The Treatment of “Spare / Sterilised” Capacity – follow up

1. The Treatment of “Spare / Sterilised” Capacity – follow up Draft for discussion purposes only

2. Licence Obligations • Ofgem decision to modify Licence – 5th Sept direction • SpC C8D paragraph 10 provides obligations with respect to Entry Capacity Substitution • Ofgem direction (5th Sept) • NG required to prepare and submit for approval by the Authority an Entry Capacity Substitution Methodology Statement by 19th May 2008 • NG required to use reasonable endeavours to have an approved Entry Capacity Methodology Substitution Statement by 2nd June 2008 • NG required to use reasonable endeavours to substitute capacity from 2nd June 2008 • As part of Section 38A notice, reconfirmed the 10% held back for shorter term and commitment to keep the limit under review

3. High Level Review of Responses to Informal Consultation Summary • 7 responses received • Preference to hold back more than 10% • As stated Ofgem position clarified in Section 38A notice therefore, issue not considered further by NG at this stage for general auctions • However, for substitution the 10% rule may not be applicable • No clear consensus on preferred option for substitutions / transfer & trades – support for Options 1 through to 5. • All responses available on Joint Office website • Next slides consider substitution option 2 in detail and the variant elements of options 3 & 4 • Our intention is to review Transfer and Trade comments as part of enduring solution workshops

4. Range Of Substitution Options: Recap • Option 1: The Fast & Furious • triggered at QSEC (implemented Sept 08) • applicable from Y+2 • all available capacity subject to substitution • no NPV test • no limit on exchange rates • Option 5: Driving Miss Daisy • undertaken every 5 years as part of TPCR following consulted upon Ofgem methodology

5. Range Of Options • Option 2: • triggered at QSEC (implemented Sept 08) • applicable from Y+2 • all available capacity subject to substitution • lower NPV test • limit on exchange rates Option 1: The Fast & Furious Option 5: Driving Miss Daisy

6. Expansion of Option 2: • When? • Triggered at QSEC (implemented Sept 08) • Earliest obligated capacity release date – April 2010 • Default incremental capacity release date – April 2012 • New ASEPs • Separate auctions for specific new ASEPs • possible to benefit from substitution before existing ASEPs (through auction in June – Sept 08). Is this acceptable / discriminatory? • What? • Capacity available to be substituted • All unsold obligated capacity at any ASEP except the [10%] held over to other auctions • Capacity must not be sold for any quarter after that considered for substitution • But what limits should be placed on “one quarter” bookings? (See subsequent slides).

7. Expansion of Option 2 (continued): Consider the one quarter issue Obligated level ASEP A Booked capacity Capacity

8. Expansion of Option 2 (continued): Consider the one quarter issue Obligated level ASEP A Booked capacity Capacity Requested capacity ASEP B Booked capacity Obligated level

9. Expansion of Option 2 (continued): Consider the one quarter issue NB – Substitutions may not be at 1:1 exchange rate. Diagram is intended to indicate process not absolute values. ASEP A Period 2 Period 1 Capacity No issue with substitution Potential substitution ASEP B

10. Expansion of Option 2 (continued): Consider the one quarter issue Period 2 Period 1 ASEP A Sterilised capacity? Revised obligated level (applies from period 2) Capacity Potential substitution Revised obligated level (applies from period 2) ASEP B • For Period 1 should NG: • Invest for capacity at ASEP A or ASEP B (is this economic?); or • Substitute capacity and be remunerated for increased Buy-Back risk (risk also to Users of non-availability of capacity) • Reject the substitution • Substitution could be time limited as for transfers (current Licence does not allow). • Solution still required for the single quarter. • Prohibit / limit single quarter booking, e.g. set a minimum booking.

11. Expansion of Option 2 (continued): • Exchange Rates • In previous consultation general consensus to limit • Set to avoid excessive capacity destruction – views? • Exchange rate of 2:1 is a halving of capacity – is this excessive? • NPV Test • Existing NPV test to guarantee incremental capacity release • Lower NPV test for substitution; does not guarantee release of capacity • Suggested minimum qualifying bid: • 4 quarters within 2 consecutive years • With bid price for all 4 quarters at incremental price step

12. Expansion of Option 2 (continued): • Allocation • 1st - Bids for obligated capacity – released in full. • 2nd – Incremental capacity requests meeting existing NPV test – release in full, substitute where possible. • 3rd – Incremental capacity requests meeting lower NPV test – release only if substitution opportunities remain after above 2 stages • Bids ranked according to % of NPV, i.e. bid value vs. estimated project value • Full bid assessed, not parts • Unless full bid allocation, no incremental allocation made

13. Range Of Options • Option 3: • Capacity substitution • triggered at QSEC (implemented Sept 08) • applicable from Y+2 • only certain capacity subject to substitution • lower NPV test • limit on exchange rates Option 5: Driving Miss Daisy Option 1: The Fast & Furious

14. Only certain capacity available for substitution(from last time) • The key issue seems to be to define “sterilised / spare” capacity. This could be based just on long term bookings or alternative metrics could be considered. • For example where there is a degree of long term bookings and short term usage the capacity should not be substituted away as this would not be “sterilised / spare” capacity e.g.: • If there are bookings in 2 quarters for four consecutive years at 50% of the existing baseline and flows during the last year have been 90% of the baseline no capacity will be substituted away.

15. Responses • Generally there appeared to be support for consideration of such an approach • But no concrete ideas forthcoming • At the meeting however it was suggested that it should not be “all or nothing” a sliding scale was proposed • It would be intended that this would sterilise this capacity from substitution for the whole auction period • Initial attempt at this ….

16. Sliding scale on capacity available for substitution Baseline 100 90% Capacity available for substitution 50% 25% 0% 50% booking for 4 Quarters in consecutive years from y+2 Historic (last year) utilisation 50% 75% booking for 4 Quarters in consecutive years from y+2 Historic (last year) utilisation 75% No long term bookings 90% booked for QSEC period

17. Further developed… • Maximum capacity available for substitutions = [90%] of obligated level – this is term “A” • This is reduced by two factors: • Factor 1: booked capacity as a percentage of obligated level - term “B”, with booked capacity defined as the 4th highest booked level (quarter) measured over any 2 consecutive years from Y+2 to Y[+17]; • Factor 2: Historical usage term C as a percentage of obligated level, historical usage defined as peak flow in the preceding 2 years – only applies if C > B. • Capacity available for substitution term D: • D= Obligated level * (A – B – (C-B)/2) (to be rounded down to nearest 10% increment)

18. Range Of Options • Option 4: • triggered at QSEC (implemented Sept 08) • applicable from Y+4 • only certain capacity subject to substitution • same NPV test as for incremental • limit on exchange rates Option 1: The Fast & Furious Option 5: Driving Miss Daisy

19. Summary • We will now produce a report detailing the work undertaken in the 3 workshops and the comments we have received • This should be available in the next 2 weeks • As part of this we will also review and update the proposed timeline