Power Grid AND ELECTRICITY PRICING - EnergyCAP

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Power Grid AND ELECTRICITY PRICING - EnergyCAP
Power Grid
AND ELECTRICITY PRICING
Power Grid AND ELECTRICITY PRICING - EnergyCAP
This eBook provides an overview of the structure and function of
the electricity grid in North America. It explains the responsibilities
 of grid operators and explores the nature of grid supply/demand
   and pricing. This eBook is intended for energy stakeholders
interested in understanding grid operations, and factors involved in
                 delivery and pricing of electricity.
Power Grid AND ELECTRICITY PRICING - EnergyCAP
Table of Contents
The Grid...................................................................................................................... 2
Transmission............................................................................................................... 4
Grid Operators........................................................................................................... 5
Regulation................................................................................................................... 7
Grid Organization....................................................................................................... 8
Electricity Supply and Demand............................................................................... 9
Electricity Pricing......................................................................................................11
Day-Ahead and Real-Time Energy Markets.........................................................12
Locational Marginal Price....................................................................................... 15
Factors Affecting Demand......................................................................................19
The Grid and Capacity Markets............................................................................ 23
The Grid and Your Utility Bill.................................................................................. 26
Acknowledgements.................................................................................................29
About This eBook.................................................................................................... 31
Power Grid AND ELECTRICITY PRICING - EnergyCAP
“We believe that electricity exists, because the electric company keeps sending
       us bills for it, but we cannot figure out how it travels inside wires.”
                     -Dave Barry, Syndicated Columnist

What’s your view of electricity? Perhaps it’s similar to Dave Barry’s view.
You know it exists. You know you use it. But you don’t really know how it all
works behind the scenes.

The Grid
What is the grid and who keeps it running? Properly speaking, the “power
grid,” is the high voltage transmission system. It’s not the wooden telephone
or electric poles that you see outside of your house. The grid is really the
backbone of the larger electricity distribution system. It is the network of
steel towers that transmits large volumes of electricity from the generating
plants, wherever they’re located, to the users, the consumers, commercial
industry, et cetera. The grid is a huge, humming, interconnected entity
that also encompasses every electricity generator and every electric utility
company connected to those wires. And every electricity generator that is
connected to the grid is fully synchronized with every other generator at all
times. In the United States, each of those generators is rotating at a speed
of 60 cycles (hertz) per second. And the rate is very precise. There’s very
little tolerance for deviation.

                                                                                 2
Power Grid AND ELECTRICITY PRICING - EnergyCAP
In the United States and Canada, the grid is segmented into three primary
  interconnected regions:

                                                                    Eastern
                                                                Interconnection

    Western
Interconnection
                                                 Electricity Reliability Council
                                                   of Texas Interconnection
                                               Graphic provided by U.S. Department of Energy

  Why three grids instead of one? The reasons are geographical and
  geopolitical. The Eastern Interconnection and the Western Interconnection
  are divided by the Rocky Mountains. The logistics of maintaining the grid
  infrastructure over those distances and terrain make a full blown connection
                                                                                          3
Power Grid AND ELECTRICITY PRICING - EnergyCAP
impractical. The Eastern Interconnection encompasses everything
east of the Rocky Mountains and north of Texas. It is the largest of the
regions, and could be thought of as the largest motor in the entire world.
The Western Interconnection includes states and territories west of the
Rockies. The third region is ERCOT—the Electricity and Reliability Council
of Texas. It exists because of the determination of Texans to maintain grid
operations within state borders, free of the federal regulation that follows
interstate commerce.

Now, there are some ties between these three regions, but they are not
synchronous ties. They are direct current (DC) ties. But within each of the
primary regions, everything is completely synchronized, and any action
that occurs within one of those grids can affect every other organization
within the same grid. If a generator in Florida fails, the ripple effect can
be felt up the east coast into Canada and throughout the entire Eastern
Interconnection.

Transmission
So how does electric power get from the electricity generator to the end
user—your home or business? First, let’s look at the variety of electricity
generators. We have the coal-fired plants. There are also generators
that run on natural gas or oil. There are nuclear-powered plants. Some
generators have the potential to switch fuel sources depending on what
source is the least expensive. There are also the renewables: wind,
                                                                               4
Power Grid AND ELECTRICITY PRICING - EnergyCAP
solar, and hydroelectric. Regardless of the fuel type, the generators don’t
supply their power directly to residential customers, even if they’re nearby.
Instead, the output of those generators passes through a transformer at a
substation, where the electrical output is converted to a higher voltage to
travel across the high voltage transmission system.

Why is this conversion necessary? It’s all about efficiency. When electricity
is converted to a higher voltage, there are fewer line losses during
transmission; that is, losses of electricity, usually in the form of heat. It is
also easier to transport electricity over very long distances at the higher
voltages (up to 768 kilovolts in the United States). So the transformer
provides up-conversion from the voltage coming from the generator to the
higher voltage handled by the high voltage transmission lines. This process
in carefully monitored by a grid operator.

Grid Operators
There are several grid operators across North America. They are
responsible for:
. ensuring that the transmission system is operating in a reliable fashion
. providing all generators with equal access to the grid
. balancing the output of generators with the ever-changing demand for
  electricity
. operating the grid’s resources as cost-effectively as possible
                                                                                   5
Nuclear
                                               Generation

                                                               High Voltage
            Grid           Control                             Transmission Lines
        Operator           Room

                                                                        Substation

                                                Wind

Hydro

                                                       Local Distribution Lines
          Residential

                                                    Graphic provided by PJM Interconnection

 After the electricity has been transported for long distances via the high
 voltage transmission towers, it is converted down to lower voltages at
 substations. Then it can be transported on those wooden poles, down your
 street, and eventually to your home or business. By the time the electricity
 “arrives” at your outlet, voltage has been reduced to roughly 110 volts.

                                                                                         6
Depending on the rules in your state, you may work with a single electricity
Within a particular state,     utility to both provide and distribute your electricity or you may have the
regulations are typically      choice to select your electricity provider (company responsible for procuring
                               your electricity) separate from your local distribution company (LDC), which
managed by a state public
                               manages and maintains the local low-voltage distribution system.
utility commission. These
entities approve electricity   Regulation
tariffs and rates for the      How is the grid regulated? The Federal Energy Regulatory Commission

LDCs, electricity providers,   (FERC) is responsible for interstate trade of energy, including the electric
                               grid. The FERC also oversees natural gas transportation across state
and consumers within
                               borders. This oversight includes approval of tariffs; the FERC strives to
their jurisdiction.            ensure price fairness and non-discriminatory pricing for consumers. The
                               FERC offices are located in Washington, D.C.

                               Within a particular state, regulations are typically managed by a state public
                               utility commission. These entities approve electricity tariffs and rates for the
                               LDCs, electricity providers, and consumers within their jurisdiction.

                               As a result of this overlap of responsibilities, there may be two different
                               jurisdictions responsible for the trade of electricity in your area. But disputes
                               involving interstate commerce will involve the FERC.

                                                                                                              7
Grid Organization
In 1996, the FERC issued Order 888, which helped to break apart utility
monopolies. As part of that effort, the FERC encouraged additional
independence and transparency for grid operators and created a new term
to classify and differentiate these entities—Independent System Operators.
An Independent System Operator (ISO) is an organization that might not
own any assets of the grid – their role is to manage the grid in a way that
allows all participants fair and equal access. Their function is similar to air
traffic controllers, who are tasked with managing the skies in a fair and
efficient manner. The Federal Aviation Administration (FAA) doesn’t own the
planes; their employees have a managerial/oversight role.

After ISOs were established, the FERC expanded some of the definitions for
what those types of organizations could do in Order 2000. And in fact, they
created another classification: Regional Transmission Organization (RTO). If
an ISO is the equivalent of a bachelor’s degree, an RTO is the equivalent of
a master’s degree. Every RTO has requirements that are above and beyond
the requirements of an ISO.

An RTO can offer additional grid reliability in the form of ancillary services.
RTOs are also more directly involved in planning and grid infrastructure
development.

                                                                                  8
Electricity Supply and Demand
Grid management is an incredibly dynamic process. A helpful analogy
would be to think of the “pool” of available electrical energy on the grid as
a bathtub full of water with a spigot and a drain. The spigot is supply, and
the drain is demand. But the drain aperture is constantly changing in size.
The grid operators’ responsibility is to maintain the water level despite this
uncertainty. When the drain gets bigger, the operators open the spigot a
little more. When it shrinks, they close the spigot to reduce the supply.

On the grid, there is a constant tension or push and pull between the
resources (generators) that are adding power to the grid and the consumers
that are drawing electrical power from the grid to do work. Since there are
few options for electricity storage, this balance can only be maintained by
balancing available generation resources to match the current demand.

Whenever electricity is used, the drag on the system tends to slow the
frequency, which must be kept constant to avoid damage to devices using
the electrical current. The chart on the next page illustrates the frequency
variation during normal grid operations.

                                                                                 9
PJM eData system

Whenever the trend line is above zero, the grid is over-producing in
comparison to grid demand. Whenever the trend line is below zero, there is
more power being drawn from the system than is currently being supplied.
Grid operators try to keep that trend line as close to the center as possible.
Typical boundaries (measured in hertz) would be from 59.95 to 60.05. If
these tolerances are exceeded, certain grid equipment has automated
procedures for self-regulation that may include automatically shutting down
equipment or turning off electricity for some users. Grid operators are
constantly managing the system to ensure that these more extreme actions
are not required.
                                                                               10
Electricity Pricing
Now that we understand more about grid operations, let us examine how
prices for electricity are determined. The dynamics and variation of pricing
may surprise you.

In the “old days” prior to some of the organizational changes brought about
by the FERC actions, electricity prices were often set by utility companies
and approved by state utility commissions. The rates were often determined
based on the concept of cost recovery. The more that the utilities spent
on infrastructure and generators for production, the more returns could be
“justified.” Those returns were, for the most part, set as a percentage of
the total approved investment cost (rate base). While these types of returns
provided limited risk for utility investors, from a consumer’s perspective,
there was too little incentive for efficiency and conservation activities that
would serve to lower consumer prices.

The FERC has tried to provide that incentive by requiring segmentation
of the business operations of electrical distribution, transmission,
and generation, even if those operations are performed by the same
corporation. The purpose for this segmentation is to take the financial risk
of constructing expensive generators off the electric consumer and place
that risk on the shoulders of investor-owned corporations. For instance,
Exelon, a very large utility company in the United States, owns generators,
grid transmission equipment, and distribution companies that distribute

                                                                                 11
electricity to individual consumers (e.g., PECO, ComEd). However, the FERC
requires Exelon and other similar organizations to create organizational-
structural-financial barriers within their companies. In practice, these
companies are barred from sharing operational information between
their generation portfolio and their transmission portfolio. This division is
intended to ensure that everyone who uses the grid is treated fairly and
doesn’t have an advantage, one over another. And that’s really where
competition comes into play, because as the generator businesses compete
for a share of the electricity market, competition drives down the cost of
electricity for all consumers.

Day-Ahead and Real-Time Energy Markets
Grid operators project anticipated demand well into the future for planning
purposes. But most procure actual generation capacity through two related
electricity market mechanisms: the Day-Ahead Energy Market and the Real-
Time Energy Market.

The Day-Ahead Energy Market (DAM) is a financial market where
participants purchase and sell electricity at financially binding day-ahead
prices for the following day. For instance, on a daily basis each participating
generator will provide an hourly rate for the electricity they are willing to
provide during the next day, along with their output, possibly including
tiered (block) pricing depending on the amount of energy purchased during
each hour.
                                                                                12
Up to 98% of the anticipated load is procured using the Day-Ahead Market,
depending on market design and market confidence. The DAM allows
buyers and sellers to lock in their price and hedge against volatility in the
Real-Time Energy Market, where additional actions and transactions must
take place to respond to real-time conditions.

Let’s see how this is done using a real world example. The black line on the
graph below represents the electric load curve for a single day for the grid
operator. This is the aggregate electricity usage of all consumers within a
particular grid region.

                                                               Graphic provided by PJM
                                                                                  13
Initially, demand is close to 100,000 megawatts. Then the trend line dips
down, then back up, and finally back down in the evening. The grid operator
is constantly working to predict what this demand curve will look like today,
tomorrow, and even a week in advance. They use historical load curves and
weather patterns to predict the exact amount of electricity that will be used
at all times throughout the day.

The grid operator may set a regular deadline of noon for submitting bids
and offers for the DAM, and any participating electricity generator must
submit tomorrow’s hour-by-hour pricing offer into the DAM before the noon
deadline. The offer will include how much energy they can and will provide,
and how much it will cost. The offer may include tiered (block) pricing based
on the amount of energy purchased.

A sophisticated DAM software package analyzes the demand forecast
and all available energy resources and costs in a two-stage process. The
software can often run for several hours while it determines how to best
match grid demand and infrastructure capability with the energy available. A
variety of factors contribute to the final outcome, including generator prices
and production capacity, location of generators, the capability of each piece
of transmission equipment, known equipment outages, generator start-up
and shut-down costs, and many other variables.

The DAM then selects generators based on the most favorable (least-
cost) scenario that also ensures reliable operation of the high voltage
transmission equipment. Essentially, the DAM software “stacks up”
                                                                            14
generators based on their price and makes selections that are both cost
             effective and reliable.

             In the Real Time Energy Market, grid operators are continuing to monitor
             and predict load throughout their region. They often predict and make
             decisions on last-minute generator changes (additional/fewer generators
             and different generator output levels) 20 minutes to three hours in advance.
             Final decisions on output for each generator are made and sent to
             generators electronically on a constant basis.

             Locational Marginal Price
             In electricity markets, price is not simply based on time of day or availability.
             There is a “cost” involved in actually transmitting electricity through the grid.
             This cost is measured by practical limits of the transmission infrastructure,
             as well as line losses associated with the transmission.

Locational                                   Transmission
                System                                                         Cost of
 Marginal                                     Congestion
              Energy Price                                                     Losses
  Price                                          Cost

                                                                                           15
Generators are selected for use by grid operators in part based on how
available their electricity is for the rest of the grid. Although a generator
may not be the least expensive generator, it may be the only one available
to deliver power when needed due to “constraints” on the transmission
system. This results in a higher electricity price.

Likewise, customers pay, in part, based on how easy it is for the grid
companies to get inexpensive power to them. If they are in a location where
it is difficult to provide power from inexpensive generators, the Locational
Marginal Price (LMP) helps reflect that difficulty. Customers in areas where
expensive generators must be turned on to provide their power will be
responsible for the additional costs of those generators.

As mentioned previously, prices on the electric grid are dynamic. They can
change every five minutes, based on which generators are producing, what
line losses are associated with the system, and how difficult is it to get
power from one part of the grid to another given the limitations of the high
voltage transmission system.

                                                                                16
Graphically, this is what dynamic electric pricing looks like.

This is a representation from the Midcontinent ISO (MISO) and their pricing
for a particular moment in time on the electric grid. The colors represent a
variety of different prices. As you can see, prices in some areas are very
low. In fact, they may even be negative, an anomaly that we will address in
detail shortly.

                                                                               17
In other parts of the system, the prices are quite high. If you look at pricing
in western Kentucky or the southern part of Illinois, they are much higher.
Remember—the price is based on three factors:
1. The costs of generators used.
2. The location of the generators and end use customers.
3. Additional generation required to overcome losses on the system.

The higher prices in the eastern region are most likely due to limitations
with transmission lines that are close to being overloaded. As a result, more
expensive electricity generators are being turned on in the east, contributing
to the price differential.

On the next page is another example from Superstorm Sandy—this graph
is from PJM Interconnection—an electricity grid operator responsible for
delivery of electricity in 13 states and the District of Columbia.

                                                                              18
In this particular case, Superstorm Sandy hit the Northeast and downed
power lines, blacking out portions of Pennsylvania and New Jersey. As
a result, demand was effectively reduced to zero, and prices in that part
of the grid went negative. The grid was overproducing in that area, and
generator companies would have paid big bucks to anyone in the northeast
who would use their energy, so they wouldn’t have to spend time and
money shutting down and idling generators that might take days to get
back online. In those types of circumstances, it is more economical to pay
consumers to use electricity in certain areas than it would be to curtail
energy production. So, negative prices do exist on the grid, even if we don’t
see them in our retail electric bills.
                                                                            19
Factors Affecting Demand
We have discussed factors affecting electric pricing. But what factors
influence demand? The biggest two influences on electricity prices
are weather and human behavior.

The two charts below represent a weekday load curve in summer
and in winter—how much electricity is being used in the summer
versus how much electricity is being used in the winter.

                                                     Graphics provided by PJM

                                                                         20
As you can see, the scale for each graph is different. The summer peak
is close to 150,000 megawatts, but in the winter, it’s around 100,000
megawatts. That difference in magnitude can be explained in two words:
air conditioning. In summer, as temperatures rise during the day, more and
more air conditioners are turned on. This explains the steady increase in
electricity use as the day gradually warms up.

By contrast, the winter increase is more angular. We see a very steep
change in electric use relatively quickly as people are getting out of bed
and turning on more lights and heating systems. These types of changes
are very difficult for a grid operator to manage. But then during the day,
once buildings have heated up, there is often a gradual decline in electricity
usage. As people return home at night, we see a secondary peak for
lighting and heating that occurs primarily at the residential level. This human
behavior, factored in with weather, determines how much electricity the grid
operator has to supply throughout the day.

Grid operation becomes a kind of balancing act, juggling supply (and
demand) through a combination of art and science. The art is in the
forecasting of electricity use for a dynamically-changing grid with demand
determined by a myriad of individual choices. The science is in the
analytics, which blends historic and real-time data to produce the very best
guess about the electrical resources that will be required. Grid operators
also need to schedule the cheapest generation possible, acknowledging
that not every factor is theirs to control. They also have to make sure that at

                                                                             21
no point in time are they damaging the transmission system, burning down
lines or causing problems that would have a long-term effect on the grid.
And they must react quickly to unexpected changes. Suppose, for instance,
that a steel plant operator suddenly fires up all the company’s furnaces. In
that particular situation, the grid operator has to suddenly react to a huge
change in demand in a very small area of the grid. Those types of changes
occur all the time.

As we have seen, daily demand variations produce corresponding variability
in pricing schedules. There are peaks and valleys. The peaks represent the
highest cost for electricity, while the valleys represent opportunities to run
more cost effective generators and produce savings for the consumers.

Unfortunately, consumer pricing is often flat rate pricing. You don’t get
“extra credit” or a reduction in your monthly utility bill for turning on your
dishwasher at 2:00 a.m. In many instances, utility companies cannot legally
charge variable electricity rates to consumers–prices that rise and fall with
the prices on the grid. And consumers can’t take advantage of unique
negative pricing events. But it is conceivable that Smart Grid technologies
may change that. Perhaps in the not-too-distant future, you may be able to
charge your electric car at 1:00 a.m., use it as a battery, and sell its stored
energy back to the grid the next afternoon!

                                                                                  22
Capacity market providers
                                 The Grid and Capacity Markets
                                 How does the grid respond to unusual situations? What happens when
are a kind of insurance to       weather and/or human behavior combine to create abnormal demand

ensure that the grid will have   loads? In these cases, the grid operators must plan for the unexpected and
                                 prepare for the worst.
enough available generation
                                 These worst-case scenarios are often not handled solely by the standard
to meet demand–even on           electricity markets (DAM and Real Time Market). Instead, there are
the most challenging of days.    additional electricity markets and ancillary services which provide for these
                                 particular situations.

                                 Capacity market providers are a kind of insurance to ensure that the grid
                                 will have enough available generation to meet demand–even on the most
                                 challenging of days. In addition to any real generation that they provide
                                 in the DAM and/or Real Time Market, they are also funded via capacity
                                 charges, which are often itemized on your utility bill. Capacity markets help
                                 ensure that all customers have electricity whenever they want to use it.
                                 The grid operators plan for only one controlled blackout every ten years.
                                 That’s an input to the statistical model that they use in their calculations to
                                 ensure an adequate power supply sometimes years in advance of when
                                 the electricity will be used. Grid operators use forecasting and statistical
                                 analysis to determine what future use–meaning use one to five years into
                                 the future–might look like.

                                                                                                                23
These capacity charges that we all pay as consumers or businesses provide
a daily revenue stream to ensure that those generators that are used
very infrequently, but are yet critical to the reliability of the grid, have an
adequate revenue stream to stay in business. So another term for capacity
charges is “demand charges.” If you look at your electricity bill, especially
as a business user, you will notice that there are demand charges. Those
charges go to pay for the capacity market providers that ensure the
reliability of the grid on those peak days during the year.

Below is an example of load curves that compares peak electric use during
different seasons of the year.

        Capacity Requirement
        Constant Year Round

                                                                                  24
And you can see that in April and October, the use profile is much lower
than in the summer. This is because the combined heating and cooling
demands are minimal. But unfortunately, grid operators cannot plan for
these best-case use scenarios. They can’t suddenly build more generators
or transmission lines when the summer hits. It is necessary to have
generating capacity “on call” to meet those summer and winter peaks.

So the capacity requirement ends up being based on the worst use day of
the year (peak load) plus a buffer. The grid operator must be prepared with
available generation capacity to meet that summer peak, and then some.
Those demand costs are passed on to consumers through the entire year.
Often, consumers and commercial users fail to realize how lowering their
electricity usage on peak days in the summer can translate into direct
savings by reducing the demand charges that they pay on their monthly
bills.

In addition to capacity payments, there are other grid services like
regulation, spinning reserves, black start, and reactive services. These are
other types of services that grid operators need to have, or tools that they
have in their toolbox in order to ensure grid reliability. They refer to how
fast generators can respond when there are problems, how much reserve
there is available to be called onto the system within 15 minutes, what
happens if you have to restart the grid up following a blackout, and how to
sustain required voltage levels on the system at all times.

                                                                               25
The Grid and Your Utility Bill
           When you add up all of the services provided by electricity suppliers, grid
           operators, and distributors, what does it look like in terms of your utility bill?

                                           Reliability
     Total: $48.26/MWh                     (Capacity), 4.77

                                                          Transmission, 4.51

                                                                Regulation, 0.28
                                                                   Operating
                                                                   Reserve, 1.54
                                                                   PJM Cost, 0.34
                                                                   Reactive, 0.34
                                                                   Transmission Owners
                                                                   Control, 0.08
                    Energy, 36.24                                  Synchronized
                                                                   Reserve, 0.03
                                                                   Black Start, 0.14
YTD February 2013                                                                  Source: PJM
($/MWh)

                                                                                           26
This is a sample of total billed charges from PJM during the beginning of
2013. At that time, you can see that more than 75 percent of consumer
cost went to pay for the electricity they consumed. This makes sense—
the more electricity you use, the higher your costs will be. However, the
second highest payment amount is dedicated to capacity or demand
charges. As a consumer or a business owner, you can control this
capacity charge to some extent. If you are tracking daily electric loads,
you can determine when your peak days are. If you can curtail your energy
use during those peak days during the year, you can save money on your
electric bill all the time.

The remaining items on your bill are generally specialized services—
transmission services for maintaining transmission lines, grid response
services (previously discussed) and (of course) taxes.

The costs described above are for electricity supply and grid services.
Your local distribution company (LDC) will also add their fees/services to
your monthly electricity bill.

                                                                             27
“Edison’s greatest achievement came in 1879 when he invented the electric
  company. Edison’s design was a brilliant adaptation of the simple electrical
 circuit: the electric company sends electricity through a wire to a customer,
 then immediately gets the electricity back through another wire, then (this is
the brilliant part) sends it right back to the customer again. This means that an
      electric company can sell a customer the same batch of electricity
thousands of times a day and never get caught, since very few customers take
                 the time to examine their electricity closely.”
                    -Dave Barry, Syndicated Columnist

Like Dave Barry, we may not fully understand the electricity that powers
our lives. But now we have a better understanding of its journey from the
generator to our home or office.

We also understand more of what we are paying for with each utility bill—
not just the electricity we use, but the range of services and equipment that
helps ensure that generators will be available to meet our energy needs
today and into the future.

                                                                              28
Acknowledgements
Content for this eBook has been derived primarily from a webinar
presented by David Ulmer, Chief Product Officer for EnergyCAP, LLC.

                           David is a Penn State University graduate with
                           extensive experience in electrical grid project
                           management, including consulting and full-time
                           employment at PJM Interconnection–an electricity
                           grid operator responsible for the reliable and
                           efficient delivery of electricity in 13 states and
the District of Columbia. During his tenure at PJM, David helped develop
solutions to support PJM’s real-time grid management and the operation
of PJM’s electricity markets–the largest wholesale electricity markets in the
world. To complement his technical experience with PJM, David earned his
MBA from Penn State’s Smeal College of Business in 2008. He spent the
following three years as PJM’s International Relations Liaison and traveled
around the world learning from other electricity grid operators and sharing
industry best practices.

                                                                                29
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                                                                            30
About This eBook
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