PSEG Overview

1

• 12th Annual Latin American Energy Conference
• San Diego, California
• May 19th, 2003

Liquidity, Restructuring And the
Current Investment Appetite

• Presented by
• Michael J. Thomson
• President CEO
• PSEG Global Inc.

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Background / Situation

• Globalization accelerated rapidly in the 1990s
• The electric sector was seen as a prime
  globalization candidate and an enabler of the
  shift to market-driven economies
• Many OECD companies, with lower growth prospects
  in their home markets, saw an opportunity to
  create economic value for their shareholders by
  deploying capital and know-how to acquire or
  build, and then operate, energy infrastructure
  assets in rapidly growing emerging markets

The turmoil of the past fifteen months has caused
many companies to investigate this premise
3
The shift from state-run economies to market
economies accelerated rapidly in the mid to late
1990s.
Liberalization The Transition to Market Economies

• Means
• Removal of tariffs, and other barriers to open
  markets for trade and investment
• Deregulation of industries
• Privatization of key industries
• Creation of appropriate institutions and legal
  structures to ensure market-based operations

• Expected Results
• More competitive and efficient industries
• Increased trade in goods and services
• Increased cross-border capital flows
• Higher rates of economic growth, wealth creation
• Increased knowledge transfer

Liberalization and globalization were expected to
bring enormous societal benefits.
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The electricity sector was seen as both a prime
candidate for and an enabler of the shift to
market-driven economies.
Electricity Deregulation and Privatization

• Basic Elements
• Removal of barriers to private sector
  participation
• Privatization of government-run companies
• Deregulation
• Creation of legislative and regulatory framework
  with independent regulatory function
• Transparent rate setting free from politics and
  non-market forces

• Rationale
• Creates greater efficiency through market
  discipline
• Restores financial health to sector
• Reduces governments role in the economy
• Raises revenue for the state
• Provides new source of capital to ensure supply
  of reliable, reasonably-priced energy for growing
  economies

Multilateral agencies played an important role in
encouraging this trend.
5
Despite high expectations and investment,
liberalization / globalization has produced
significant disappointments
Disappointments of Liberalization / Globalization

• Economic growth remains overly dependent on the
  US market 64 of total world economic growth
  1995-2002
• Sustained GDP growth and realization of the
  promises of globalization in emerging markets
  have remained elusive economic recessions and
  declining FX values have left a surfeit of
  over-indebted developing countries
• Often privatization became the only effective
  method of raising capital at favorable terms.
  Reforms stalled after privatization funds were
  collected
• Increased capital flows increased volatility,
  putting enormous pressure on governments and
  economies that did not put their fiscal positions
  in order
• Often, benefits of liberalization tended to flow
  to the elite classes and further increased wealth
  concentration benefits to the poor, while real,
  were much harder to discern
• Wars and terrorism have created new uncertainties

and reforms are on a significantly slower track
today.
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For the electric sector, rapid deregulation
privatization created conflicts, especially as
economic turmoil hit many countries.

• Situation
• The electricity sector is / was a
  government-owned service in most parts of the
  world, unlike the United States
• Considered necessary for the public good
• Not profit-driven and chronically under-funded
• Pricing determined politically, often subsidized
• Independent regulatory frameworks, policies, and
  safeguards largely non-existent

• Transitional Conflicts
• Difficulties with contract enforcement or in
  properly raising or restructuring tariffs
• Phasing out of subsidies
• Designing equitable tariff
• Incomplete reforms of regulatory and legal
  frameworks, including independence and
  transparency
• Failure to anticipate sometimes strong, opposing
  vested interest
• Poor visibility in addressing social hardships
• Inability to eliminate the considerable scope for
  political patronage and corruption
• Poorly implemented national macroeconomic
  policies

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Compounding the situation, the electricity sector
has characteristics that create limitations
compared to other global businesses

• Characteristics
• Assets are capital intensive, stationary, unable
  to be moved to a better location
• Assets are very long-lived (30 to 50 years)
• Electricity generally cannot be exported it is
  produced and consumed in-country
• Payment for service is in local currency

• Effects
• Investment largely becomes captive in the
  country
• Investments require a long time horizon for full
  recovery
• Exit strategies are limited
• Local currency fluctuations (declines) dampen
  financial performance

challenging the fit of electricity with the
liberalization / globalization wave.
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Electric Sector Lessons Learned

• A number of issues must be addressed if electric
  sector liberalization and privatization is to be
  considered sucessful for existing investments,
  e.g., system /tariff design issues, phasing out
  of subsidies, strength of industry participant
  credit, and corruption
• Prospectively, due to the characteristics of the
  electric business -- system design, regulations,
  etc., should be reasonably and thoroughly dealt
  with prior to the sale of property or new
  investment in capacity
• In the future, a deeper understanding of the
  maturity of key institutions will clearly change
  the terms and return expectations on which
  private capital enters the electric sector
• One bright line test for the electric business
  may have to be the existence of local sources of
  capital in local currency (bank debt, bonds,
  equity) for investment in the sector
• Reflects the maturity of key institutions
• Reflects the cost of money in the local economy
  for the industry
• Allows investors to manage risks more effectively
• However, this test would also significantly
  reduce the number of target markets

9
The resulting disappointing performance and
market volatility have caused companies to
rethink their strategies.

• Competitor Reactions
• In response to rapid changes in the business
  environment, existing players quickly shifted
  focus from growth to cost reductions, portfolio
  realignment including asset sales and
  abandonment, and survival strategies
• Some players have announced a complete exit from
  the international arena
• New entrants are identifying opportunities to
  capitalize on others setbacks and readying to
  buy assets at distressed prices to create a new,
  lower-cost structure.

10
Where to from here

• Liberalization / Globalization will likely
  continue but more slowly and with rough spots
  along the way.
• For the electric sector to attract FDI, serious
  issues need to be addressed including tariff
  design, access to local capital, contract
  sanctity, independent and fair judiciary
  procedures.
• Emerging economies remain the primary source of
  growth markets, but incomplete and inadequate
  reforms create risk and uncertainty for
  investors.
• Taking into account the lessons learned, the
  population of attractive target markets shrinks
  significantly.
• The industry is wiser
• Financial expectations will realign with economic
  reality
• Capital will be more skeptical of promises of
  future change and good behavior

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Where to invest?
Market Fundamentals

• Privatization Process
• Market based
• Well defined with a schedule
• Transparent rules
• Political will and consensus
• Energy Sector
• Competition in the fuels market and transparent
  pricing
• Independent and competitive wholesale market
• Sufficient infrastructure fuel, transmission
  and transportation
• Electric Sector
• A track record (not a story) on reforms with
  clear, stable and concise rules for governing
• Credible regulatory process
• Ability to secure long-term bilateral contracts
• Sustainable pricing structure

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Where to invest?
Institutional Support

• A political system and leadership that supports
  change
• A transparent local legal system or equivalent
  remedies

• Policy formulation and execution that targets
  diversity in the economy and open markets
• Responsible national macroeconomic policies
• Stable financial and banking system
• Workable tax structures, treaties incentives
• Existing and/or growing access to local capital
  in local currency

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Summary

• Liberalization / Privatization / Globalization
  were on an unrealistic timetable, given the
  degree of change required
• Free markets are easy to declare, but difficult
  to implement
• Without reasonably developed and tested
  institutional safeguards quality of
  policy-making coherent laws and the enforcement
  of contracts competent, impartial courts
  independent regulators and control over
  corruption privatization will continue to be
  problematic for foreign investors
• This is becoming the big divide in the world
  economy
• Economies were often liberalized without fully
  accounting for societal, political, and
  historical concerns
• Good technical blueprint, but lacked local
  consensus and was frequently too much too soon
• As a result, the backlash was underestimated,
  causing governments to back away from
  market-oriented policies to more populist agendas
• Rapid changes to traditional business practices,
  social structures, and cultural mores creates
  challenges
• Disproportionate benefits creates class-based
  anger in the weaker economies
• Nonetheless, liberalization / globalization will
  likely continue but more slowly and with many
  stops and starts along the way
• Roots will take longer to develop country by
  country due to economic cycles, the challenges of
  change, opposition groups, and periodic setbacks
• A process that can easily take a generation for
  some countries

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Outlook
For the electric sector, long term investors will
no longer put money into stories and market
economy blueprints. A reasonable track record
on reforms, competitive return expectations, and
some access to local capital will be important
leading indicators. This will mark the great
divide in the allocation of FDI in the electric
sector.