Memphis Light, Gas and Water Division Electric Prepayment

1. Memphis Light, Gas and Water DivisionElectric Prepayment September 2006

2. Outline of Presentation • MLGW Environment • Why Prepay with TVA? • Prepay Details • Alternatives • Challenges • Mitigating Risks • Prepay Contract Terms and Protections • Conclusions

3. MLGW Electric Environment • TVA has monopolistic control in its statutory service territory due to: • Federal law • Long-term, all-requirements power contracts with distributors • Federal law constraints: • TVA cannot be required to transport power purchased from other suppliers to MLGW • MLGW is prohibited from selling power to other entities • TVA is an federal monopoly with: • Control of Generation and Transmission • Rates set by the TVA Board

4. MLGW Electric Environment (cont.) • MLGW is TVA’s largest distributor representing about 10% of TVA’s distributors’ sales. • MLGW pays TVA about $800 million annually for power. • MLGW’s transmission connections to other systems are limited • TVA is a AAA/Aaa rated Agency of the Federal Government

5. Why Prepay with TVA? • Benefits of Prepayment: • MLGW mitigated supply risks by securing baseload supply from TVA’s low-cost resources. • MLGW achieved a price discount for 15 years totaling $225 million over the life of the transaction. • TVA secured MLGW (its largest customer) for half its energy requirements for 15 years. The prior contractual arrangement was only for 5 years. • Current Federal law impedes all alternative supply options for MLGW. • Electric prepayment is the single most viable risk management tool available to MLGW to achieve supply security and low cost power in the current industry environment.

6. Prepay Details Graphical Representation of Prepay

7. Prepay Details (cont.) Annual load duration curve illustrating MLGW’s hourly demands sorted from highest to lowest.

8. Prepay Details (cont.) • The annual debt service displaces power cost that MLGW would have paid anyway without the prepayment. • Total annual power costs is $13 million less than it otherwise would have been without the prepayment • Prepay transaction locks in the “discount”, not power prices. TVA’s future rates may go up or down, but MLGW will always receive a discount on the prepay portion equal to debt service + $13 million

9. Alternatives? • Build • Buy • Do Nothing

10. Alternatives? (cont.) • Prohibiting factors to building generation: • MLGW has a bundled all-requirements contract with TVA for a minimum of 5 years. • Environmental restrictions (plant location issues) • The 1959 TVA Act amendment prohibits off-system sale of any distributor generated power. • Economics do not show benefits compared to the current arrangement and the risk is greater.

11. Alternatives? (cont.) • Prohibiting factors of purchasing from alternative suppliers: • Federal Law – MLGW is a captive customer of TVA. • “TVA Fence” • Anti-cherry picking • Existing contract • 5 year minimum all-requirements • Transmission constraints • MLGW has no interconnections with other utilities. • Load flow studies indicate insufficient transmission capacity within surrounding utilities.

12. Challenges- State Law Limitations Problem • State law only allowed municipal bonds to be issued for capital projects. • State law prohibited issuance of bonds for payment of power costs. Solution • MLGW pursued modifications to the law to allow this transaction. • MLGW efforts were successful and State law was modified (Apr 2003).

13. Challenges- Treasury/IRS Regulations Problem • Original Treasury/IRS regulations (pre-April 2002) would have made this transaction almost impossible. • In April 2002, Treasury/IRS proposed new regulations that would allow gas prepayments, but not electricity prepayments (actually tightened rules). Solution • MLGW efforts to modify the regulations: • Filed detail comments on new proposed Treasury prepay regulations. • Testified before and met with key Treasury officials. • MLGW President and TVA Chairman • MLGW’s CFO provided oral & written testimony • Developed new proposed regulations that would allow transaction. • Developed a business case. • Enlisted political support (Sen. Frist, etc.) • August 1, 2003 new Treasury regulations were released that allows electricity prepayments like this transaction.

14. Mitigating Risks • Risk centers around TVA performance, not MLGW. • MLGW secured only a portion of energy requirements • Counterparty is AAA rated • Counterparty is already operational and connected to MLGW system. . • Strong punitive default provisions are in place. • Prepay contract terms and protections mitigate risks of prepayment.

15. Prepay Contract Terms and Protections • TVA remains committed to supply all of MLGW’s power requirements to be provided, as required, from all TVA generation and transmission facilities or market purchases. TVA is to provide all transmission necessary to deliver power to MLGW’s gate electrical stations. • MLGW is absolutely guaranteed by TVA a fixed Monthly Savings each month for 15 years. The guaranteed fixed discount will be sufficient to pay debt service on the bonds and provide an annual $13 million in savings to MLGW. • TVA will not discriminate against MLGW in eligibility for various programs or by charging MLGW a special rate for the purpose of reducing or canceling out the Monthly Savings. • MLGW is entitled to fully exercise and participate in any partial requirements option or right arising pursuant to Act of Congress, executive order, court decision, or regulatory act, or any other right or opportunity under any partial requirement program offered by TVA. This right is limited to that portion of MLGW load for which MLGW has not made a prepayment.

16. Prepay Contract Terms and Protections (cont.) • TVA’s obligation to deliver to MLGW the full amount of power associated with the prepaid capacity is absolute and unconditional and is not excused by force majeure‑type events or by TVA’s loss of its generation or transmission facilities. This obligation on the part of TVA, as well as the remedies outlined below, significantly exceed those in the current MLGW power contract and those offered by TVA on other distributor contracts. • If TVA fails to deliver to MLGW the power associated with the prepaid capacity in any hour, TVA will reimburse MLGW for all costs of any replacement power MLGW purchases from another source. • If TVA fails to deliver to MLGW all of the power associated with the prepaid capacity over the 15‑year period, or delivers less than the full monthly allocation of such power for 3 consecutive months, or delivers less than half of the monthly allocation of such power in any one month, then MLGW has the option to terminate the agreement, and TVA must pay to MLGW a Default Payment equal to the net present value of all the remaining Monthly Savings plus any costs associated with MLGW’s calling the bonds plus any other actual damages to MLGW, including covering for the cost of replacement power, plus interest. • If in any month, the highly unlikely event occurs that MLGW’s prepaid power credit exceeds system requirements, in monetary terms, the credit balance shall be applied to the next monthly invoice and carried forward with interest. In the event that a credit balance is outstanding at the end of the contract period, TVA shall pay MLGW the outstanding amount.

17. Prepay Contract Terms and Protections (cont.) • If TVA makes a more favorable deal or repayment arrangement with another distributor, TVA will make MLGW whole for any difference, to be determined by mediation if necessary. • If the agreement is assigned by TVA without MLGW’s permission or by operation of law, MLGW may terminate the agreement and TVA must pay to MLGW the Default Payment. This contract provision protects MLGW from privatization of TVA or breakup and sale of TVA assets. • TVA expressly agrees that the agreement is legally binding on it and enforceable by a lawsuit in U.S. District Court in Tennessee. Traditionally, no appeals process has existed for distributors on actions taken by TVA. This contractual language provides MLGW a methodology to be used to settle disputes arising with TVA in regard to the prepayment transaction. While a procedure for Alternative Dispute Resolution (ADR) is provided in the contract, neither party is required to participate or delay the commencement of litigation on the basis of the ADR process. This right to ADR and litigation far exceeds that which MLGW has under its current power agreement.

18. Prepay Contract Terms and Protections (cont.) • The agreement did not become effective until MLGW had obtained tax‑exempt financing at a cost that it found acceptable in its sole discretion. • At any time prior to the execution of the bond purchase agreement, MLGW could request a one‑time adjustment of the economic terms of the agreement to preserve the economics of the prepayment transaction. If TVA and MLGW did not reach agreement on adjusted terms, then the agreement would not become effective.

19. Conclusions • The transaction structure justified a AAA/Aaa rating based on contractual protections and the credit strength of both parties. The counterparty to this transaction, TVA, is a federal entity with a AAA rating. • There are significant tangible and intangible benefits to both parties. • This was MLGW’s best available option to secure long-term, low-cost baseload power with the least risk. • MLGW will save approximately $225 million over the term on its cost of power. • The savings will allow MLGW to hold down its rates, which substantially improves its competitive outlook in the future. • TVA is assured of retaining 50% of the energy needs of its largest customer and can effectively use the proceeds of the prepayment for capital projects or debt reduction that will only further its ability to meet the needs of MLGW and other customers.