Explain to me why Fred shouldn't exterminate his species, or tell me that he should.

The extortion aspect isn't essential. Fred could have been manipulated by true claims about making simulated people super happy.

I don't know what it means for a person to be simulated. I don't know if the simulated people have consciousness. Are we talking about people whose existence feels as real to themselves as it would to us? This is NOT an assumption I ever make about simulations, but should I consider it so for the sake of the argument?

• If their experience doesn't feel real to themselves, then obviously there isn't any reason to care about what makes them happy or unhappy, that would be Fred being confused, as he conflates the experience of real people with the fundamentally different simulated people.
• If their internal experience is as real as ours, then obviously it wouldn't be the extermination of Fred's species, some of his species would survive in the simulations, if in eternal captivity.

He should or shouldn't exterminate his flesh-and-blood species based on whether his utility function assigns a higher value to a free (and aliive) humanity, than to a trillion of individual sentients being happy.

On my part, I'd choose for a free and alive humanity still. But that's an issue that depends on what terminal values we each have.