Advanced Capacity Agreement Planning Updates and Financial Commitment Discussion

1. Planning and Advanced Reservation of Capacity Agreement TX issues workgroup – 31st January 2013

2. Proposed Agenda • Update on outstanding workgroup NG actions • PARCA Funding arrangements • Options we have considered and proposed way forward • Financial commitment • Revenue driver approach • PARCA scenarios • Focus on interactive projects and scenarios around this • “Flip chart” session • Outstanding issues update and clarification

3. Update on Actions TX issues workgroup – 31st January 2013

4. Action TR0801: Provide worked examples of the PARCA approach under differing scenarios. • We aim to cover this in the scenario interactive session • Focus on interactive projects and “what if” scenarios around this, for example: • Investment needed for both, one or none • one project terminates • Substitution etc

5. Action TR0903: Produce an expanded document to clearly demonstrate the need for change • Our ambition is to raise the UNC modification by April 2013 • Potential system impacts (if any) need to be understood and we are engaged with xoserve on this • The UNC modification will be the first step in developing the expanded document and justification for the PARCA approach over currently discounted options • The expanded document will also include and justify: • Licence changes – incentive arrangements, lead times, revenue driver triggers • Charging impacts • methodology statement changes

6. Action TR1201: Indicative pipeline specs/multiparty use Complex even with simplifying assumptions but as an indicative guide: There are numerous other factors to be considered in applying this; two examples: Increased diameter vs. increased length In most cases additional capability is provided through pipeline duplication and a larger increment is provided through increasing the length of the duplication rather than the diameter Use of compression Development of existing compressor station may not trigger Planning Act process; ‘switchover’ point between pipeline and compression solution (e.g. between single / multi party) may be critical For more information please refer to the Transmission Planning Code (NG website) Specifically section 9 describes the factors considered when planning network reinforcement 6

7. Action TR1202: Interactive Offers (electricity) • Interactivity is assessed where 2+ customers submit applications for their connection offers (CUSC 3 month timeframe) at the same time, for the same geographical area • Where the connections are deemed ‘interactive’, NGET will inform the customers – the offers will be drafted as such; • First customer to sign its offer will be progressed as per its requirements • Second customer may resubmit its application but likely to be connected on a different timescale • For PARCA interactive question: National Grid would progress both PARCAs where the customers have signed i.e. not adopt the electricity interactive offer approach

8. Action TR1204: Planning Consents • Town & Country Planning Act 1990 • Section 91 provides a default time limit of three years – or as agreed • May be extended but subject to conditions • Electricity Act Section 36 (S36) (Power Stations) • Consent is 3 years (default) – or as agreed • May be extended on request - but subject to conditions and not perpetually • Planning Act 2008 (as amended) • Consent (Prescribed Period) is 5 years • Failure to commence development within this prescribed period will lead to the DCO ceasing to have effect

9. PARCA - Funding for Capacity made available through the PARCA process TX issues workgroup – 31st January 2013

10. Purpose of these slides • Alongside the PARCA UNC mod, we will propose incremental capacity funding arrangements to include in our licence • The Planning Act drives more cost earlier in our processes than before so existing funding arrangements are no longer appropriate • These proposals were largely contained in our RIIO-T1 business plan but have not been included in FPs to avoid pre-judging a commercial solution • These slides detail options that we have considered (and our proposed way forward) on how to recover allowed revenue • Considering appropriate financial commitment alongside the reservation of capacity through PARCA • We would welcome your thoughts and discussion on these slides and are happy to also discuss in more detail as necessary at an NTS Charging Methodology Forum 10

11. Some points for awareness • The ‘Totex’ approach and ‘Totex Incentive Mechanism’ have been set by Ofgem for the whole 8 year price control under FPs • We are proposing three distinct funding mechanisms (see slide 6) within the PARCA process • The majority of these mechanisms incorporate the use of the Generic Revenue Driver Methodology (GRDM) • The GRDM is dependent on a pre-agreed unit cost library, which is currently under discussion with Ofgem • There is currently no defined process for the timelines and responsibilities for setting revenue drivers – this is currently under discussion with Ofgem • Draft Licence conditions have been expanded to include tables relating to baseline, substituted and legacy capacity • Therefore more frequent licence modifications are likely going forward, which may affect Revenue Driver timelines 11

12. Principles • Some key principles we have considered when looking at funding options are: • There should be some element of financial commitment associated with reserving capacity through the PARCA • Funding arrangements should not form a barrier to entry • If the PARCA is terminated prior to capacity being delivered, any costs that have been levied on the wider industry should be reimbursed 12

13. Our funding proposals (for a project requiring National Planning) Schedule 1a Schedule 4 (National Planning only) Schedule 0 Schedule 1b NTS Investment: Project Needs Case / Technical Options NTS Reinforcement required National Planning Project Customer Information Provision Strategic Options Assessment PARCA Stage Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 X Pre Capacity Allocation RD calculated by end of Schedule 1a Pre Capacity Allocation RD triggered and profiled over 4 years X Post Capacity Allocation RD triggered and profiled over 3 years X Post Capacity Allocation RD calculated during Stage 3 (EIA) of Schedule 4 X Post Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. Standard UNC Security commitments apply to User following allocation of capacity No Financial commitment under PARCA Schedule 0 Pre Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. PARCA Signatory securitises value of RD All costs charged to PARCA Signatory Classified as 100% Excluded Services – no impact on Allowed Revenue Invoiced up front and reconciled Pre Capacity Revenue Driver runs up to DCO Funding / Charging 13 *Value of RD’s are reconciled with actual costs, reconciliations through Transportation charges.

14. PARCA Schedule 1a Schedule 1a Schedule 4 (National Planning only) Schedule 0 Schedule 1b NTS Investment: Project Needs Case / Technical Options NTS Reinforcement required National Planning Project Customer Information Provision Strategic Options Assessment PARCA Stage Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 X Pre Capacity Allocation RD calculated by end of Schedule 1a Pre Capacity Allocation RD triggered and profiled over 4 years X Post Capacity Allocation RD triggered and profiled over 3 years X Post Capacity Allocation RD calculated during Stage 3 (EIA) of Schedule 4 X Post Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. Standard UNC Security commitments apply to User following allocation of capacity No Financial commitment under PARCA Schedule 0 Pre Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. PARCA Signatory securitises value of RD All costs charged to PARCA Signatory Classified as 100% Excluded Services – no impact on Allowed Revenue Invoiced up front and reconciled Pre Capacity Revenue Driver runs up to DCO Funding / Charging *Value of RD’s are reconciled with actual costs, reconciliations through Transportation charges.

15. PARCA Schedule 1a (determine project need case) • We propose that: • Schedule 1a of the PARCA is fully funded by the PARCA signatory • The PARCA signatory pays the estimated cost of schedule 1a upfront • We expect this will cost around £120k - £150k per application based on estimated effort and man-power costs (today’s prices) • This will be reconciled (cost compared to estimate and the PARCA signatory invoiced or refunded) when schedule 1a is complete and the output delivered • We propose that this is treated as excluded services under the licence (this means it does not pass through allowed revenue as per costs for the connection process): • Allows for the cost to be fully funded by the PARCA signatory • PARCA signatory receives defined output providing information on NTS implications without signing up to whole PARCA at start • Potentially reduces speculative applications 15

16. From Schedule 1b up to point of capacity allocation Schedule 1a Schedule 4 (National Planning only) Schedule 0 Schedule 1b NTS Investment: Project Needs Case / Technical Options NTS Reinforcement required National Planning Project Customer Information Provision Strategic Options Assessment PARCA Stage Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 X Pre Capacity Allocation RD calculated by end of Schedule 1a Pre Capacity Allocation RD triggered and profiled over 4 years X Post Capacity Allocation RD triggered and profiled over 3 years X Post Capacity Allocation RD calculated during Stage 3 (EIA) of Schedule 4 X Post Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. Standard UNC Security commitments apply to User following allocation of capacity No Financial commitment under PARCA Schedule 0 Pre Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. PARCA Signatory securitises value of RD All costs charged to PARCA Signatory Classified as 100% Excluded Services – no impact on Allowed Revenue Invoiced up front and reconciled Pre Capacity Revenue Driver runs up to DCO Funding / Charging 16 *Value of RD’s are reconciled with actual costs, reconciliations through Transportation charges.

17. From Schedule 1b up to point of capacity allocation • Funded by a pre capacity allocation revenue driver • Process for calculation will be included in the Generic Revenue Driver Methodology for transparency • Calculated by the end of schedule 1a and triggered when the PARCA signatory confirms that they wish to proceed to schedule 1b • The project’s capacity requirement and location will be entered into the transportation model to produce a project cost • The revenue driver will be equal to 17% of the estimated project cost calculated by the transportation model, phased across 4 years • 2% in Year N, 5% in Year N+1, 5% in Year N+2 and 5% in Year N+3, where N is the formula year in which the PARCA signatory confirms they wish to proceed to schedule 1b • Security requirements will match the Revenue Driver phasing • Covers all planning and development activities up to the point of capacity allocation 17

18. Pre Capacity Allocation Revenue Driver – Revenue recovery options • Pre Capacity Allocation revenue driver will adjust overall allowed revenues that are recovered through Transportation charges • Considerations in relation to funding / charging arrangements are: • Charges should not be disproportionate, i.e. should not form a barrier to entry • Transportation charges can not currently be recovered from non-UNC signatories • PARCAs can be signed by non-UNC signatories • We have considered three potential options • The following pros and cons provide the background to these 18

19. Pre Capacity Allocation Revenue Driver – Revenue recovery options

20. Pre Capacity Allocation Revenue Driver – Revenue recovery options • Based on the Pros and Cons our preferred option is Option 3: • 0% PARCA signatory funded, 100% in Transportation charges • PARCA signatory securitises full profile of Revenue Driver and pays all costs (and committed spend) should the PARCA be terminated • Comments / thoughts on this as an approach?

21. Pre Capacity Allocation Revenue Driver – revenue recovery proposal • National Grid will notify Ofgem when a pre allocation revenue driver has been triggered to allow it to be included in the next run of the annual iteration model. • Adjusts allowed revenue from the following April (which could mean that the first two years’ allowance is recovered together) • The allowed revenue is collected from Users through charges • The PARCA signatory is required to provide security to cover the revenue driver amount • Where the PARCA is terminated the PARCA signatory will be invoiced for the costs incurred and committed spend (covered by their security if required) in order to refund Users’ charges 21

22. Example 1 – pre capacity allocation revenue driver calculation • Using information provided by the PARCA signatory, the required capacity level and location is fed into Transportation model • Transportation model calculates total project cost (£100m in this example) • 17% of this (e.g. £17m) would be fed into our allowed revenue (via Ofgem model), phased over four years • According to the totex framework 10% of the £17m would be recovered as fast money in the year of expenditure and 90% as slow money. • Slow money is funded via the Regulated Asset Base (through depreciation and allowed return) – which together are used to calculate the allowed revenue for each year • The allowed revenue is recovered from Users through charges • The PARCA signatory is required to securitise the allowed revenue, it will ramp up in line with the revenue driver phasing (but not necessarily expenditure) • Actual expenditure will be compared to allowances and any under or over spend passed through the totex incentive mechanism • shared with users 2 years post expenditure (once the RIIO sharing factor of 44.36% has been applied to under or over spend) 22

23. Example 1 – what would this mean for allowed revenue and security requirements? 45 years 23

24. Example 1 – Transportation Charging Impact for the industry All Entry and Exit Charges have been rounded to 4 d.p’s

25. PARCA Termination Between schedule 1b and the capacity allocation, the PARCA can be terminated In this situation, the PARCA signatory will be invoiced for the costs incurred (which will be covered by the security if required) and a one off credit made to the industry (though a reduction in allowed revenue for that year) Depreciation and return on the previous allowed revenue will continue to be funded through charges but will have been offset by the one off credit 25

26. Example 2 – pre capacity allocation revenue driver where the PARCA is terminated • In this example, the same calculation is utilised in example 1 • Transportation model calculates total project cost of £100m, for example • 17% of this (£17m) would be fed into our allowed revenue (via Ofgem model), phased over four years • 10% of the £17m would be recovered as fast money in the year of expenditure and 90% as slow money, funded via the Regulated Asset Base (through depreciation and allowed return) – which together are used to calculate the allowed revenue for each year • But in this example the PARCA is terminated Year N+1 • When the agreement is terminated the PARCA signatory is invoiced for the expenditure that has already been incurred, which is then reimbursed to the industry 26

27. PARCA Termination credit Start with TO Allowed Revenue for year Deductions taken off (DN Pensions and NTS Metering) Termination credit also taken off (refunds to industry should any PARCA be terminated between Schedule 1a and Capacity Allocation) There is a split 50/50 of residual revenues between Entry and Exit Charges, both a mixture of Capacity and Commodity charges that, together, aim to recover the allowed revenues for any given financial year TO Allowed Revenue TO Charges DN Pensions Deficit & NTS Metering & PARCA Termination Credits Entry Capacity Exit Flat Capacity Entry Commodity(when a revenue shortfall from capacity auctions is forecast) Exit Commodity

28. Example 2 – what would this mean for industry and the PARCA Signatory? 45 years PARCA terminated at the end of year N+1 PARCA Signatory invoiced for costs incurred which, assuming expenditure = allowances, is £7m 28

29. Example 2 – what would this mean for industry and the PARCA Signatory? 45 years PARCA terminated at the end of year N+1 PARCA Signatory invoiced for costs incurred which, assuming expenditure = allowances, is £7m Amount that PARCA Signatory has paid is returned to industry by reducing allowed revenue by £7m Future depreciation and return is adjusted 29

30. Example 2 – Transportation Charging Impact for the industry All Entry and Exit Charges have been rounded to 4 d.p’s

31. Post capacity allocation Schedule 1a Schedule 4 (National Planning only) Schedule 0 Schedule 1b NTS Investment: Project Needs Case / Technical Options NTS Reinforcement required National Planning Project Customer Information Provision Strategic Options Assessment PARCA Stage Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 X Pre Capacity Allocation RD calculated by end of Schedule 1a Pre Capacity Allocation RD triggered and profiled over 4 years X Post Capacity Allocation RD triggered and profiled over 3 years X Post Capacity Allocation RD calculated during Stage 3 (EIA) of Schedule 4 X Post Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. Standard UNC Security commitments apply to User following allocation of capacity No Financial commitment under PARCA Schedule 0 Pre Capacity Allocation Revenue Driver triggered RD* added to Allowed Revenue and charged to industry via Transportation Charges. PARCA Signatory securitises value of RD All costs charged to PARCA Signatory Classified as 100% Excluded Services – no impact on Allowed Revenue Invoiced up front and reconciled Pre Capacity Revenue Driver runs up to DCO Funding / Charging 31 *Value of RD’s are reconciled with actual costs, reconciliations through Transportation charges.

32. Post capacity allocation– revenue driver calculation Covers all activity following the formal capacity allocation e.g. construction works Will calculate the cost required to reinforce the network as per the Generic Revenue Driver Methodology, with reference to a pre agreed unit cost library Any works already funded through the pre capacity allocation revenue driver will be discounted from the calculation Calculated no later than Stage 3, Schedule 4 (EIA study and pipeline design) The allowed revenue will be phased 42% in T-1, 55% in T and 3% in T+1 where T is the formula year during which capacity is delivered As the GRDM is consulted upon, there will be no need to consult on methodology employed to calculate the project specific revenue driver. Inclusion in the licence will be subject to the normal s23 statutory consultation 32

33. Post capacity allocation – revenue driver collection • Triggered upon formal capacity allocation to a User (i.e. PARCA signatory or User nominated by the PARCA signatory) • The allowed revenue is collected from Users through charges • Once Capacity is invoiced, collected revenue increases hence reducing industry impact • UNC credit rules will apply to the capacity allocation • Once the capacity is allocated this can not be cancelled – as per existing UNC capacity allocation provisions 33

34. Example 3 – post allocation revenue driver • Post allocation revenue driver: • Using information provided by PARCA signatory, the generic revenue driver methodology is used to calculate a project cost - in this example £100m, which would be phased over three years • Any works that have already been funded in relation to pre capacity allocation activities (such as planning) will be discounted • e.g. £17m, leaving a revenue driver of £83m • According to the totex approach 10% of this would be recovered as fast money in the year of expenditure and 90% as slow money funded via the Regulated Asset Base (through depreciation and allowed return) – which together are used to calculate the allowed revenue for each year • The allowed revenue is recovered from Users through charges • No requirement to securitise this through the PARCA as a formal capacity signal will have been provided by this point meaning that UNC credit rules apply 34

35. Example 3 – what would this mean for allowed revenue? 45 years 35

36. Example 3 – Transportation Charging Impact for the industry *Whilst these changes show the impact the revenue change would have, the actual charges would take account of the User now paying Capacity charges 36 All Entry and Exit Charges have been rounded to 4 d.p’s

37. Example 4 – totex incentive mechanism The totex incentive mechanism (TIM) has been mentioned a number of times in these slides It is the mechanism included in Ofgem’s Final Proposals to true up allowed revenues during the RIIO-T1 period In year T-1 Ofgem will assess National Grid’s expenditure against its allowances in year T-2 Allowed revenue will be adjusted in year T to account for any over or under spend in year T-2 National Grid will be exposed to 44.36% of any over or under spend and the remainder will be recovered through allowed revenue 37

38. Example 4 – what would this mean? 38

39. Planning and Advanced Reservation of Capacity Agreement- “What if” scenarios TX issues workgroup – 31st January 2013

40. Planning and Advanced Reservation of Capacity Agreement- Update on outstanding Issues TX issues workgroup – 31st January 2013

41. Update on outstanding issues • Aim: to propose a way forward today on the current outstanding actions and issues • Develop business rules and the UNC modification as appropriate • Our ambition is to formally raise the Cap/Con UNC modification (for subsequent workgroup development) by April 2013 • We need to consider system impacts (if any) e.g. is existing functionality fit for purpose.

42. Outstanding Issues: Fine tuning of Capacity within the PARCA • Fine tuning should be permitted • The fine tuning range is provided by the PARCA signatory • upon agreement of the PARCA • Demo info will need to detail the customers project design margins/uncertainty and provide rationale for them • As part of stage 1a, NGG inform the PARCA signatory of whether the range can be accommodated. • Where it can not be accommodated, NG provide a revised range at the earliest opportunity within stage 1a. • The PARCA signatory can review and adjust their initial capacity requirement within the permitted range • Prior to the progression of each PARCA stage and up to the point of capacity allocation • subject to demonstration information being provided

43. Outstanding Issues: Fine tuning of Capacity within the PARCA (2) • National Grid NTS have opportunity, through the PARCA lifecycle, to revise the permitted range and communicate why the revision is required. • supply/demand assumptions could change • other capacity signals may manifest etc • may provide additional or reduced scope for further refinement • may be opportunity for the PARCA signatory to refine the range • Several scenarios may need to be considered with respect to fine tuning impacts on unsold capacity at the point or donor points (substitution) • If a PARCA can be met entirely through unsold or substitution, any fine tuning increase to capacity requirements from that initially reserved could be booked through the auction/application processes?

44. Outstanding issues: PARCA Window and Ad-hoc PARCA processes We believe the following was considered by the workgroup to be an appropriate way forward: • PARCA window is not required. • National Grid NTS should be aware of imminent projects that could be interactive • National Grid NTS will publish pertinent information to industry to inform views • This premise also encourages potential projects to engage with National Grid NTS at the earliest opportunity. • PARCA triggered Ad-hoc Exit process - not required. • Existing ad-hoc provisions are sufficient combined with clearly defined NG publishing obligations • PARCA Ad-hoc Entry process • Retain in business rules to allow Entry users the opportunity to book unsold capacity outside of the March QSEC • does not limit when an Entry PARCA can be progressed. i.e. it does not necessarily have to be linked to the March QSEC process.

45. Outstanding Issues: Does the solution need to comply with EU Capacity codes? Agreed way forward: • Incremental EU rules in their infancy • Cap/Conn – seeking implementation by April 2014, ahead of currently anticipated CAM, CMP and incremental implementation timeframes • PARCA solution should be progressed to include EU IPs • EU IP arrangements may need to change upon EU code implementation

46. Outstanding Issues: What scope should there be to amend the capacity delivery date? Agreed way forward: • Applies to both National Grid NTS and the PARCA signatory • National Grid NTS commit to an indicative capacity delivery date post stage 1a • subject to the terms and conditions of the PARCA e.g. planning consent may not be granted, demo info not provided etc. • As the project progresses, there may be scope to bring the date forward e.g. acceleration of planning activities or finessing of options • Only where valued & requested must consider the impact on other Users

47. Outstanding Issues: What scope should there be to amend the capacity delivery date? (2) • NG NTS cannot, by default, extend indicative delivery timescales unless agreed to by the PARCA signatory (subject to the PARCA terms and conditions e.g. has planning consent been granted). • Constraint management principles apply where National Grid NTS do not deliver to the indicative delivery date (subject to the PARCA Terms and conditions) • We believe this commitment is necessary to provide increased certainty and value to our customers • PARCA signatory agrees to the capacity delivery date and formal capacity allocation date post stage 1a of the PARCA • The failure to provide demonstration information should not provide for undue delay to the capacity delivery date • Capacity delivery date should initially take into account the potential for demo info not being provided by the first, second or third demo date.