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                                                                 Exhibit 10.7



                             WATER SUPPLY AGREEMENT


                                 by and between


                               AES RED OAK, L.L.C.


                                       and


                              BOROUGH OF SAYREVILLE















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                                TABLE OF CONTENTS



ARTICLE I DEFINITIONS.......................................................1


ARTICLE II SUPPLY OF UNTREATED WATER........................................4

   SECTION 2.1       WATER SUPPLY...........................................4
   SECTION 2.2       COMPENSATION...........................................5
   SECTION 2.3       MINIMUM BILL AMOUNT....................................6
   SECTION 2.4       SERVICE INTERRUPTIONS..................................7

ARTICLE III INFRASTRUCTURE AND REAL ESTATE RIGHTS...........................8

   SECTION 3.1       CONCERNING THE LAGOON WATER PIPELINE, LAGOON PUMPING
                     STATION AND SAYREVILLE INTERCONNECTION NUMBER 2........8
   SECTION 3.2       OPERATION AND MAINTENANCE OF INFRASTRUCTURE............9
   SECTION 3.3       INFRASTRUCTURE STUDIES AND ADDITIONS..................10
   SECTION 3.4       CAPITAL IMPROVEMENTS..................................10

ARTICLE IV ADDITIONAL OBLIGATIONS OF THE PARTIES...........................11

   SECTION 4.1       ADDITIONAL OBLIGATIONS OF THE BOROUGH.................11
   SECTION 4.2       ADDITIONAL OBLIGATIONS OF AES.........................12

ARTICLE V FORCE MAJEURE....................................................13

   SECTION 5.1       FORCE MAJEURE.........................................13

ARTICLE VI TERM............................................................13

   SECTION 6.1       TERM..................................................13
   SECTION 6.2       EARLY TERMINATION FOR EVENT OF DEFAULT................14

ARTICLE VII MISCELLANEOUS..................................................15

   SECTION 7.1       AMENDMENT, ETC........................................15
   SECTION 7.2       ASSIGNMENT............................................15
   SECTION 7.3       COOPERATION IN FINANCING..............................15
   SECTION 7.4       NOTICES, ETC..........................................15
   SECTION 7.5       INFORMATION SHARING...................................16
   SECTION 7.6       COOPERATION RELATED TO THE WATER SUPPLY AGREEMENT.....16
   SECTION 7.7       SEVERABILITY..........................................16
   SECTION 7.8       BINDING EFFECT........................................16
   SECTION 7.9       GOVERNING LAW.........................................16
   SECTION 7.10      HEADINGS..............................................16
   SECTION 7.11      EXECUTION IN COUNTERPARTS.............................16
   SECTION 7.12      WAIVER OF JURY TRIAL..................................17

ARTICLE VIII REPRESENTATION AND WARRANTIES OF THE PARTIES..................17

   SECTION 8.1       REPRESENTATIONS AND WARRANTIES OF THE BOROUGH.........17
   SECTION 8.2       REPRESENTATIONS AND WARRANTIES OF AES.................18


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                             WATER SUPPLY AGREEMENT

         WATER SUPPLY AGREEMENT (this "AGREEMENT"), dated as of December 22,
1999, by and between AES Red Oak, L.L.C. ("AES") and the Borough of Sayreville
(the "BOROUGH"). Both AES and the Borough are hereinafter sometimes referred to
as a "PARTY" and, collectively as the "PARTIES."

         WHEREAS, AES is developing a power generation facility (as further
defined below, the "PROJECT") which will provide substantial benefits for the
State of New Jersey and the Borough of Sayreville.

         WHEREAS, the Borough owns and operates a raw water system; and

         WHEREAS, the Borough is willing to provide and AES is willing to
accept, in each case pursuant to the terms of this Agreement, Untreated Water

         NOW THEREFORE, the Parties hereto, for good and valuable consideration
the receipt and sufficiency of which is hereby acknowledged, do hereby agree as
follows:

                                   ARTICLE I

                                   DEFINITIONS

         "BOROUGH'S FACILITY" means the raw water facilities owned and operated
by the Borough located in the Borough of Sayreville, New Jersey, which will
supply Untreated Water under and in accordance with the terms of this Agreement.

         "BUSINESS DAY" means any day other than a Saturday, a Sunday or a day
on which banking institutions are authorized or obligated by law or executive
order to close in the City of New York or the State of New Jersey.

         "CAPITAL IMPROVEMENTS" means any new equipment or facilities, or
replacement of existing equipment or facilities (in either case such as force
main piping or pumps) and relevant related items necessary to ensure that the
Infrastructure is capable of supplying Untreated Water to the Point or Points of
Delivery in the quantities specified in this Agreement.

         "COMMENCEMENT NOTICE" means a written notice from AES to the Borough
specifying that delivery of Untreated Water is to commence in accordance with
the terms of this Agreement.

         "CONTRACT YEAR" means each period of one year with the first Contract
Year beginning six months after the delivery of a Commencement Notice. The final
Contract Year shall end on the day on which this Agreement is terminated.

         "DUHERNAL O&M RATE" shall have the meaning given that term in Section
2.2(d).


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         "DUHERNAL PAST ACQUISITION RATE" shall have the meaning given that term
in Section 2.2(d).

         "DUHERNAL WATER" means untreated water originating from the Duhernal
acquifer and transported through the Duhernal Water Pipeline.

         "DUHERNAL WATER RATE" shall have the meaning given that term in Section
2.2(d).

         "DUHERNAL WATER PIPELINE" means the existing 30-inch pipeline which
transports Duhernal water and part of which is located adjacent to the Project
site.

         "EXCESS WATER" shall have the meaning given that term in Section
2.1(d).

         "FINANCING PARTIES" shall mean those Persons (other than AES) party to
the loan contracts, promissory notes, documents, guarantee contracts, mortgages,
pledges, subordination contracts, assignment contracts, subscription contracts,
capital contribution contracts, indenture agreements and other documents related
to the acquisition of debt (whether senior or subordinate) and capital to carry
out the Project, including any modification, extension, renewal, refinancing or
replacement of the same.

         "FORCE MAJEURE" means an event beyond the reasonable control, and not
attributable to the negligence or willful misconduct, of the Party affected,
including but not limited to the following: flood; earthquake; storm; lightning;
fire; explosion; war; riot; civil disturbance; strike; sabotage; or electrical
outage; provided, however, that Force Majeure shall not include any equipment
failure due to normal wear and tear or due to neglected maintenance or repair.

         "GOVERNMENTAL APPROVAL" means any law, rule or regulation of any
Governmental Authority and any authorization, consent, approval, license,
franchise, lease, ruling, permit (including but not limited to any National
Pollutant Discharge Elimination System (NPDES) permit), tariff, rate,
certification, exemption, filing or registration by or with any Governmental
Authority (including, without limitation, zoning variances, special exceptions
and non-conforming uses) relating to the construction, ownership, operation or
maintenance of the Project, the Lagoon Water Pipeline, the Sayreville
Interconnection Number 2 or the Borough's Facility (including those relating to
Untreated Water), as the case may be.

         "GOVERNMENTAL AUTHORITY" means any national, federal, state,
provincial, departmental or municipal government or any political subdivision
thereof, and any other entity exercising executive, legislative, judicial,
regulatory or administrative functions of or pertaining to government, and any
other governmental entity with authority over any aspect of the construction or
operation of the Project, the Pipeline or the Borough's Facility, but excluding
in each case the Borough.

         "INDUSTRIAL CUSTOMERS" means Borough water customers that purchase or
contract for the purchase of 100,000 gallons or more per day of water.


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         "INFRASTRUCTURE" means the Lagoon Water Pipeline, Lagoon Pumping
Station, and Sayreville Interconnection Number 2.

         "INITIAL PAYMENT" means the payment to be made pursuant to Section
2.2(a).

         "LAGOON PUMPING STATION" means the pumping station to be located at
the Lagoons which shall consist of pumps, force main piping and other facilities
necessary to pump Untreated Water from the Lagoons to the Project with a design
capacity of 3500 gallons per minute rate, and including separate electric
metering equipment to measure the consumption of electricity by the equipment
comprising the pumping station.

         "LAGOON WATER PIPELINE" means the approximately 0.5 mile pipeline, and
ancillary facilities required, together with the Lagoon Pumping Station, to
connect the Project with the Borough's Facility for the purpose of delivery of
Untreated Water in accordance with this Agreement. The Pipeline will be
comprised of, among other things, an approximately 18" diameter force main
piping.

         "LAGOONS" means the lagoons just north of Bordentown Avenue which hold
South River Water and from which South River Water will be provided to the
Project.

         "PERSON" means any individual, corporation, partnership, limited
liability company, joint venture, incorporated or unincorporated association,
joint stock company, trust, or other unincorporated organization, governmental
body, instrumentality or agency, or other entity of any kind.

         "POINT OR POINTS OF DELIVERY" means the point or points where the
Lagoon Water Pipeline and the Duhernal Water Pipeline, including any Capital
Improvements thereto, are physically connected to the Project, which location(s)
shall be at or inside the border of AES' property and which shall be as
otherwise agreed to by the Parties.

         "PROJECT" means the power generation facility to be constructed in the
Borough of Sayreville, New Jersey, including any Untreated Water supply
facilities installed by AES on AES' side of the Point of Delivery.

         "PROJECT FINANCIAL CLOSING" means the date AES obtains an initial
drawdown on the debt financing for the construction of the Project. AES agrees
to provide written notice to the Borough within thirty (30) days after AES
obtains such initial drawdown.

         "REAL ESTATE RIGHTS" means those interests in real estate of a
recordable and insurable nature, including but not limited to fee interests,
easements and rights of way and any other interests in real estate reasonably
acceptable to AES including revocable or irrevocable licenses, necessary or
desirable for construction, maintenance and operation of the Lagoon Water
Pipeline, the Lagoon Pumping Station and the Sayreville Interconnection Number
2. All Real Estate Rights shall be in the name of the Borough and shall
explicitly provide for a right of access to AES or its contractors or agents in
order to carry out AES' rights or obligations under this Agreement.


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         "SAYREVILLE INTERCONNECTION NUMBER 2" means the approximate 18"
pipeline from the Duhernal Water Pipeline to the Project's site boundary and
related facilities necessary to make a connection to the Duhernal Water Pipeline
at a point near the Project site.

         "SHORTFALL NOTICE" shall have the meaning given that term in Section
2.3.

         "SOUTH RIVER O&M RATE" shall have the meaning given that term in
Section 2.2(b).

         "SOUTH RIVER PAST INFRASTRUCTURE RATE" shall have the meaning given
that term in Section 2.2(b).

         "SOUTH RIVER WATER" means water pumped from the South River to the
Lagoons or otherwise obtained from the South River for purposes of delivering
Untreated Water to the Project.

         "SOUTH RIVER WATER RATE" shall have the meaning given that term in
Section 2.2(b).

         "TREATED WATER" means potable water.

         "UNTREATED WATER" refers to Duhernal Water, South River Water, and
other untreated water available to the Borough that is suitable for use by the
Project with the equipment and treatment facilities installed for making use of
Duhernal Water or South River Water.

         "UPGRADES" shall have the meaning given that term in Section 3.3 (b).

                                  ARTICLE II

                            SUPPLY OF UNTREATED WATER

         SECTION 2.1  WATER SUPPLY.

         Subject to the terms hereof, the Borough agrees to sell and deliver and
AES agrees to purchase and receive the Untreated Water requirements of the
Project.

         (a) Except as provided in Section 2.1(b), the Borough will provide AES
with South River Water, which shall be drawn by the Lagoon Pumping Station and
transported by the Lagoon Water Pipeline to the Project at a suitable Point or
Points of Delivery. Subsequent to completion of the Lagoon Water Pipeline and
promptly following delivery of a Commencement Notice and throughout the Term of
this Agreement, the Borough shall use all reasonable efforts acting as a
reasonable and prudent operator, to make available to AES a supply of South
River Water, in quantities up to 4.6 million (4,600,000) gallons per day and
1533 million (1,533,000,000) gallons per year. The Borough will use all
reasonable efforts, acting as a reasonable and prudent operator, to maintain the
Lagoons' water level at elevation twenty-nine (29) feet to the greatest extent
possible when water is available from the South River. The Borough anticipates
that the water level in the Lagoons will be drawn down to a water level below
this level during periods of South River withdrawal limitations. The Borough
shall not sell

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South River Water to new Industrial Customers after signing this agreement if
doing so would prevent or hinder supplying AES with the quantities of South
River Water specified. Nothing in this Agreement shall limit any water supply to
the Borough's water treatment facilities used for producing Treated Water and
supplying Treated Water to Borough customers.

         (b) AES shall be supplied with South River Water except when the
Lagoons' water level is below 20 feet and South River Water is unavailable due
to low flow or chloride limitations as specified by the NJ Department of
Environmental Protection, or when the water in the Lagoons is necessary to
ensure the supply of Treated Water to Borough customers. If South River Water is
not available for the foregoing reasons or in the event of Force Majeure or
mechanical failure that prevents the supply of South River Water, the Borough
will provide AES with notice (written or oral) and will supply AES with Duhernal
Water or other water supply suitable for use by the Project in quantities up to
4.6 million (4,600,000) gallons per day. Duhernal Water shall be transported to
a suitable Point of Delivery within the boundaries of the Project by the
Sayreville Interconnection Number 2.

         (c) Actual acceptances of Untreated Water by AES may be less than the
maximum allowed, and actual usage will vary according to the electric dispatch
of the Project, weather conditions and electrical outages (forced or scheduled).
Title and risk of loss of Untreated Water shall pass to AES upon AES's receipt
of such Untreated Water at the Point of Delivery. Until such time as title to
Untreated Water passes to AES, the Borough shall bear risk of loss of and be
responsible for the Untreated Water.

         (d) The Borough shall have the right to substitute other Untreated
Water for South River Water or Duhernal Water for its own operating purposes. If
South River Water would otherwise be available in the event of a substitution,
then the South River Water Rate shall apply to all such Untreated Water. If
South River Water would otherwise not be available in the event of a
substitution, then the Duhernal Water Rate shall apply to all such Untreated
Water.

         (e) The Borough shall use reasonable efforts to comply with requests
by AES for Untreated Water in excess of the amounts specified in Section 2.1(a)
and 2.1(b) above ("EXCESS WATER") and any acceptances of Excess Water shall be
in accordance with the terms of this Agreement, including but not limited to
Section 2.2.

         (f) Solely for informational purposes, AES shall from time to time
notify the Borough of its anticipated Untreated Water needs and the Parties
shall work together in good faith to coordinate the timing of delivery of
Untreated Water in accordance with such notice and the other terms of this
Agreement. Subject to the requirements of applicable Governmental Approval and
prudent practice, the Borough shall use its best efforts to coordinate any
transmission of Untreated Water so as to maximize the quantity of Untreated
Water made available to AES with due regard to the timing of the Project's
Untreated Water requirements.

         SECTION 2.2  COMPENSATION.

         (a) As consideration for the Borough's agreement to supply AES with
Untreated Water, AES will pay the Borough, at the Project Financial Closing, one
hundred and fifty

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thousand dollars ($150,000) ("INITIAL PAYMENT"). Such amount will be a credit to
AES and will be used to offset the cost of water purchased during the Project's
start-up and testing phase and the first year of the Project's operation.

         (b) AES will pay the Borough monthly for all South River Water
delivered to the relevant Point of Delivery during the prior month. The base
rate for the South River Water supplied shall be two hundred and sixteen dollars
($216) per million gallons (the "South River Water Rate") which includes fifty
three dollars ($53) per million gallons to cover the Operations, Maintenance and
Administration costs (the "South River O&M Rate") and one hundred sixty three
dollars ($163) per million gallons to cover past infrastructure costs (the
"South River Past Infrastructure Rate").

         (c) The South River O&M Rate specified in Section 2.2(a) above is
stated as of April 1, 1999. During the Term such rate shall be subject to
escalation equal to the weighted average (based on number of customers)
percentage changes in water rates after April 1, 1999 that apply to all other
Borough water customers, or, if the parties so elect, any other mutually
agreeable escalation index.

         (d) AES will pay the Borough monthly for all Duhernal Water delivered
to the relevant Point of Delivery during the prior month. The base rate for
Duhernal aWter supplied shall be $932 per million gallons (the "Duhernal Water
Rate") which includes seven hundred eighty five dollars ($785) per million
gallons to cover the Operations, Maintenance and Administration costs (the
"Duhernal O&M Rate") and one hundred forty seven dollars ($147) per million
gallons to cover the acquisition costs (the "Duhernal Past Acquisition Rate").

         (e) The Duhernal O&M Rate specified in Section 2.2(e) above is stated
as of April 1, 1999. During the Term such rate shall be subject to escalation
equal to the weighted average (based on number of customers) percentage changes
in water rates after April 1, 1999 that apply to all other Borough water
customers, or, if the parties so elect, any other mutually agreeable escalation
index.

         (f) If the Borough incurs additional costs from Middlesex Water
Company as a result of the Borough providing AES with Duhernal Water, AES shall
be responsible for paying to the Borough any such additional costs. The Borough
shall provide reasonable evidence to AES that any such additional costs have
been incurred by the Borough.

         (g) All Treated Water supplied to the Project shall be at the
Borough's normal rates for such water.

         SECTION 2.3  MINIMUM BILL AMOUNT

         In respect of each Contract Year starting with the first Contract Year,
there shall be a "Minimum Bill Amount". The Minimum Bill Amount for each
Contract Year shall be three hundred thousand dollars ($300,000) per year with
one twelfth (1/12) of such amount paid each month (the "Minimum Monthly
Amount"), adjusted by the aggregate of the following:


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         (a) For the first Contract Year only, reduced by an amount equal to
the Initial Payment.

         (b) Reduced by an amount equal to the quantity of Untreated Water
which would have been delivered but for a service interruption by the Borough
times the South River Water Rate.

         (c) Starting with the eighth Contract Year and with six months prior
written notice, AES shall have the right to reduce the Minimum Bill Amount for
any Contract Year so long as the annual quantity to be provided by the Borough
is reduced by 5.11 million gallons for each one thousand dollar ($1000)
reduction in the Minimum Bill Amount. The maximum reduction of the Minimum Bill
Amount shall be limited to fifteen percent (15%) of the Minimum Bill Amount per
Contract Year until the commencement of the twentyfirst Contract Year at which
time there shall be no limit to the reduction.

         (d) Subject to availability from the Borough, AES shall have the right
to increase the Minimum Bill Amount for any Contract Year so long as the annual
quantity to be provided by the Borough is increased by 5.11 million gallons for
each one thousand dollar ($1000) increase in the Minimum Bill Amount.

         SECTION 2.4  SERVICE INTERRUPTIONS.

         Upon the event of a temporary interruption or curtailment in Untreated
Water delivery attributable to a break in the Infrastructure, the Borough and
AES shall discuss and agree the best way to make the repairs and restore full
service. If it is decided that the Borough shall make the repairs, then the
Borough shall have a reasonable period of time to make needed repairs and to
restore full service. The Borough shall provide a "SHORTFALL NOTICE" upon the
interruption or curtailment of Untreated Water under this Section. If the
Borough fails to restore full service within a reasonable period of time, the
following provisions shall apply:

         (a) AES has the right, but not the obligation, to contract with such
contractors as reasonably approved by the Borough from time to time to step in
and remedy the interruption or curtailment, with the good faith cooperation and
under the direction of the Borough engineer or other duly appointed official of
the Borough.

         (b) All reasonable costs associated with the taking of actions under
Section 2.4 will be borne by AES.


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                                  ARTICLE III

                      INFRASTRUCTURE AND REAL ESTATE RIGHTS

         SECTION 3.1  CONCERNING THE LAGOON WATER PIPELINE, LAGOON PUMPING
STATION AND SAYREVILLE INTERCONNECTION NUMBER 2.

         (a) The Borough shall be solely responsible for the design of the
Lagoon Water Pipeline, the Lagoon Pumping Station (which shall be capable of
pumping to both AES and the Borough's water treatment facilities) and the
Sayreville Interconnection Number 2, but its designs shall be consistent with
standard water system practice. As soon as is reasonably practical following the
execution of this Agreement and from time to time thereafter as is reasonably
necessary, the Parties shall meet to discuss the design of the Lagoon Water
Pipeline, the Lagoon Pumping Station and the Sayreville Interconnection Number
2. AES shall have the right to review and comment on the design of the Lagoon
Water Pipeline, the Lagoon Pumping Station and the Sayreville Interconnection
Number 2, and the Borough will consider in its final designs those comments that
are in accordance with prudent practice and applicable Government Approvals. AES
will pay the Borough, in advance and in accordance with Borough procedures, for
the reasonable cost and expenses of designing the Lagoon Water Pipeline, Lagoon
Pumping Station and the Sayreville Interconnection Number 2 (including
reasonable costs and expense of legal counsel and technical advisors approved by
AES in writing.)

         (b) The Borough shall be solely responsible for obtaining all
Government Approvals necessary in connection with the construction, siting,
ownership and operation of the Lagoon Water Pipeline, Lagoon Pumping Station and
Sayreville Interconnection Number 2. AES shall compensate the Borough for the
reasonable costs of obtaining the needed Government Approvals, (including
reasonable costs and expense of legal counsel and technical advisors approved by
AES in writing.)

         (c) The Borough and AES shall cooperate in good faith to obtain the
necessary Real Estate Rights for the construction, operation and maintenance of
the Lagoon Water Pipeline, the Lagoon Pumping Station and the Sayreville
Interconnection Number 2. If necessary, the Borough shall exercise its power of
eminent domain to obtain needed Real Estate Rights with all costs born by AES.

         (d) AES will be responsible for obtaining the Real Estate Rights and
for paying the costs of constructing and installing the Lagoon Water Pipeline,
Lagoon Pumping Station, and the Sayreville Interconnection Number 2 (including
where applicable the reasonable costs and expense of the Borough's legal counsel
and technical advisors). Those Real Estate Rights which the Borough owns or
controls shall be provided by the Borough at a nominal cost.

         (e) Upon the completion of the Lagoon Water Pipeline, the Lagoon
Pumping Station, and the Sayreville Interconnection Number 2, AES shall provide
the Borough with prompt written notice. Upon the Borough's receipt of written
notice, the Parties shall execute such agreements and documents as shall be
necessary to evidence the Borough's ownership of the

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Lagoon Water Pipeline, the Lagoon Pumping Station and the Sayreville
Interconnection Number 2. The Borough shall not be required to pay any
compensation in exchange for obtaining ownership of the Lagoon Water Pipeline,
Lagoon Pumping Station and the Sayreville Interconnection Number 2.

         (f) AES shall be responsible for selecting a reputable contractor for
the construction of the Lagoon Water Pipeline, Lagoon Pumping Station and
Sayreville Interconnection Number 2. Such contractor shall be experienced in the
construction of similar water facilities and shall be acceptable to the Borough
engineer (such acceptance not to be unreasonably withheld). All costs associated
with the construction and construction inspection of the Lagoon Water Pipeline,
Lagoon Pumping Station and Sayreville Interconnection Number 2 shall be borne by
AES.

         SECTION 3.2  OPERATION AND MAINTENANCE OF INFRASTRUCTURE.

         (a) The Borough shall operate and maintain all Infrastructure
necessary to supply South River Water and Duhernal Water up to the Project
boundary in a workmanlike manner, consistent with prudent practices and shall
continuously maintain the Infrastructure in good operating condition and in
compliance with all Governmental Approvals applicable to the Infrastructure.
Such operation and maintenance shall be accomplished in a manner so as to
minimize to the maximum extent practicable any disruption or interruption in the
services to be provided under this Agreement.

         (b) AES shall own and maintain, on its side of the Point or Points of
Delivery, metering equipment to measure the delivery of Untreated Water from
each source to the Point of Delivery and shall transmit a signal of the meter
measurements to the Borough SCADA system. The Borough will use the information
from this signal to compile a bill, and both the Borough and AES shall keep
records of the daily amount of Untreated Water delivered from each source to the
Point of Delivery in accordance with this Agreement. At least once every five
years, or more frequently if either Party reasonably requests, and with at least
one week prior written notice to the other Party, AES shall test the accuracy of
the metering equipment, at which time the Borough shall have the right to be
present. If such test indicates that the metering equipment is not measuring
accurately, AES shall recalibrate or replace the metering equipment and, if
appropriate, a billing adjustment shall be made.

         (c) The Borough shall own and maintain metering equipment to measure
the delivery of Untreated Water to the Point or Points of Delivery. The Borough
may elect to read the meters monthly to confirm the quantities of Untreated
Water supplied from each source. At least once every five years, or more
frequently if requested by either Party, and with at least one week prior
written notice to the other Party, the Borough shall test the accuracy of the
metering equipment, at which time AES shall have the right to be present. If
such test indicates that the metering equipment is not measuring accurately, the
Borough shall recalibrate or replace the metering equipment.

         (d) In addition to the amounts specified in the Section 2, AES shall
reimburse the Borough for the maintenance and replacement costs of the Lagoon
Water Pipeline, Sayreville Interconnection Number 2, and the Lagoon Pumping
Station that service AES. AES shall also

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reimburse the Borough for the cost of electricity consumed by the Lagoon Pumping
Station in providing water to AES, as measured by the electricity meters
included at the Lagoon Pumping Station. AES may elect to test the electricity
meters at its own expense with prior written notice to the Borough who shall
have the right to be present during the test. If such test indicates that the
metering equipment is not measuring accurately, the Borough shall request that
the utility company repair or replace such meters and make equitable billing
adjustments which, if made, shall be passed on to AES.

          SECTION 3.3  INFRASTRUCTURE STUDIES AND ADDITIONS

         (a) AES will pay for infrastructure studies, at actual cost subject to
a mutually agreed cap to assess the feasibility, cost, schedule and benefits of:

             (i) Installing a new pipeline from the existing South River
Pipeline to a point above the Duhernal dam; and

             (ii) Improving the existing South River intake structure to
increase South River Water withdrawal capability.

         (b) AES will have the right to choose to pay for the upgrades,
improvements, and/or new infrastructure identified in the infrastructure studies
(the "Upgrades"), in exchange for the right to enjoy the benefits allowed with
their implementation. If other users (other than the Borough using the Upgrades
for making Treated Water) benefit from any such Upgrades, then such other users
shall pay a pro rata portion, based on volume of water used, of the costs. Such
pro rata amount shall be used to pay for the Upgrades and reduce the amount AES
shall pay by an equivalent amount; or if the Upgrades have previously been paid
for by AES, the pro rata amount shall be paid to AES.

          SECTION 3.4  CAPITAL IMPROVEMENTS

         (a) In the event the Borough or AES reasonably determines that Capital
Improvements to the Infrastructure are required, such Party shall notify the
other Party and the Parties shall meet in good faith to determine the scope of
such Capital Improvements.

         (b) AES shall determine if it would be more cost effective or
expeditious for it or a contractor, as opposed to the Borough, to implement the
Capital Improvements agreed upon in accordance with Section 3.4(a).

         (c) In the event AES determines to implement the Capital Improvements
itself or through a contractor reasonably acceptable to the Borough, AES or such
contractor shall coordinate with the Borough in order to ensure the minimum
disruption of the Parties' activities. The Borough agrees to use its best
efforts to assist AES or such contractor in completing the Capital Improvements
and agrees to promptly execute such documents and instruments as may be
necessary or desirable to complete the Capital Improvements.


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         (d) In the event AES determines that it would be more cost effective
or expeditious for the Borough to implement the Capital Improvements, AES shall
give the Borough written notice to that effect. Upon receipt of such notice the
Borough shall use its best efforts to promptly implement the Capital
Improvements with the minimum disruption of the Parties' activities; PROVIDED,
that prior to implementing such Capital Improvements the Borough shall provide
to AES a budget and work plan (including timetable) for the implementation of
the Capital Improvements.

         (e) AES shall bear its own costs and expenses in connection with the
implementation of the Capital Improvements. In addition, AES shall reimburse the
Borough for its reasonable costs and expenses in connection with the
implementation of the Capital Improvements including all necessary inspections.

         (f) In the event that AES causes damage to the Capital Improvements or
Infrastructure while constructing, installing, operating, maintaining or
repairing the Project, AES shall restore or pay the Borough to restore, at the
Borough's election, the Capital Improvements or Infrastructure as nearly as
possible to its condition prior to such damage. The provisions of this Section
3.4(f) are subject to all applicable laws of the State of New Jersey (including
those that relate to municipality authorities).

                                   ARTICLE IV

                      ADDITIONAL OBLIGATIONS OF THE PARTIES

          SECTION 4.1  ADDITIONAL OBLIGATIONS OF THE BOROUGH.

          (a) At the earliest opportunity after the execution of this Agreement,
the Borough will use its best efforts to amend its existing permit, which limits
pumping from the Lagoons to one million (1,000,000) gallons per/day, or to
change or secure any other permit or approval necessary to allow it to meet its
obligations to supply Untreated Water under this Agreement. The Borough shall
keep AES informed of the status of the requested permit amendment and other
permit or approval related efforts.

         (b) Promptly upon obtaining knowledge thereof, the Borough shall
provide AES with oral notice (followed by prompt written confirmation) or
written notice of any violation of applicable Governmental Approvals relating to
the Borough's Facility.

         (c) Promptly after submission thereof to the applicable Governmental
Authority, the Borough shall provide AES with a copy of any report, filing,
notice, request for variance or similar document filed with or submitted to a
Governmental Authority that relates to the Borough's Facility.

          d) Not later than the fifteenth day of each month following the
commencement of delivery of Untreated Water or at such other time as required in
accordance with this Agreement, the Borough shall provide to AES a written
invoice specifying in reasonable detail (including the

                                       11


<PAGE>


method of calculation of any amounts invoiced) the amount claimed by the Borough
from AES in accordance with this Agreement. Undisputed amounts set forth in any
invoice shall be due and payable by AES not later than 30 days following receipt
of such invoice.

         (e) The Borough shall, upon prior written or oral request therefore,
provide AES, the Financing Parties and each of their respective agents and
representatives with escorted access during normal business hours to the
Borough's Facility, any infrastructure owned by the Borough and the other
property of the Borough as may be reasonably requested in connection with the
development, financing, construction, operation and maintenance of the Project.
The Borough shall, upon prior written or oral request therefore, provide AES,
the Financing Parties and each of their respective agents and representatives
with access during normal business hours to (and the right to reproduce) the
Borough's books and records (including books and records relating to
Governmental Approvals and compliance therewith) as may be reasonably necessary
in connection with the development, financing, construction, operation and
maintenance of the Project with all costs to be borne by AES.

         (f) Upon the reasonable request of AES, the Borough shall, at the cost
and expense of AES, execute such additional certificates, documents,
instruments, agreements and take such actions as may be reasonably required to
give effect to the terms and conditions of this Agreement.

         (g) The Borough shall use all reasonable efforts to secure, as soon as
possible, documentation from Middlesex Water Company that states that the
Borough will not incur additional charges as a result of the Borough providing
AES with Duhernal Water. If such documentation cannot be secured, the Borough
shall use all reasonable efforts to minimize incurring additional charges as a
result of the Borough providing AES with Duhernal Water.

         SECTION 4.2  ADDITIONAL OBLIGATIONS OF AES.

         (a) Promptly upon obtaining knowledge thereof, AES shall provide the
Borough with oral notice (followed by prompt written confirmation) written
notice of any violation by the Borough of applicable Governmental Approvals
relating to Untreated Water delivery by the Borough in accordance with this
Agreement.

         (b) Not later than the fifteenth day of each month following the
commencement of delivery of Untreated Water or at such other time as required in
accordance with this Agreement, AES shall provide to the Borough a written
invoice specifying in reasonable detail (including the method of calculation of
any amounts invoiced) the amount claimed by AES from the Borough in accordance
with this Agreement. Undisputed amounts set forth in any invoice shall be due
and payable by the Borough not later than 30 days following receipt of such
invoice.

         (c) Upon the reasonable request of the Borough, AES shall, at its cost
and expense, execute such additional certificates, documents, instruments,
agreements and take such actions as may be reasonably required to give effect to
the terms and conditions of this Agreement.


                                       12

<PAGE>

                                   ARTICLE V

                                  FORCE MAJEURE

         SECTION 5.1  FORCE MAJEURE.

         If either Party shall be unable to carry out any obligation under this
Agreement due to Force Majeure, this Agreement shall remain in effect, but such
obligation shall be suspended for the period necessary as a result of the Force
Majeure, PROVIDED, THAT:

         (a) the non-performing Party gives the other Party written notice not
later than forty-eight (48) hours after the occurrence of the Force Majeure
describing the particulars of the Force Majeure, including but not limited to
the nature of the occurrence and the expected duration of the disability, and
continues to furnish timely regular reports with respect thereto during the
period of Force Majeure and the disability;

         (b) the suspension of performance is of no greater scope and of no
longer duration than is required by the Force Majeure; and

         (c) the non-performing Party uses its best efforts to remedy its
inability to perform.

         Notwithstanding the foregoing, the settlement of strikes, lockouts, and
other labor disputes shall be entirely within the discretion of the affected
Party, and such Party shall not be required to settle any strike, lockout or
other labor dispute on terms which it deems inadvisable.

                                   ARTICLE VI

                                      TERM

         SECTION 6.1  TERM.

         (a) This Agreement shall take effect upon execution of the appropriate
counterpart by each Party and, except as provided in Section 6.1(b), Section
6.1(c) or Section 6.2 below, shall remain in effect for a period of thirty (30)
years (the "TERM"). Either Party may elect, to extend this Agreement for one (1)
or more five (5) year terms (but in no event may the Parties between them extend
the Agreement for more than a total of four (4)) successive five (5) year terms)
by providing written notice to that effect to the other Party not later than one
(1) month prior to the expiration of the then effective Term. All references in
this Agreement to the word "Term" shall mean the initial thirty (30) year Term
as extended by the Parties.

         (b) This Agreement may be terminated by AES in its sole discretion (i)
if AES is unable to obtain debt financing for the Project or (ii) if AES is
unable to obtain all permits, licenses, and approvals necessary to construct and
operate the Project. Termination under this Section 6.1(b) shall be effective
upon the Borough's receipt of notice to that effect.


                                       13


<PAGE>

         (c) Either Party may terminate this Agreement if AES has not delivered
a Commencement Notice on or prior to December 31, 2003. In the event a
Commencement Notice is delivered subsequent to December 31, 2003, but prior to
the delivery of written notice terminating this Agreement under this Section
6.1(c), this Section 6.1(c) shall become inapplicable.

         SECTION 6.2  EARLY TERMINATION FOR EVENT OF DEFAULT.

         (a) AES may terminate this Agreement (i) upon a Bankruptcy Event (as
such term is defined in Section 6.2 (c)) of the Borough or (ii) if the Borough
fails to perform or observe any of its material obligations under this Agreement
within the time contemplated by this Agreement and such failure continues for a
period of time greater than thirty (30) days from the Borough's receipt of
notice thereof; PROVIDED, that if the Borough is diligently pursuing a cure of
such failure and such failure is not capable of remedy within such thirty (30)
day period, such thirty (30) day period shall be extended to such period of time
as AES may agree in its sole discretion. For the avoidance of doubt, it is
understood that the failure to provide Untreated Water shall be grounds for
early termination under this Section; PROVIDED, that if the failure to provide
Untreated Water is excused due to the occurrence of Force Majeure, AES may only
terminate this Agreement if such Force Majeure continues for a period of time in
excess of 60 days whether or not such failure is excused by the occurrence of
such Force Majeure.

         (b) The Borough may terminate this Agreement (i) upon a Bankruptcy
Event of AES or (ii) if AES fails to perform or observe any of its material
obligations under this Agreement within the time contemplated by this Agreement
and such failure continues for a period of time greater than thirty (30) days
from the Borough's receipt of notice thereof; PROVIDED, that if AES is
diligently pursuing a cure of such failure and such failure is not capable of
remedy within such thirty (30) day period, such thirty (30) day period shall be
extended to such period of time as the Borough may agree in its sole discretion.
The foregoing notwithstanding, the Borough may not terminate this Agreement
without first giving the Financing Parties written notice of the Borough's
intention to terminate this Agreement and giving such Financing Parties an
additional reasonable period of time (but in any event not less than an
additional 90 days) to remedy the event giving rise to the right of the Borough
to terminate this Agreement. AES covenants and agrees to give written notice to
the Borough concerning the identities and contact information of the Financing
Parties from time to time and the Borough shall only be obligated to provide the
aforementioned notice to Financing Parties of which it has received notice.

         (c) For the purposes of this Agreement, Bankruptcy Event means, in
respect of any Person, (1) such Person shall (i) apply for or consent to the
appointment of, or the taking of possession by, a receiver, custodian, trustee
or liquidator of itself or of all or substantially all of its property, (ii)
admit in writing its inability, or be generally unable, to pay its debts as such
debts become due, (iii) make a general assignment of the benefit of its
creditors, (iv) commence a voluntary case under the Bankruptcy Code or any
similar or corresponding insolvency law, (v) file a petition seeking to take
advantage of any law relating to bankruptcy, insolvency, reorganization,
winding-up, or composition or readjustment of debts, (vi) fail to controvert in
a timely and appropriate manner, or acquiesce in writing to, any petition filed
against such Person

                                       14


<PAGE>

in an involuntary case under the Bankruptcy Code or any similar or corresponding
insolvency law, or (vii) take any other action for the purpose of effecting any
of the foregoing; or (2) a proceeding or case shall be commenced without the
application or consent of such Person in any court of competent jurisdiction,
seeking (i) its liquidation, reorganization, dissolution, winding-up, or the
composition or readjustment of debts, (ii) the appointment of a trustee,
receiver, custodian, liquidator or the like of such Person under any law
relating to bankruptcy, insolvency, reorganization, winding-up, or composition
or adjustment of debts, and such proceeding or case shall continue undismissed,
or any order, judgment or decree approving or ordering any of the foregoing
shall be entered and continue unstayed and in effect, for a period of 90 or more
consecutive days, or any order for relief against such Person shall be entered
in an involuntary case under the Bankruptcy Code or any similar or corresponding
insolvency law.

                                  ARTICLE VII

                                  MISCELLANEOUS

         SECTION 7.1  AMENDMENT, ETC.

         No amendment or waiver of any provision of this Agreement shall be
effective unless in writing and signed or consented to by the Parties and then
such waiver shall be effective only in the specific instance and for the
specific purpose for which given.

         SECTION 7.2  ASSIGNMENT.

         Neither Party may assign this Agreement without the prior written
consent of the other Party; PROVIDED, HOWEVER, that AES may assign this
Agreement to the Financing Parties without the prior written consent of the
Borough.

         SECTION 7.3  COOPERATION IN FINANCING.

         The Borough agrees to cooperate from time to time with AES and the
Financing Parties in connection with the financing of the Project. In
furtherance thereof, the Borough agrees to enter into such consents to
assignments or other agreements as AES or the Financing Parties may reasonably
request and the Borough agrees to provide such certificates from its officers
and such opinions of counsel (which may be outside counsel) as AES or the
Financing Parties may reasonably request. AES agrees to reimburse the Borough
for any costs and expenses reasonably incurred by the Borough in complying with
its obligations under this Section 7.3, including the reasonable fees and
expenses of counsel to the Borough.

         SECTION 7.4  NOTICES, ETC..

         All notices and other communications provided for hereunder shall be in
writing (including by telecopier) and shall be mailed, telecopied or delivered,
if to AES, to it at The AES Corporation, 1001 North 19th Street, Arlington,
Virginia 22209 Attention: Project Manager; if to the Borough, to it at 167 Main
Street, Sayreville, NJ 08872 Attention: Borough Clerk, as to each

                                       15


<PAGE>

Party, to it at such other address or telecopier number as designated by such
Party in a written notice to the other Parties. All such notices and
communications shall be deemed received, (a) if personally delivered, upon
delivery, (b) if sent by first class mail, on the third business day following
deposit into the mails and (c) if sent by telecopier, upon acknowledgment of
receipt thereof by the recipient.

         SECTION 7.5  INFORMATION SHARING

         The Parties agree to keep each other informed of activities (their own
or others), notices, or information related to the Water Supply Agreement.

         SECTION 7.6  COOPERATION RELATED TO THE WATER SUPPLY AGREEMENT

         The Parties agree to cooperate with each other, and with each other's
agents or representatives in all matter related to the Water Supply Agreement.

         SECTION 7.7  SEVERABILITY.

         Any provision of this Agreement that is prohibited, unenforceable or
not authorized in any jurisdiction shall, as to such jurisdiction, be
ineffective to the extent of such prohibition, unenforceability or
nonauthorization without invalidating the remaining provisions of this Agreement
or affecting the validity, enforceability or authorization of such provision in
any other jurisdiction.

         SECTION 7.8  BINDING EFFECT.

         This Agreement shall be binding upon and inure to the benefit of the
Parties and their respective successors and permitted assigns.

         SECTION 7.9  GOVERNING LAW.

         This agreement shall be governed by, and construed in accordance with,
the laws of the state of New Jersey without reference to the conflict of law
principles thereof.

         SECTION 7.10  HEADINGS.

         The section and subsection headings used herein have been inserted for
convenience of reference only and do not constitute matters to be considered in
interpreting this Agreement.

         SECTION 7.11  EXECUTION IN COUNTERPARTS.

         This Agreement may be executed in any number of counterparts and by
different Parties hereto in separate counterparts, each of which when so
executed shall be deemed to be an original and all of which taken together shall
constitute one and the same agreement.

                                       16


<PAGE>

         SECTION 7.12  WAIVER OF JURY TRIAL.

         The parties hereby knowingly, voluntarily and intentionally waive the
right each may have to a trial by jury in respect of any litigation based
hereon, or arising out of, under or in connection with this agreement and any
agreements contemplated hereby to be executed in conjunction therewith, or any
course of conduct, course of dealing, statements (whether oral or written) or
actions of each party. This provision is a material inducement for the parties
entering into this agreement.

                                  ARTICLE VIII

                  REPRESENTATION AND WARRANTIES OF THE PARTIES

         SECTION 8.1  REPRESENTATIONS AND WARRANTIES OF THE BOROUGH.

         The Borough hereby represents and warrants to and for the benefit of
AES as follows:

         (a) ORGANIZATION AND QUALIFICATION. The Borough (i) is a governmental
body, duly organized and validly existing under the laws of the State of New
Jersey, with full right, power and authority under its organizational documents
and under the laws of the State of New Jersey to enter into this Agreement, to
perform its obligations hereunder and to consummate the transactions
contemplated hereby, and (ii) has the power to carry on its business as now
being conducted and as proposed to be conducted.

         (b) AUTHORIZATION AND ENFORCEABILITY. The Borough has taken all
necessary action to authorize the transactions contemplated by this Agreement.
This Agreement has been duly executed and delivered by the Borough and
constitutes the legal, valid and binding obligation of the Borough enforceable
in accordance with its terms, except as the enforceability thereof may be
limited by (i) bankruptcy, insolvency, reorganization or other similar laws
affecting the enforcement of creditors' rights generally and (ii) general
equitable principles regardless of whether the issue of enforceability is
considered in a proceeding in equity or at law.

         (c) NO CONFLICT. Neither the execution and delivery of this Agreement
nor compliance with any of the terms and provisions hereof (i) contravenes any
Governmental Approval applicable to the Borough or any of its respective
properties or other assets, (ii) conflicts with, breaches or contravenes the
provisions of the organizational documents of the Borough or any contractual
obligation of the Borough, or (iii) results in the creation or imposition of any
lien upon any of the property or assets of the Borough under, or in a condition
or event that constitutes (or that, upon notice or lapse of time or both, would
constitute) an event of default under any contractual obligation of the Borough.

         (d) GOVERNMENTAL APPROVALS. No Governmental Approval is required
(other than those which have previously been obtained and are in full force and
effect) to authorize, or is required in connection with the execution and
delivery of this Agreement by the Borough.


                                       17


<PAGE>

         SECTION 8.2  REPRESENTATIONS AND WARRANTIES OF AES.

         AES hereby represents and warrants to and for the benefit of the
Borough as follows:

         (a) ORGANIZATION AND QUALIFICATION. AES (i) is a limited liability
company, duly organized and validly existing under the laws of the state of
Delaware with full right, power and authority under its organizational documents
and under the laws of the state of Delaware to enter into this Agreement, to
perform its obligations hereunder and to consummate the transactions
contemplated hereby, and (ii) has the power to carry on its business as now
being conducted and as proposed to be conducted.

         (b) AUTHORIZATION AND ENFORCEABILITY. AES has taken all necessary
action to authorize the transactions contemplated by this Agreement. This
Agreement has been duly executed and delivered by AES and constitutes the legal,
valid and binding obligation of AES enforceable in accordance with its terms,
except as the enforceability thereof may be limited by (i) bankruptcy,
insolvency, reorganization or other similar laws affecting the enforcement of
creditors' rights generally and (ii) general equitable principles regardless of
whether the issue of enforceability is considered in a proceeding in equity or
at law.

         (c) NO CONFLICT. Neither the execution and delivery of this Agreement
nor compliance with any of the terms and provisions hereof (i) contravenes any
Governmental Approval applicable to AES or any of its respective properties or
other assets, (ii) conflicts with, breaches or contravenes the provisions of the
organizational documents of AES or any contractual obligation of AES, or (iii)
results in the creation or imposition of any lien upon any of the property or
assets of AES under, or in a condition or event that constitutes (or that, upon
notice or lapse of time or both, would constitute) an event of default under any
contractual obligation of AES.

         (d) GOVERNMENTAL APPROVALS. No Governmental Approval is required
(other than those which have previously been obtained and are in full force and
effect) to authorize, or is required in connection with the execution and
delivery of this Agreement by AES.

                                       18


<PAGE>



         IN WITNESS HEREOF, the Parties hereto have each caused this Agreement
to be executed by their duly authorized officers and attested on the date first
above written.

                                            AES RED OAK, L.L.C.


Attest:


By:  /s/ Bart R. Rossi                    By:  /s/ Charles B. Falter
     --------------------------------          --------------------------------
     Name:  Bart R. Rossi                      Name:  Charles B. Falter
     Title: Vice President                     Title: Vice President



                                            BOUROUGH OF SAYREVILLE


Attest:


By:  /s/ Gladys R. Rzepka                 By:  /s/ James L. Zagata
     --------------------------------          --------------------------------
     Name: Gladys R. Rzepka                    Name:  James L. Zagata
     Title:  Municipal Clerk                   Title: Mayor