Electricity Uncertainties model

1. Electricity Uncertainties model User Guide – v1.1 November 2011

2. Overview of the risk and uncertainty model • The risk and uncertainty model allows users to examine the effects of various types of cost uncertainties and uncertainty mechanisms on National Grid’s expected rate of return for both: • TPCR4 type control and • RIIO-T1 type control • The model is a simplification of the tool which was used to support the July 2011 RIIO-T1 business plan submission and is fully documented in the “Managing Risk and Uncertainty” annex to the business plan which can be found on the Talking Networks website. • It uses Monte Carlo simulation techniques and has been re-written so that no additional proprietary product or licences other than a copy of Microsoft Excel is needed. • All the workings are shown. Users can therefore change the model but National Grid is not able to provide full support for the code in the model. • Additionally, whilst every effort has been made to fully test the model, given the timescales, National Grid cannot provide guarantees for the code in the model.

3. Probability distributions for each of the uncertainties Including specific management actions Input simultated values into two Price controls: TPCR4 RIIO-T1 with associated parameters, such as: Gearing Number of years Incentive rate Simulation output gives: Δ load-related capex Δ non-load related capex Δ opex Δ outputs Monte Carlo simulation Uncertainty mechanisms Produces summary statistics of the following outputs (on Results sheet): Internal Rate of Return (IRR) Return on Equity (ROE) Overview of the risk and uncertainty model (2) The following provides a high-level overview of the logic followed within the model:

4. Model simplifications # Note that within Excel 2003 there is a limit on the number of elements which can be processed by some matrix worksheet functions, therefore if ‘correlations’ is selected, a maximum of 455 can be performed. There is no such limit in Excel 2007 • In order to produce a model for which proprietary software is not required, it has been necessary to make a number of simplifications • Maximum number of iterations [#] • This can restrict the accuracy of the results and make it more difficult to assess the impact of lower materiality uncertainty mechanisms (i.e. their effect is lower than the error margin of the result) • Restricted number of uncertainty mechanisms • We have restricted the modelled uncertainty mechanisms to one for each uncertainty

5. Model simplifications (2) • Restricted modelling of probabilistic distributions • We have restricted the modelling of uncertainties to only Normal and LogNormal distributions only • If stakeholders are interested in exploring particular issues not covered by this simplified model, please contact us, and we will endeavour to adapt the model accordingly

6. Model features • The model has been constructed to examine the following types of cost uncertainties: • Undergrounding • Wider works [three boundaries only – B6, NW3, EC5] • Generation connections • Offshore network • Design standards • Network renewal volumes • Demand-related infrastructure • Real price effects • Critical National Infrastructure • Flooding • The model shows the impact of each of these on the distribution of the pre-tax return on equity and internal rate of return (IRR) for both the TPCR4 type control and the RIIO-T1 price control. • Each uncertainty can be investigated in turn or any combination of uncertainties can be modelled.

7. Model features (2) The Control data block includes: • Number of simulations to be run* • Tick-boxes to enable the effects of the various uncertainties and their associated uncertainty mechanisms to be modelled • Radio-button to enable the uncertainties to be correlated (or not) • Radio-button to enable the output from each run of the simulation to be written to the Output worksheet (or not) • Tick-box to enable the default parameters to be restored (these are held on the Input Data worksheet) * As previously noted, the maximum number of simulations in Excel 2003 is 780. There is no such limit in Excel 2007. • The model contains a number of worksheets which allow Users to control how the spreadsheet is run • A convention of dark blue cells has been used to show which cells Users should change. • The Control worksheet is where Users can select the data to be used. • The worksheet is made up of a number of blocks which are described below:

8. Model features (3) • Regulatory gearing (i.e. the ratio of debt to (debt plus equity)) • Control length (number of years for the price control modelled – max of 8 years) • Base Depr life (number of years over which assets are depreciated) • RIIO Incentive rate (totex efficiency rate – exposure to under/over spend) • RIIO Capitalisation rate (totex proportion treated as “slow money” and added to RAV with remainder treated as “fast money” and expensed in year of spend) • TPCR4 Incentive rate (capex incentive rate used in TPCR4 period) • TPCR4 CoD (cost of debt) • TPCR4 CxIncRA wacc (weighted average cost of capital used in TPCR4 capex incentive) • TPCR4 CxIncRA depr (depreciation life assumption in TPCR4 capex incentive) • TPCR4 CoE (cost of equity) • The Price Control parameters data block includes:

9. Model features (4) The Uncertainties parameters data block includes: • Type of distribution to be modelled for each uncertainty (model currently uses either Normal or LogNormal distributions (selectable via drop-down boxes)) • Parameters for the distributions to be simulated for each of the Uncertainties over the 8 years of the price control period (if control length is set lower than 8 (say 5) then only those in the first 5 years are used) • if LogNormally distributed variables are required, the parameters of the underlying Normal distribution should be provided. • in order to achieve this, a converter block has been added onto the sheet • input the Normal variable parameters in the blue boxes and then input the resultant equivalent LogNormal parameters from the yellow boxes in the Uncertainties block

10. Model features (5) • Some of the uncertainties have been modelled as the product of two distributions (volume * cost) and hence separate distributions have been specified for the cost element • These are included within the Uncertainty cost parameters data block as: • Type of distribution to be modelled for each cost uncertainty in 2009/10 prices (model currently uses either Normal or LogNormal distributions (selectable via drop-down boxes)) where applicable • Parameters for the cost distributions to be simulated for each of the relevant Uncertainties over the 8 years of the price control period (if control length is set lower than 8 (say 5) then only those in the first 5 years are used)

11. Model features (6) • The Correlations data block includes: • the correlation matrix between the various uncertainties being modelled • note that if this is amended, it must be a valid correlation matrix (i.e. a square matrix that is positive definite or positive semi-definite)

12. Model results • The Results worksheet shows the results of the simulation: • The first block summarises the input data (i.e. the cost uncertainties) • The second block provides the results on the IRR and Return on Equity under the: • TPCR4 type control • RIIO-T1 type control

13. Model results (2) • The results are also shown graphically:

14. Model results (3) • The results are also shown graphically:

15. Other worksheets • If the Output raw simulation data button is selected, the model will write the individual simulation run data to the Simulated Data worksheet • This can be used to check through the modelling results in more detail • The NGET Forms of Control worksheet contains the price control calculations for the TPCR4 and RIIO-T1 type controls • This should not need to be amended by Users • The Uncertainties and Mechanisms worksheet contains the data which produces the simulation output to feed into the NGET Forms of Control worksheet • This should not need to be amended by Users • The Input Data worksheet contains the parameters to feed into the Uncertainties and Mechanisms worksheet • This should not be changed by Users (and the area which contains the data as supplied has been protected)

16. Getting started • Open the spreadsheet in Microsoft Excel • (2003 & 2007 editions tested but others should work) • Enable macros to run when prompted (old Excel versions) or by using “options” in security warning banner at top of sheet (new Excel versions) • The spreadsheet should open on the Control worksheet (dark blue tab) • Select the parameters required (as discussed above) then press the “Start Simulation” button: • The spreadsheet reports progress in the Status bar at the bottom of the screen • The spreadsheet will take around 25 seconds to process 1000 simulations • When finished, the results are written to the Results worksheet (green tab).

17. Help • If you need help running the model or using any of its facilities please contact: • Hêdd Roberts on 01926 6554385 or mailto:hedd.roberts@uk.ngrid.com • Elaine Calvert on 01926 654574 or mailto:elaine.b.calvert@uk.ngrid.com