constraints quantities. The market based resource expansion algorithm

(MRX) builds resources by planning region based on user-defined profitability

and/or minimum and maximum reserve margin requirements in determining

prices. In addition, strategic retirements are made of non-profitable units based

on user-defined parameters.

Gas Price Forecasts

To forecast natural gas prices, Global Energy uses three forecasting phases:

Table 2-1

Gas Price Forecasting Phases

Forecast Phase Period Length Data Source Forecast Technique

Futures Driven First 24 Months NYMEX Henry Hub futures and market differentials

Calculated Henry Hub and liquid market center differentials

Mean Reversion Next 24 Months Global Energy Linear process to gradually equate near-term to long-term trend

Long-term Trend Remaining forecast period (to 2030)

Various Global Energy data sources

Fundamental supply and demand analysis modeling

SOURCE: Global Energy.

To derive the burner-tip forecasts used, Global Energy first examined regional

prices and basis swaps at a number of trading hubs. Using this historical data for

the first 24 months of the forecast, Global Energy developed a differential price

between the appropriate market center nearest to the power plant and the Henry

Hub. Gas prices used for the first 24 months were driven by Henry Hub futures

market prices plus a basis differential (if any). Applying this approach permitted

1 For 2007 Global Energy Horizons, Global Energy Advisors utilized version 2007.163 with a July 19, 2007 executable. The data is representative of spring 2007 Energy Velocity Market Ops with updates for new entry and fuel forecasts.

Global Energy’s forecast to include the recent shifts in natural gas prices. During

the following 24 months of the forecast period, Global Energy imposed a linear

mean reversion process on the forecast. This process aligns natural gas prices

during the first 24 months back to their long-term, fundamental levels. Beyond

the initial 48-month period, Global Energy uses RBAC’s GPCM gas forecasting

model to assess medium- to long-term fundamentals. Prices and gas demand for

electric generation from GPCM are integrated with Global Energy’s North

American Reference Case price forecast.2

Market Areas

Global Energy’s regional market analysis for Global Energy Horizons follows our

Reference Case topology encompassing 76 market zones or transmission zones.

Figure 2-2 Market Areas

SOURCE: Global Energy.

Environmental Emissions Costs and Reduction Targets

Global Energy models emissions of NOX, SO2, Hg, and CO2. Global Energy

Intelligence’s Energy Velocity database includes detailed station data for all these

variables that are based on publicly available data from the EIA and EPA. The

total emissions resulting from our model are also calibrated against historical

EPA data. A description of how each of these pollutants is treated in our model is

discussed below. For all emission costs modeled in this study, we assume that

flexible market based cap-and-trade programs are used (rather than state or unit

specific emission caps).

2 The North American Reference Case is a 25-year price forecast of 76 competitive power markets across every North American Electric Reliability Council region. These forecasts are updated twice per year.

The emission targets modeled in this study are all based on the latest proposed

rules from the EPA. For NOX, SO2, and PM2.5, emission reduction targets are

based on the Clean Air Interstate Rule (CAIR). In a separate regulatory initiative,

the EPA issued in March of 2005, its final Clean Air Mercury Rule (CAMR) that

sets nationwide limits on mercury (Hg) emissions from electric generating units

by introducing Hg emission caps effective in 2010 and 2018. This program covers

all 50 states and seeks to limit Hg emissions by 30 percent by 2010 and 70

percent by 2018, compared to year 2000 emissions of 48 tons nationwide.

In this study, three alternative scenarios are examined. In terms of emission

regulation, the same NOX, SO2, and Hg (but not CO2) rules are adopted under

each scenario. The major difference is the Technology Evolution and Global

Economy scenarios reflect enactment of CO2 legislation and Return to Reliability

has a greenhouse gas tax.

Business Model Implications across the Scenarios

The four scenarios provide a rich format for understanding how the business

landscape may change, key drivers, what are the likely opportunities, and what

capabilities will be essential in creating value. Below we examine how today’s

generic strategies are likely to perform across the scenarios given the

opportunities and risks along the energy value chain. The six generic strategies

selected are those that presently overlap with the wholesale power market.

Scenario analysis provides a means of market testing alternative business

strategies and regulatory regimes to better understand the impacts and

unintended consequences of policy and strategy choices. In every scenarios there

are both risks and opportunities that present challenges to different business

models and types of energy market participants. Global Energy Horizons sees to

help clients manage uncertainty by better understanding both the risks and the

sweet spots in each scenario environment.

A key factor for many clients will be the implications of CO2 regulation on the

choice of fuels, power generation investment options and business strategies.

Two of the four scenarios identify a pathway for meeting expected long term

goals for reducing greenhouse gas emissions---Technology Evolution and Global

Economy. Conversely, two scenarios highlight the risks associated with Global

Turmoil and a fragmented approach to protectionism.

Figure 5-1 Projected CO2 Emissions (U.S. Only)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2007 2011 2015 2019 2023 2027 2031

Ton

s

Global Turmoil Technology Evolution Global Economy Reliability

Target

SOURCE: Global Energy.

Gary L. Hunt, President, Global Energy Advisors l ghunt@globalenergy.com