Chris,


Hopefully the following points should answer your questions. Feel free to 
call me (34292) if you still have any question.

Yvan




1_  We will value Teco as a series of hourly Spread options. 
Legitimate points of concern: 
a) Are we valuing an index deal or a physical deal?
  b) If it is a physical deal can the plant realistically react on an hourly 
basis?

Answer: The deal Enron enters into is based on an spread between PJM index 
and the appropriate OIL curve (New York Harbor + basis). However, the trigger 
for the default of the contract (which is really what we are concerned with) 
is a function of the plant cash flows compared to the debt level. The plant 
cash flows depend on the physical operations of the plant and its capacity to 
dispatch during the most expensive hours of the year. Therefore the question 
of whether the plant can or cannot ramp up quickly enough to dispatch 
economically is very pertinent to our valuation. 
I would argue that the plant will always (or almost always) be able to 
dispatch economically for the following 2 reasons. In the first place, its 
operational ramp up time is only 10 minutes. Secondly, the scalar curve we 
use is fairly well behaved and doesn,t swing around a mean position (see 
graph below), hence allowing sufficient preparation for the dispatchers. The 
chances of dispatchers being caught by surprise when prices spike up or down 
should therefore be relatively small, and the plant should be able to follow 
the real time prices pretty well.





2_ The power curve we use is PJM west. Even though the plant is located in 
the south east end of PJM (i.e. the del Marva peninsula), we prefer not to 
use the east curve which is too thinly traded to be meaningful. 

4_ So far we have only used monthly vol for power. Should we start using 
daily vol as well, then the blending formula would be:
'fvol = Sqr((dblMvol * dblMvol * (jDate - jToday) + dblDvol * dblDvol * 15) / 
(jDate - jToday + 15))

with  jDate the first of the considered month of dispatch
 dblMvol the monthly vol
 dblDvol the daily vol

6_ We are assuming 50% flat correlation for 20 years (a much more 
conservative assumption than 15%). However we run sensitivities where the 
correlation goes from 30% to 70%.

7_ Yes, we are deducting all operative expenses from the valuation. 
Origination is currently trying to reconcile the differences in operations 
expenses between their numbers and those used by credits.

8_ The valuation model (coded by Alex Huang, Research) is based on a 
bidimensional tree, and therefore doesn,t use the SPRDOPT function. However, 
we checked that the SPRDOPT function from the structuring model and the tree 
based model yielded the same values for the spread option.

9_ The strike for the spread option is the sum of the OIL price + the VOM.









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Please send me an excel spreadsheet which depicts the value that you see 
associated with the heat rate spread option.  I want to make sure that I 
understand exactly how you propose valuing the transaction and how this value 
would be booked.  As such, please provide the following detail:

Will we be valuing/booking a series of monthly call options or a series of 
daily call options?
What power curve are we valuing the deal against - PJM East or West Hub?
Please send me the current fuel curve that you are converting to $/MWh to 
value the deal?
What volatilities are you using to value the options - monthly volatilities 
or intra-day volatilities or a blend of the two (if blending please show me 
what formula you using to blend the two vols)?
What expiration date are you using, i.e.: for monthly call options the 15th 
of the relevant month, and for daily options?
What correlation are you assuming, 15% flat for twenty years?
Are you deducting all operating expenses from the value of the option?
Are you using the "SPRDOPT" Exotic Options function to value the option?
Are you using the $/MWh VOM dollar amount as your strike?
Has Don provided the fixed payment stream?  This stream should be covering 
both P&I and not just principal.

Yvan, and Ben, please provide answers to these question via written 
correspondence so that their is limited probability of misunderstanding.  
Thank you both very much for your time and help thus far.  Furthermore, I 
would like to reiterate that RAC's goal, prior to quoting any credit reserve, 
is to be 100% confident that: (i) the methodology that is being employed is 
consistent among the internal groups; and (ii) the inherent value of the 
price risk management contracts matches.  This enables RAC to manage the 
associated risk during the life of the transaction both effectively and 
appropriately.

Regards,

Christopher
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