Review Group 291- Ofgem Update

1. Review Group 291- Ofgem Update 21 June 2010

2. Contents • Objectives of cashout and linepack • Issues • Background to SLC27 • Rationale behind current fixed differential • Linepack: Interactions with Third Package • European Framework guidelines on gas balancing

3. Objectives of cash out and linepack • Imbalance charges should • provide the incentive to balance • be reflective of costs incurred • be placed on those who cause costs • Consultees feel that NGG should be incentivised to minimise impact on market • In particular consultees would like the linepack measure (LM) to be removed (i.e. remove the incentive to keep linepack at a specific level) • Ofgem is also concerned that LM limits use of linepack as a balancing tool

4. Issues • If SO avoids taking balancing actions by using linepack, costs may be misallocated between days (as was the situation prior to 2001) • Ofgem has approved some changes e.g. approving the introduction of a deadband in the LM • To remove the LM altogether we would need confidence costs would not be misallocated between days • In other words we would need confidence that an appropriate value of linepack was reflected in the arrangements • This could be achieved through: • an appropriate default cash out price • possibly a linepack product/trading scheme

5. Background to SLC 27 • NGG agreed to explore further a linepack trading scheme during 2009/10 • In setting the SO incentives we considered that NGG had made insufficient progress to date • Given this and the objective of moving to longer term schemes Ofgem felt it necessary to require NGG to explore these issues further

6. Further background to SLC 27 • Improvements in shippers’ balancing performance have been observed • Investments in new infrastructure have been delivered • Ofgem considered 433 to be an interim solution and has consistently stated that the fixed differential is not an appropriate long term solution for targeting costs (433 workstream and decision letter, 2004 electricity and gas cashout review) • Project Discovery identified a period of tight supplies and a large investment requirement in the face of new challenges • Necessary to ensure costs are appropriately targeted in order that supply security is maintained • There may be potential to link a differential to a linepack product that can provide a more appropriate price for flexibility

7. Rationale behind current fixed differential • Fixed differential follows principle that Shippers who balance their positions should be better off than those who do not. • Uses the price of Hornsea injection/ withdrawal as a proxy for the value of flexibility in the system in the absence of appropriate value of linepack. • Hornsea chosen as this was the most obvious storage flexibility price that could be used to go long or short on a difficult day. It was argued that LNG was more used for peak shaving and transmission support and Rough more for large volumes of gas taken over a sustained period. • Network Code modification 433 workstream

8. Linepack: Interactions with Third Package • Compliance with the Third Package will be an important characteristic of any linepack product • Potential products need to be further developed before a conclusive assessment is possible or appropriate • A question was raised at the last meeting as to whether NGG in offering a linepack product would be categorised as a Storage System Operator (SSO) • Our preliminary view is that NGG would not be an SSO as the definition of “linepack” in Article 2 and the wording of Articles 33 and 41 of the Gas Directive distinguish between linepack providers and SSOs

9. European Framework guidelines on gas balancing • ERGEG working on gas balancing guidelines until ACER is operational in March 2011 • The earliest we’ll see a network code is 2012 • Draft Framework Guidelines for consultation in summer will contain proposals for harmonisation • Given different stages of market development unlikely that all balancing rules will be harmonised - the approach will be to define a target model • On linepack there are different experiences across Member States

11. Alternatives proposed since 433 Network Code Modification Proposals 606 and 607 • 0606- “Reform of the cash out arrangements and the inclusion of costs of OM gas used for end of day balancing using a stack process” • 607- “Changes to the cash out arrangements where Transco defines OM gas usage for end of day balancing purposes” • Both proposals were rejected because of concerns over introducing non market-related costs into cash out prices and the appropriateness of increasingly determining cash out prices via fixed price differentials. • However, Ofgem considered that in principle the inclusion of OM gas could make the regime more cost effective

12. Framework Guidelines development process Source: Discussion paper on Third package guidelines and codes http://ec.europa.eu/energy/gas_electricity/forum_gas_madrid_en.htm