Gas emergency cash-out Ofgem perspective

1. Gas emergency cash-outOfgem perspective Transmission Workstream - 3 July 2008

2. Decision on Modification 149/149A • Mod UNC149A accepted on 19 October 2007 and implemented on 1 November 2007 • In its decision letter, Ofgem stated preference in principle for dynamic cash-out approach (Mod UNC149) but expressed concerns with possible unintended consequences (and lack of analysis to allay these concerns) • Our main concern was the possibility of price spiralling and resulting credit issues for shippers • Decision letter flagged other possible approaches: • Expanded role for SO in a Gas Deficit Emergency (GDE): • Ability to buy gas • Arrangements with other SOs • Pricing curtailed firm volumes into cash-out to establish link between SO actions and cash-out price thus mitigating the risk of price spiralling (and gaming)

3. Ofgem perspective on Grid’s proposal: OCM Physical • Ofgem is supportive in principle of the concept of dynamic pricing to create the correct signals during a GDE to attract non-UKCS gas and instigate interruption • Restricting cash-out price calculation to OCM Physical only trades as proposed by Grid may partially address the risk of price spiralling • However the question of whether prices could spiral beyond the economic value of the gas to end consumers still needs to be addressed

4. The heart of the issue Global LNG market Continental markets Norwegian producers • Under a GDE the UK effectively becomes a single trading entity competing for gas in the global market • How can it do that with a fixed ‘bid’ price? UK market 2 basic approaches Approach 1 A single entity acts on behalf of the entire market in securing gas supplies e.g. NGG Approach 2 Market arrangements signal the price that the UK is willing to pay for additional gas

5. Approach 1: NGG responsible for sourcing gas in an emergency • This would require a very different role for the NEC/NGG • Options available to it: • Placing bids on OCM • Bilateral agreements with other SOs • Council Directive 2004/67/EC on gas security of supply: “Bilateral agreements between Member States could be one of the means to contribute to the achievement of the minimum security of supply standards” • Would require new set of guidelines outlining at what price to continue buying versus shedding firm load from different categories of firm customers • Recognise interaction with E3C Downstream Emergency Plan initiative

6. Approach 2: Dynamic cash-out pricing • Would avoid major change to NEC’s role • Provides the necessary price signals • However, the solution needs to recognise that: • NEC is intervening on the demand side but with no price exposure once we hit Stage 3 of a GDE • Hence the fundamental market interaction between the supply and demand side changes

7. Supply/demand interaction under dynamic pricing Demand Supply Demand Supply P P Domestics/ SME Firm I&C Interruptibles Interruptibles V V Stage 3 NEC starts firm load shedding –> demand curve truncated -> prices could spiral? Stage 2 Price set by interaction between supply side and interruptible demand

8. Key questions that need to be addressed under dynamic pricing • How does the demand and supply side interact during a GDE? • How is gas that is made available through interruption of firm customers sold back to the market? And how does this influence the emergency cash-out price? • On the day the GDE is called • Subsequent days • Could ‘NDM shippers’ profit from high cash-out prices by selling their domestic customers’ gas back to the market following public appeals to reduce demand or during Stage 4? • Would the compensation arrangements provide the correct incentives on shippers to source gas to reconnect their firm customers following interruption? • Are there arguments for freezing the price or adopting a ‘replacement’ price during Stage 4 of an emergency?

9. Which approach? • Ofgem has an open mind as to which is the more appropriate approach • However, we recognise the (increasing) seriousness of this issue and are hoping for a quick resolution • For that reason, any proposal that is brought forward should contain as much information and analysis as possible to enable Ofgem to make an informed decision