Chapter 6. Standardized Physical Gas and Power Agreements

Chapter 6 Standardized Physical Gas and Power Agreements Craig Enochs and Paul Vrana * This chapter focuses on physical natural gas and electric power transactions in the North American over-the-counter markets. Specifically, this chapter discusses: (i) the standard form agreements used to document physical transactions, (ii) the general characteristics of physical energy transactions, (iii) the most commonly traded physical gas and power products, (iv) liquidated damages for non-performance, (v) credit risk considerations in physical energy contracts, and (vi) significant differences between the standard form agreements. I. Standard Form Agreements When the gas and power markets were deregulated, standard form contracts were not available to document the purchase and sale of gas and power. Accordingly, each trading counterparty developed its own form contract for its particular types of gas and power transactions. Problems invariably arose because each company s form contract materially differed from most other companies form contracts. Every time a new trading relationship was established, the parties would first have to determine which party s form contract to use. The parties would then review the contract and negotiate every provision until the contract was acceptable to both parties. This was an inefficient way to conduct business, leading to increased expense and unnecessary delay in establishing new trading relationships. In addition, without standardization, each contract negotiation resulted in a contract that was different from each party s contracts with its other counterparties. As a result, parties were sometimes buying gas and power under contractual terms that were different from the terms under which they were reselling the commodity. In response to these issues, several energy industry groups developed their own standard form master agreements for gas and power transactions. At the time of the writing of this chapter, four agreements * Paul Vrana and Craig Enochs are partners in the firm Jackson Walker LLP in Houston, Texas. Paul and Craig would like to thank Cynthia Lam, Theresa Nassif, Kevin Page, and Merida de la Peña for their assistance in preparing this chapter. 1 CHAPTER 6.indd 1 30/05/2008 16:00:49

Energy and Environmental Trading: US Law and Taxation have become industry standard master agreements for gas and power: (1) the Gas Industry Standards Board / North American Standards Board Agreement for the Purchase and Sale of Natural Gas, (2) the Edison Electric Institute Master Power Purchase and Sale Agreement, (3) the International Swaps and Derivatives Association, Inc. Master Agreement, and (4) the Western States Power Pool Agreement. A. Gas Industry Standards Board/North American Energy Standards Board Agreement for the Purchase and Sale of Natural Gas One of the first industry groups to address the inefficiency and expense of multiple standard form contracts was the Gas Industry Standards Board (GISB), which developed and promoted standards for the gas marketplace and routinely published implementation guides, contracts and business practice standards for the gas industry. 1 With the help of industry professionals GISB developed its Base Contract for Short- Term Sale and Purchase of Natural Gas (GISB Agreement), which was designed for transactions with a term of thirty days or fewer. The GISB Agreement standardized many of the contractual provisions required in natural gas transactions, greatly simplifying the gas contracting process. The GISB Agreement, however, did not contain many of the credit and liquidation provisions that industry participants began to require in their gas trading agreements. In 2002, GISB changed its name to the North American Energy Standards Board (NAESB) 2 and changed its mission to serving as an industry forum for the development and promotion of standards for a seamless marketplace for wholesale and retail natural gas and electricity. 3 Also in 2002, NAESB published a new standard gas agreement that revised and expanded the original GISB Agreement (NAESB Agreement). 4 In September 2006, NAESB amended the NAESB Agreement to include, 1 William F. Henze II, Standard Form Agreements: Fundamental Tools for Managing [Publication?] Risks in Today s Energy Industry, [Publication?]Apr. 2002; see also NAESB s website at http://www.naesb.org (follow Governance Documents hyperlink; then follow Link to GISB Governance Documents hyperlink) (last visited Jan. 14, 2008). 2 Press Release, NAESB, Bylaws for North American Energy Standards Board Approved by GISB Board of Directors; GISB to Go Out of Existence as Separate Organization December 31, 2001 (Dec. 6, 2001) (on file with NAESB); see also the NAESB website at http://www.naesb.org (follow Press Releases hyperlink; then follow hyperlink containing the title of the press release) (last visited Jan. 14, 2008). 3 Information obtained from NAESB s website at http://www.naesb.org (follow About NAESB hyperlink) (last visited Jan. 14, 2008). 4 Press Release, NAESB, Contract for Purchase and Sale of Natural Gas, with Canadian Addendum, Approved by NAESB Wholesale Gas Quadrant (Apr. 23, 2002) (on file with NAESB); see also the NAESB website at http://www.naesb.org (follow Press Releases hyperlink; then follow hyperlink containing the title of the press release) (last visited Jan. 14, 2008). 2 CHAPTER 6.indd 2 30/05/2008 16:00:54

Standardized Physical Gas and Power Agreements among other things, provisions that provide additional credit protection to contracting parties. 5 B. Edison Electric Institute Master Power Purchase and Sale Agreement The Edison Electric Institute (EEI) is an association of United States shareholder-owned electric companies, international affiliates, and industry associates. 6 In the spring of 2000, 7 the EEI introduced the first fully functional version of its EEI Master Power Purchase and Sale Agreement (Version 2.1) (EEI Agreement). 8 EEI worked closely with its member utilities, power marketers, and the National Energy Marketers Association during an eighteen-month period to develop the EEI Agreement. 9 C. Western Systems Power Pool Agreement The Western Systems Power Pool began operations in 1987 and developed a standardized wholesale power sales contract (WSPP) that is continuously updated to reflect changes in law and/or the power markets. 10 The current version of the WSPP is the result of a consensus reached among a diverse group of power sellers and consumers. 11 The WSPP continues to be used by a large number of industry participants to document physical power transactions, in part because of its ease of implementation. Instead of requiring the negotiation of a WSPP with each counterparty, companies are instantly enabled upon joining as participants to the WSPP to use the WSPP to engage in power transactions with the membership s approximately 300 counterparties. 12 In addition, participants are bound to subsequent revisions to the WSPP without any requirement to amend any master agreement with other 5 Press Release, NAESB, Revised, Updated NAESB Standard Natural Gas Sales Contract Approved by Membership of Wholesale Gas Quadrant (Sept. 7, 2006) (on file with NAESB); see also the NAESB website at http://www.naesb.org (follow Press Releases hyperlink; then follow hyperlink containing the title of the press release) (last visited Jan. 14, 2008). 6 Information obtained from the EEI website at http://www.eei.org (follow About EEI hyperlink) (last visited Jan. 14, 2008). 7 Information obtained from the EEI website at http://www.eei.org (follow Industry Issues hyperlink; then follow the Master Contract hyperlink) (last visited Jan. 14, 2008). 8 See Andrew S. Katz, Using the EEI NEM Master Contract to Manage Power Marketing Risks, 21 Energy L.J. 273 (2000). 9 at 269. 10 Information obtained from the Western Systems Power Pool website at http://www. wspp.org (follow About WSPP hyperlink) (last visited Jan. 14, 2008). 11 12 At the time this chapter was written, [specify], the WSPP had more than 300 members. 3 CHAPTER 6.indd 3 30/05/2008 16:00:55

Energy and Environmental Trading: US Law and Taxation WSPP members. 13 Of the standard energy trading standard master agreements, the WSPP is the most expeditious means by which a party can engage in energy transactions with the most counterparties. D. International Swaps and Derivatives Association, Inc. Master Agreement The International Swaps and Derivatives Association, Inc. (ISDA) was formed in 1985 and is the largest global financial trade association with 825 member institutions from 56 countries on six continents. 14 ISDA published its first master agreement in 1987, but it was replaced in 1992 with the 1992 ISDA Master Agreement (ISDA Agreement). The ISDA Agreement provides a standard contract for trading financial derivatives and ISDA has subsequently released a wide range of related agreements, annexes, and supplements covering various types of financial derivative transactions, including energy derivative transactions. 15 A revised version of the ISDA Agreement was released in 2002, although many industry participants continue to use the 1992 form. ISDA recently expanded the scope of the ISDA Agreement by publishing annexes to permit transactions in physical gas and power. The North American Gas Annex (Gas Annex) and North American Power Annex (Power Annex) are each structured as an annex to the Schedule to the ISDA Master Agreement and provide the requisite provisions for physical energy transactions. 16 The Gas Annex is designed to document physical gas transactions in the United States. It was drafted with the assistance of NAESB and incorporates most of the NAESB terms relating to physical gas deliveries that are not covered in the ISDA Agreement, thereby permitting market participants to document their gas trades in a manner consistent with the NAESB Agreement. 17 The Power Annex was likewise developed jointly by ISDA and EEI to document physical power transactions and it incorporates most of the EEI terms relating to physical power deliveries that are not otherwise covered in the ISDA Agreement. 18 13 14 Information obtained from the ISDA website at http://www.isda.org (follow About ISDA hyperlink) (last visited Jan. 14, 2008). 15 16 Press Release, Edison Electric Institute, ISDA and EEI Announce North American Power Annex to ISDA Master Agreement (Aug. 7, 2003) (on file with the Edison Electric Institute). link does not 17 Press Release, International Swaps and Derivatives Association, ISDA Publishes North workamerican Gas Annex (Nov. 23, 2004) (available online at https://www.isdadocs.org/conf/ conf_indexes/index_01-22-08.html). 18 See Chapter 7. 4 CHAPTER 6.indd 4 30/05/2008 16:00:55

Standardized Physical Gas and Power Agreements II. Characteristics of Physical Energy Transactions Physical energy transactions differ from derivative energy transactions because physical transactions require the transportation and/or delivery of actual products. The tangible nature of these transactions creates risks that are absent in derivative energy transactions but must be addressed in physical energy contracts. A. Transfer of Title In order to analyze the elements of a physical energy commodity transaction, it is important to determine when title transfers from the seller to the buyer. 19 The transfer of title for some energy commodities can be based on empirically verifiable events, such as the loading of coal onto a rail car or barge. However, other energy commodities, such as gas and power, are impossible to observe directly, and, therefore, title transfer is based on a meter reading or other instrument-based evidence of transfer. 20 In addition, while certain energy commodities, such as coal, can easily be tracked back to a specific mine due to the unique physical characteristics of each shipment, the almost intangible nature of gas and power, and the impossibility of tracking individual molecules or electrons in a gas pipeline or power transmission line, result in gas and power being almost entirely fungible. Consequently, the title transferred may not be title to the same molecules or electrons delivered by the seller but, instead, will be title to an equivalent quantity of gas or power. 21 B. Risk of Loss Sometimes, the quantity of gas or power actually delivered to a buyer differs from the quantity the seller deposited into the pipeline or transmission system. Risk of loss provisions are designed to specify which party is responsible for these losses at various times during the transaction. The most common way of apportioning this responsibility is to designate the seller as responsible for the risk of loss prior to the delivery point and the buyer as responsible for the risk of loss at and after the delivery point. 22 This division of responsibility ensures that any costs resulting from a loss of product will be allocated in a predictable 19 E.g. the responsibility for taxes, liability for injury resulting from the commodity and the risk of loss of the commodity all are allocated between the parties based on the transfer of title. 20 See, for example, NAESB Agreement 8.1 (stating that title to gas will transfer upon its delivery to a Delivery Point on the gas pipeline). 21 For a discussion of the tax issues with title transfer, see Chapter 17. 22 See, for example, EEI Agreement 10.3. 5 CHAPTER 6.indd 5 30/05/2008 16:00:55

Energy and Environmental Trading: US Law and Taxation manner that will result in an efficient resolution of the issue, thus avoiding protracted negotiation or litigation. C. Indemnity Although a physical energy transaction contemplates a straightforward and orderly delivery and receipt of the commodity, unanticipated events can and do occur that may expose the parties to third-party liability. 23 This risk is commonly addressed by an indemnity clause apportioning the liability for any such claims between the parties. The NAESB Agreement and EEI Agreement both designate the seller as responsible for all such claims dealing with events prior to the transfer of title to the buyer and the buyer as responsible for all such claims dealing with events after title passes. 24 Although this could result in one party having more liability than it otherwise would if it could bring the other party into the claim, this apportionment of responsibility allows the parties to focus on the transaction rather than spending time and resources resolving third-party liability issues. D. Force Majeure Force majeure is a critical element of physical energy commodity transactions because it not only shapes the energy products themselves but also defines the performance obligations of the parties. 25 The NAESB, EEI and WSPP Agreements all contain different force majeure provisions with the following common characteristics: 26 (i) a force majeure event must occur that is not within the reasonable control of the claiming party for performance to be excused; 27 (ii) an event will not be treated as a force majeure event if it is due to changes in the seller s cost to obtain power or the buyer s inability to use or resell the power based on its price; 28 (iii) the claiming party must provide prompt notice 23 E.g., third parties may raise claims disputing the title to the gas sold or asserting liens on the gas, damage to pipelines or other equipment due to gas quality, or injury to persons resulting from the commodity. 24 NAESB Agreement 8.3; EEI Agreement 10.4. The respective ISDA Gas and Power Annexes also contain this language. 25 See infra Section IV. See also Chapter 8. 26 The NAESB and EEI Agreements refer to force majeure while the WSPP Agreement refers to Uncontrollable Force. The scope of the performance excused differs across these agreements but the legal concepts are equivalent and will be referred to as force majeure in this Chapter. 27 The NAESB Agreement addresses Force majeure in Section 11, the EEI Agreement in Sections 1.23 and 3.3, and the WSPP Agreement in Section 10. A survey of the primary differences between the specific language of the Force majeure provisions of the three agreements can be found in Appendix I of this chapter. 28 6 CHAPTER 6.indd 6 30/05/2008 16:00:55

Standardized Physical Gas and Power Agreements of the force majeure event and exercise diligence in mitigating the force majeure event within a reasonable time period; 29 and (iv) any payment obligations arising prior to the force majeure event still must be timely paid. 30 Force majeure is important because it reallocates transaction risk by protecting each party from the chance that it will be liable to the other party but unable to perform due to events out of its control. Conversely, it creates risk for a party that it will not be able to hold the other party to its performance obligations if the other party suffers a force majeure event. As an example, a force majeure provision may, depending upon the precise wording, protect a seller from the risk that it would be obligated to obtain alternative supplies or pay liquidated damages to the buyer if the seller s wells are unable to produce gas because of a hurricane. Such a provision shifts this risk and the corresponding burden to obtain replacement supply to the buyer. Likewise, a force majeure provision may create the risk to the seller that if the buyer s factory is destroyed by a tornado or similar catastrophe and the buyer is excused from its obligation to purchase the seller s gas supplies, then the seller will have to find an alternative purchaser for the gas. E. Scheduling Physical energy commodity transactions require the parties to establish scheduling parameters for each transaction, including the delivery point, delivery dates, and volumes transacted. Once these parameters are set, each party is responsible for scheduling the delivery or receipt of the energy commodity with its transportation provider within these scheduling parameters. 31 If the parties schedules do not match, an imbalance will be created on the transportation system, and penalties may result. 32 If imbalance penalties are assessed, the NAESB Agreement specifically obligates the party responsible for the imbalance charges to pay such charges and to reimburse the other party for any such charges the other party may have paid. 33 III. Types of Physical Energy Products The EEI, NAESB, ISDA and WSPP Agreements each contain product definitions which set forth the buyer s and the seller s respective 29 30 31 In the case of natural gas, this is usually a pipeline, and in the case of electricity, this is usually a transmission service provider. 32 Some transportation providers permit customers a tolerance for error that permits scheduling inaccuracies without penalty up to a certain percentage of the total volume of the energy commodity shipped on the transportation provider s system. 33 NAESB Contract for Purchase and Sale of Natural Gas 4.3. 7 CHAPTER 6.indd 7 30/05/2008 16:00:56

Energy and Environmental Trading: US Law and Taxation rights and obligations for several different types of physical energy transactions. These definitions are important because they provide rules governing each party s obligation to perform. They also clearly provide the consequences of non-performance in a transaction. The various physical energy products are divided into two basic categories: interruptible products and firm products. Interruptible products are transactions under which there is no obligation to deliver or receive the energy commodity. Either party can interrupt its performance at any time, for any reason, or for no reason at all, without incurring damages to the other party. By way of example, the EEI Agreement provides that in regard to Non-Firm power products, delivery or receipt of the product may be interrupted for any reason or for no reason, without liability on part of either party. 34 Likewise, under the NAESB Agreement, parties may interrupt performance under an interruptible transaction for any reason, whether or not the interruption is caused by an event of force majeure. 35 However, the interrupting party is required to pay imbalance charges related to its interruption until the change in deliveries is confirmed by the applicable transporter. 36 Interruptible physical energy contracts are often used for short-term transactions that do not usually require rigorous credit support and liquidated damage provisions. An important advantage of interruptible transactions is that the product can be less expensive because the seller has no real obligation to deliver and therefore, the product is less reliable. As a seller the disadvantage is the lack of certainty that there is a reliable purchaser for the energy. As a buyer the disadvantage is the lack of certainty that the buyer will actually receive energy from the seller. In contrast, firm transactions are those transactions that may be interrupted only in certain limited circumstances, such as in the case of a Force majeure event. If a party fails to perform its obligations under a firm transaction, it will be obligated to pay liquidated damages to the other party. 37 The various standard form agreements contain different provisions pertaining to firm products, which are addressed in the remainder of this section. 34 See EEI Master Power Purchase and Sale Agreement, Schedule P. 35 NAESB Contract for Purchase and Sale of Natural Gas 2.20. 36 NAESB Contract for Purchase and Sale of Natural Gas 2.20. 37 See infra Section IV. 8 CHAPTER 6.indd 8 30/05/2008 16:00:56

Standardized Physical Gas and Power Agreements A. EEI Agreement Firm Products 1. Unit Firm The Unit Firm product is designed for transactions where the seller is sourcing electricity from a particular generation unit. If the unit is available to generate electricity, the seller is obligated to deliver electricity to the purchasers. 38 The occurrence of certain events that cause the generation unit to be unavailable will excuse the seller s performance in a transaction. 39 Interestingly, the definition for Unit Firm does not specifically provide what obligations the buyer has in a Unit Firm transaction. Accordingly, if the parties intend that the buyer will have purchase obligations under a Unit Firm transaction, the parties should clearly specify the nature of such obligations in the transaction confirmation. 2. System Firm The System Firm product is defined by reference to power that will be supplied from particular generation assets or purchased power assets, which are identified in the particular transaction. 40 Like the Unit Firm product discussed above, the occurrence of certain identified events that cause the generation units or the purchased power assets to be unavailable will excuse the seller s performance. 41 However, unlike the Unit Firm product, the System Firm definition specifically provides that the buyer s obligation to take power will be excused only if the buyer is prevented from performing because of one of the reasons listed in the definition. 42 38 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Unit Firm ). 39 For example, the definition of Unit Firm provides that the following events shall excuse seller s performance: (1) a Forced Outage; (2) an event or circumstance that affects the generation unit so as to prevent seller from performing its obligations, which event or circumstance was not anticipated and which is not within the reasonable control or the negligence of the seller; or (3) Buyer s failure to perform. 40 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of System Firm ). 41 For example, the definition of System Firm provides that the following events shall excuse seller s performance: (1) an event or circumstance which prevents seller from performing its obligations, which event or circumstance was not anticipated as of the date the transaction was agreed to, and which is not within the reasonable control or the negligence of the seller; (2) Buyer s failure to perform; (3) to the extent necessary to preserve the integrity of, or prevent or limit any instability on, the system; (4) to the extent the system or control area or reliability counsel within which the system operates declares an emergency condition, as determined in the system s or the control area s, or reliability counsel s reasonable judgment; or (5) by the interruption or curtailment of transmission to the Delivery Point or by the occurrence of any transmission contingency specified in a transaction as excusing seller s performance. 42 For example, buyer s failure to receive shall be excused: (i) by force majeure; (ii) by seller s failure to perform, or (iii) by the interruption or curtailment of transmission from the delivery point or by the occurrence of any transmission contingency specified in a transaction as excusing buyer s performance. 9 CHAPTER 6.indd 9 30/05/2008 16:00:56

Energy and Environmental Trading: US Law and Taxation 3. Firm LD Under a Firm LD transaction, the buyer and seller are obligated to perform unless excused by force majeure. 43 Because this product is actually defined by reference to force majeure, special consideration should be given to any proposed amendment to the standard Force majeure definition in the EEI Agreement when such agreement will be used to document Firm LD transactions. 44 4. Into [Receiving Transmission Provider] Seller s Daily Choice (Into Product) As evidenced by the unusual length of the Into Product definition, the Into Product is the most complicated of all the physical energy products traded under the EEI, WSPP, NAESB and ISDA. 45 The Into Product contains an elaborate allocation of risks associated with the obligation to obtain transmission in a transaction and the subsequent risk that such transmission will not be available. In general, however, the rights and obligations under an Into Product depend upon, among other things, the availability of Firm Transmission and whether there has been a Timely Request for Transmission. 46 5. Firm Transmission Contingent-Contract Path The Firm Transmission Contingent Contract Path product excuses performance where firm transmission is obtained but is interrupted due to a Force majeure event: (i) in the case of seller, from the generation source to the delivery point, and (ii) in the case of buyer, from the delivery point to the ultimate end-user. 47 Firm Transmission Contingent-Contract Path is helpful in mitigating the risk of firm transmission loss to a seller who purchases power at a generation facility and transmits the power across several different transmission providers to another location for resale. If any of the transmission paths were interrupted due to a force majeure event between the generation source and the delivery point, the seller would be excused from performance and would not be required to pay liquidated damages to the buyer. 43 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Firm LD ). 44 See Chapter 8, supra note 26. 45 See EEI Master Power Purchase and Sale Agreement, Schedule P (The definition of Into Product is about six pages long, in contrast to a three-line definition for the Non- Firm product, and a seven-line definition for the Firm (LD) product). 46 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Into [Receiv ing [Receiving Transmission Provider] Seller Daily Choice ( Into Product ) ). 47 Transmission See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Firm Provider] Transmission Contingent-Contract Path ). 10 CHAPTER 6.indd 10 30/05/2008 16:00:56

Standardized Physical Gas and Power Agreements 6. Firm Transmission Contingent Delivery Point The Firm Transmission Contingent Delivery Point product is similar to the Firm Transaction Contingent Contract Path product described above, except that only interruptions or curtailments of transmission paths either immediately to or from the delivery point will excuse performance. Interruptions or curtailments occurring outside of the transmission paths immediately to or from the delivery point will not excuse performance. 48 7. Firm (No Force Majeure) Under a Firm (No Force Majeure) transaction, there is no excuse for non-performance. 49 If a party fails to deliver or receive the required quantities under a contract, that party will be obligated to pay liquidated damages. 50 Because of the EEI Agreement s broad definition of force majeure, 51 it is difficult to imagine how liquidated damages would be calculated if a force majeure event occurred. Specifically, in a true force majeure situation, where alternate power is not available in the market at any price, it is unclear what price would be used to calculate liquidated damages. B. NAESB Agreement Firm Product Under the NAESB, firm means that either party can only interrupt its performance without liability to the extent that such performance is prevented for reasons of force majeure. 52 However, the party invoking force majeure for interruptions may be responsible for any imbalance charges related to its interruption after the nomination is made to the Transporter and until the change in deliveries and/or receipts is confirmed by the Transporter. 53 48 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Firm Transmission Contingent-Delivery Point ). 49 See EEI Master Power Purchase and Sale Agreement, Schedule P (definition of Firm (No Force Majeure) ). 50 51 See Andrew S. Katz, Using the EEI NEM Master Contract to Manage Power Marketing Risks, 21 Energy L.J. 273 (2000) ( Under the Master Agreement s gold-plated definition of Force Majeure, the focus is not on what might constitute a Force majeure event but instead on whether there is any way a party can perform its obligations as agreed in a transaction, even if such performance must be secured through replacement transactions in the marketplace ). 52 NAESB Contract for Purchase and Sale of Natural Gas 2.19. 53 11 CHAPTER 6.indd 11 30/05/2008 16:00:57

Energy and Environmental Trading: US Law and Taxation C. ISDA Agreement Firm Products While the ISDA Gas Annex and Power Annex generally incorporate the product definitions from the NAESB Agreement and EEI Agreement respectively, it is very important to realize that when a Firm product is sold or purchased under either the NAESB or the EEI Agreements, the parties rights and obligations may be different than if the transaction were documented under the ISDA Master Agreement containing either a Gas Annex or Power Annex. Specifically, the ISDA Agreement includes events of default and termination events that are either worded differently or are not present at all in the NAESB and EEI Agreements. Because transactions under the Gas and Power Annexes are affected by the terms of the respective Annexes (in a way identical to transactions under the NAESB and EEI Agreements), as well as the terms of the ISDA, physical gas and power transactions under an ISDA Gas or Power Annex are subject to different terms than a transaction under a NAESB or EEI Agreement. D. WSPP Firm Products 1. Economy Energy Service Economy Energy Service is non-firm energy that is subject to immediate interruption upon notification, in accordance with the WSPP Agreement. 54 Service Schedule A of the WSPP Agreement provides the details of this product, although specific terms and conditions can be negotiated. 55 2. Unit Commitment Service Unit Commitment Service is a capacity and/or associated scheduled energy transaction or a Physically-Settled Option (described below) from a specified unit for a specified period. 56 Failure to provide Unit Commitment Service can be excused by force majeure. 57 It also can be curtailed (i) based upon mutually agreed recall provisions when all or 54 See WSPP Agreement 4, effective Mar. 16, 2007; see also http://www.wspp.org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 55 See WSPP Agreement, effective Mar. 16, 2007, Schedule A; see also http://www.wspp. org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 56 See WSPP Agreement, effective Mar. 16, 2007, 4.20 & Schedule B; see also http://www. wspp.org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 57 See WSPP Agreement, effective Mar. 16, 2007, Schedule B; see also http://www.wspp. org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 12 CHAPTER 6.indd 12 30/05/2008 16:00:57

Standardized Physical Gas and Power Agreements a portion of the unit is unavailable, (ii) to prevent system separation during an emergency (provided that alternatives to curtailment have been first been exhausted), (iii) for the seller to meet its public utility or statutory obligations, or (iv) due to the unavailability of transmission service. 58 The stipulated damages provision applies to a failure to deliver or to take this product unless the parties agree otherwise. 59 3. Firm Sales or Exchange Service Service Schedule C addresses Firm Sales or Exchange Services. 60 The stipulated damages provision in this schedule is analogous to the one in Service Schedule B. 61 Firm service can be curtailed within mutually agreed recall times due to Uncontrollable Force or to meet public utility or statutory obligations. 62 In the latter case, the seller will pay damages consistent with the WSPP if it interrupts its delivery of power. 63 4. Physically-Settled Options The WSPP also allows for the sale of Physically-Settled Options, which include a call option and a put option. A call option is the right, but not the obligation, to buy power. A put option is the right, but not the obligation, to sell power. 64 IV. Liquidated Damages for Nonperformance The NAESB, EEI, WSPP, and ISDA Agreements each contain liquidated damages provisions to remedy a party s failure to perform its obligation to deliver or receive the energy commodity. These contracts all utilize liquidated damages to avoid disputes concerning routine supply or receipt disruptions occurring during the normal course of business that are easily remedied by the payment of monetary damages. 58 59 60 See WSPP Agreement, effective Mar. 16, 2007, 4.7 & Schedule C; see also http://www. wspp.org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 61 62 63 See WSPP Agreement, effective Mar. 16, 2007, Schedule C & 21.3; see also http:// www.wspp.org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 64 See WSPP Agreement, effective Mar. 16, 2007, 4.14(a); see also http://www.wspp.org (follow Documents, then WSPP Agreement Description hyperlink) (last visited Jan. 14, 2008). 13 CHAPTER 6.indd 13 30/05/2008 16:00:57

Energy and Environmental Trading: US Law and Taxation A. NAESB Agreement Section 3.2 of the NAESB Agreement requires the payment of liquidated damages in the event the seller fails to deliver, or the buyer fails to receive, quantities of gas agreed to in a transaction. 65 The cover sheet to the NAESB Agreement requires the parties to elect to use either the Cover Standard or the Spot Price Standard method of calculating liquidated damages at the time the contract is signed. 66 Once a standard is selected, that standard becomes the exclusive remedy in the event of a breach of an obligation to deliver or receive gas. 67 Both standards require the payment of liquidated damages within five business days after the presentation of the performing party s invoice setting forth the basis upon which such amount was calculated. 68 In addition, if the failure to deliver or receive results in the imposition of imbalance charges, both the Cover Standard and the Spot Price Standard require the party whose act or omission caused the imbalance charges to pay for such charges. 69 NAESB Contract for Purchase and Sale of Natural Gas 4.3. This section provides that: 1. Cover Standard The Cover Standard requires the performing party to use commercially reasonable efforts to either (i) obtain gas or an alternate fuel to replace the gas that the seller failed to deliver or (ii) sell the gas that the buyer failed to take, in each case at a price that is reasonable for the delivery point or production area. 70 The price paid or received by the performing party 65 NAESB Contract for Purchase and Sale of Natural Gas 3.2. 66 NAESB Contract for Purchase and Sale of Natural Gas 3.2; see also cover sheet (stating that, if neither option is selected, then Cover Standard is the default election). 67 See NAESB Contract for Purchase and Sale of Natural Gas 3.2. 68 69 NAESB Contract for Purchase and Sale of Natural Gas 4.3. This section provides that: [t]he parties shall use commercially reasonable efforts to avoid the imposition of Imbalance Charges. If Buyer or Seller receives an invoice from a Transporter that includes imbalance charges, the parties shall determine the validity as well as the cause of such Imbalance Charges. If the Imbalance Charges were incurred as a result of Buyer s receipt of quantities of Gas greater than or less than the Scheduled Gas, then Buyer shall pay for such Imbalance Charges or reimburse Seller for such Imbalance charges paid by Seller. If the Imbalance Charges were incurred as a result of Seller s deliver of quantities of Gas greater than or less than the Scheduled Gas, then Seller shall pay for such Imbalance Charges or reimburse Buyer for such Imbalance Charges paid by Buyer. 70 NAESB Contract for Purchase and Sale of Natural Gas 3.2. Section 2.12 provides that: Cont... 14 CHAPTER 6.indd 14 30/05/2008 16:00:57

Standardized Physical Gas and Power Agreements attempting to effect cover in this manner is the price that will be used to calculate any payment due under Section 3.2. Under the Cover Standard, the reasonableness of the price received or paid for gas can be affected by several factors, including: (i) the amount of notice provided by the non-performing party, (ii) the immediacy of the buyer s consumption needs or the seller s sales requirements, (iii) the quantities involved, and (iv) the anticipated length of failure by the non-performing party. 71 The Cover Standard also provides that if the seller fails to deliver the gas as required by the contract, the seller is obligated to pay to the buyer the positive difference between (i) the purchase price paid by the buyer utilizing the Cover Standard, and (ii) the contract price. 72 Similarly, if [Cover Standard] shall mean that if there is an unexcused failure to take or deliver any quantity of Gas pursuant to this Contract, then the performing party shall use commercially reasonable efforts to (i) if Buyer is the performing party, obtain Gas (or an alternate fuel if elected by Buyer and Gas is not available), or (ii) if Seller is the performing party, sell Gas, in either case, at a price reasonable for the delivery or production area, as applicable, consistent with: the amount of notice provided by the nonperforming party; the immediacy of the Buyer s Gas consumption needs or Seller s Gas sales requirements, as applicable; the quantities involved; and the anticipated length of failure by the nonperforming party. 71 NAESB Contract for Purchase and Sale of Natural Gas 2.10. 72 NAESB Contract for Purchase and Sale of Natural Gas 3.2. This section provides that: [t]he sole and exclusive remedy of the parties in the event of a breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the positive difference, if any, between the purchase price paid by buyer utilizing the Cover Standard and the Contract Price, adjusted for commercially reasonable differences in transportation costs to or from the Delivery Point(s), multiplied by the difference between the Contract Quantity and the quantity actually delivered by Seller for such Day(s); or (ii) in the event of a breach by Buyer on any Day(s), payment by Buyer to Seller in the amount equal to the positive difference, if any, between the Contract Price and the price received by Seller utilizing the Cover Standard for the resale of such Gas, adjusted for commercially reasonable differences in transportation costs to or from the Delivery Point(s) multiplied by the difference between the Contract Quantity and the quantity actually taken by Buyer for such Day(s); or (iii) in the event that Buyer has used commercially reasonable efforts to replace the Gas or Seller has used commercially reasonable efforts to sell the Gas to a third party, and no such replacement or sale is available, then the sole and exclusive remedy of the performing party shall be any unfavorable difference between the Contract Price and the Spot Price, adjusted for such transportation to the applicable Deliver Point, multiplied by the difference between the Contract Quantity and the quantity actually delivered by Seller and received by Buyer for such Day(s). Imbalance Charges shall not be recovered under this Section Cont... 15 CHAPTER 6.indd 15 30/05/2008 16:00:57

Energy and Environmental Trading: US Law and Taxation the buyer fails to receive the gas as required by the contract, the seller is entitled to the positive difference between the contract price and the price received by the seller utilizing the Cover Standard. 73 The damages calculated pursuant to this method will, in both instances, be adjusted for commercially reasonable differences in transportation costs to or from the delivery points. 74 2. Spot Price Standard The Spot Price Standard sets forth a materially different method of calculating damages from the Cover Standard Method. 75 If a party fails to deliver or receive gas as required by a transaction, the non-performing party must pay to the performing party the positive difference between the contract price and the Spot Price. Spot Price is defined as the price at the geographic location in closest proximity to the delivery points for the relevant days listed in the publication elected by the parties on the NAESB Agreement cover sheet. 76 3.2, but Seller and/or Buyer shall be responsible for Imbalance Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five Business Days after presentation of the performing party s invoice, which shall set forth the basis upon which such amount was calculated. 73 74 75 Spot Price Standard is defined as: 16 [t]he sole and exclusive remedy of the parties in the event of a breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the difference between the Contract Quantity and the actual quantity delivered by Seller and received by buyer for such Day(s), multiplied by the positive difference, if any, obtained by subtracting the Contract Price from the Spot Price; or (ii) in the event of a breach by Buyer on any Day(s), payment by Buyer to Seller in an amount equal to the difference between the Contract Quantity and the actual quantity delivered by Seller and received by Buyer for such Day(s), multiplied by the positive difference, if any, obtained by subtracting the applicable Spot Price from the Contract Price. Imbalance Charges shall not be recovered under this Section 3.2, but Seller and/or Buyer shall be responsible for imbalance Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five Business Days after presentation of the performing party s invoice, which shall set forth the basis upon which such amount was calculated. 76 NAESB Contract for Purchase and Sale of Natural Gas 2.26. This section refers to the price listed in the publication indicated on the Base Contract ; thus, if the parties choose the Spot Price Standard for calculating damages, the parties must then select a reliable market publication that will allow them to determine the spot price on any given day. This section also provides that if there is no single spot price published for a Cont... CHAPTER 6.indd 16 30/05/2008 16:00:58

Standardized Physical Gas and Power Agreements B. EEI Agreement The EEI Agreement provides remedies for a failure to deliver or receive electric capacity, energy, or other related products when the failure is not excused under the definition of the product or by the other party s failure to perform. 77 The remedies available under the EEI Agreement are different from the remedies provided in the NAESB Agreement in that: (i) the EEI Agreement cover sheet does not contain an election requiring the parties to specify whether cover or spot damages will apply before entering into transactions under the agreement, and (ii) the EEI Agreement cover sheet does contain an election for Accelerated Payment of Damages. The EEI Agreement allows the performing party to elect cover or spot damages at the performing party s discretion. If the seller fails to perform and such non-performance is unexcused, the seller is required to pay the buyer the positive difference, if any, obtained by subtracting the Contract Price from the Replacement Price. 78 If the buyer fails to perform, and such performance is not excused, the buyer is required to pay the seller the amount equal to the positive difference, if any, obtained by subtracting the Sales Price from the Contract Price. 79 The cover sheet of the EEI Agreement contains an election for the parties to determine the timing for the payment of damages for failures to deliver or receive. 80 If the parties elect Accelerated Payment of Damages to apply, then the payment of damages is to be made within five business days of receipt of an invoice specifying the damage payment owed. 81 If Accelerated Payment of Damages is not elected by the parties, payment is to be made on the date payment would otherwise be due in respect of the month in which the failure occurred. 82 particular location on a particular day, but there is a published range of prices, then the spot price will be the average of the highest and lowest prices listed. If there is no range of prices published, then the spot price will be the average of (1) the price for the first day for which a price or range of prices is published that next precedes the day(s) of the breach, and (2) the price for the first day for which a price or range of prices is published after the day of the breach. 77 EEI Master Power Purchase and Sale Agreement 4. 78 The definition of Replacement Price is: (i) the price at which the buyer, acting in a commercially reasonable manner, purchases at the contract delivery point a replacement for the product not delivered, plus costs and additional transmission charges reasonably incurred; or (ii) at the buyer s option, the market price at the contract delivery point for such product. See EEI Master Power Purchase and Sale Agreement 1.51. 79 The definition of Sales Price is: (i) the price at which the seller, acting in a commercially reasonable manner, resells at the contract delivery point any product not received by the buyer, deducting any costs and additional transmission charges reasonably incurred; or (ii) at the seller s option, the market price at the contract delivery point for such product. See EEI Master Power Purchase and Sale Agreement 1.53. 80 See EEI Master Power Purchase and Sale Agreement, Cover Sheet, Article Four. 81 See EEI Master Power Purchase and Sale Agreement 4. 82 17 CHAPTER 6.indd 17 30/05/2008 16:00:58

Energy and Environmental Trading: US Law and Taxation C. WSPP Section 21 of the WSPP provides for liquidated damages for a party s failure to deliver or receive capacity and/or energy in violation of the terms of the WSPP and any confirmation. 83 Unless the parties agree otherwise, the only product excluded from the liquidated damages provision is Economy Energy Service. 84 Section 21 provides that the performing party is entitled to receive cover-type damages from the non-performing party, provided such non-performance is unexcused. 85 If a purchaser fails to take power, the purchaser is required to pay damages based on the difference between the contract price and the seller s resale price, plus any additional net transmission charges the seller incurs. A more precise formula is as follows: if the amount the purchaser scheduled or received in any hour is less than the applicable hourly Contract Quantity, the purchaser shall be liable for (i) the product of the amount (whether positive or negative), if any, by which the Contract Price 86 differed from the Resale Price 87 and the amount by which the quantity provided to the purchaser was less than the hourly Contract Quantity plus (ii) transmission charges, if any, for firm transmission service upstream of the delivery point which the seller incurred to resell, less the reduction, if any, in transmission charges as a result of the reduction in the purchaser s schedule or receipt of electric energy (based on the seller s reasonable commercial efforts to achieve such reduction). 88 If the total amounts for all hours calculated in accordance with this formula are negative, then neither the purchaser nor the seller is required to pay any amount. 89 If the seller fails to deliver, seller will pay damages to purchaser based on the purchaser s replacement price less the original contract price, plus the amount of additional transmission costs less transmission savings. 90 A more precise formula is as follows: the seller shall be liable 83 WSPP Agreement 21, effective Mar. 16, 2007; see also http://www.wspp.org (follow Documents, then WSPP Agreement hyperlink) (last visited Jan. 14, 2008). 84 85 86 Contract Price is defined as [t]he price agreed to between the Seller and the Purchaser for a transaction under the Agreement and Confirmation. WSPP 4.1e. 87 Resale Price is defined as [t]he price at which the Seller, acting in a commercially reasonable manner, effects a resale of the capacity and/or energy not received by the Purchaser or, absent such a resale, the market price for such quantity of capacity and/or energy, as determined by the Seller in a commercially reasonable manner at the delivery point specified for the transaction in a Confirmation. WSPP 4.16b. 88 WSPP Agreement 21.3(a)(1), effective Mar. 16, 2007; see also http://www.wspp.org (follow Documents, then WSPP Agreement hyperlink) (last visited Jan. 14, 2008). 89 90 WSPP Agreement 21.3(a)(2), effective Mar. 16, 2007; see also http://www.wspp.org (follow Documents, then WSPP Agreement hyperlink) (last visited Jan. 14, 2008). 18 CHAPTER 6.indd 18 30/05/2008 16:00:58