Entry Capacity Substitution

1. Entry Capacity Substitution Transmission Workstream – 6th August 2009

2. Agenda • Current Status • Methodology Statement: overview. • Charging Proposal. • Methodology Statement: retainers. • UNC Modification Proposal.

3. Current Status • Three simultaneous processes with consultations aligned to complete prior to Ofgem Impact Assessment. • Methodology Statement. • Consultation started 24th July; closes 24th August. • Submission to Authority for approval 7th September. • Charging Consultation. • Consultation (draft) started 28th July; • Formal consultation starts 11th August; closes 14th September. • UNC Modification Proposal. • Propose submission to UNC mod panel following discussion today. • Mod Panel meeting 20th August 2009.

4. Methodology Statement: Overview Transmission Workstream – 6th August 2009

5. Proposed Entry Capacity Substitution Methodology • National Grid is proposing a methodology that uses “retainers” to limit the exposure of ASEPs to substitution. • Based on the “Option Approach” discussed at workshops. • Retainer considered to better describe the role of the new product. • Avoids confusion with existing Option products. • National Grid believes that this approach is a good compromise between the two extremes of the Mechanical Approach and the Two-Stage Auction. • Requires User Commitment • Relies on Shippers’ assessment of needs not National Grid judgement. • Relatively simple to implement.

6. “Retainer” Approach • A retainer will prevent capacity at an ASEP from being substituted to a different ASEP in response to an incremental signal elsewhere. • The retainer requires a signal and commitment from Shippers. • The retainer • does not give rights to the Shipper to use the capacity covered by the retainer; • does not give the Shipper first option to buy the capacity; but • it would keep the capacity at the relevant ASEP.

7. What is the Retainer? • It is proposed that the retainer: • identifies and excludes capacity from substitution processes thereby protecting capacity for the duration of the retainer; • is placed ahead of QSEC and applies for 12 months, • i.e. covers (normally) one QSEC and any ad-hoc QSECs before the next retainer window. • will be subject to a one-off NTS Entry Capacity Retention Charge. This will be a fixed price per unit of capacity and will be the same for all ASEPs. • for the purposes of defining refunds the retainer nominally applies in respect of the 12 months commencing Oct Y+4, i.e. from the default 42 month lead-time; • will still prevent capacity being substituted away if the incremental capacity is allocated earlier or later than the default lead time; • The retainer will not: • prevent other Shippers (or the relevant Shipper) buying capacity at that ASEP in the period covered by the retainer; • be sold in quantities above the quantity available in QSEC (usually 90% baseline – sold); • be available to non-Users. However, extending the process to non-Users could be an option to be considered for 2011. • The Retention charge will be discussed on later slides

8. Capacity Available for Substitution at Donor ASEPs A key factor in the substitution process is to identify the amount of capacity available at donor ASEPs that can be substituted. The retainer reduces the available quantity. Capacity. 90 % of baseline capacity. (May be higher if incremental capacity has previously been released). Available capacity for substitution Sold capacity Time Retained quantity 42 months Default capacity release lead-time at recipient ASEPs

9. Substitution Methodology – Associated Issues • National Grid is proposing an exchange rate cap of 3:1 • This is significantly lower than the cap applied to Transfer and Trades. • With Shippers having an opportunity through the use of retainers to protect capacity is an additional constraint on substitution by way of any exchange rate cap appropriate? • Partial substitutions will be progressed • Where appropriate incremental capacity will be met through a combination of investment and substitution. • Entry Zones are proposed to be used for selecting potential donor ASEPs. • Within zone, donor ASEPs would be selected on the basis of best exchange rate. Out of zone, donor ASEPs would be selected on the basis of shortest pipeline distance from the recipient ASEP. • Network Analysis will be undertaken to determine substitution opportunities. • Analysis will be consistent with the Transmission Planning Code and hence assessment undertaken to determine investment requirements.

10. Charging Consultation - NTS GCM 18 • The retainer requires a signal and commitment from Shippers. • The charging consultation NTS GCM 18 will • determine the NTS Entry Capacity Retention Charge and • ensure any revenue streams appropriately offset other NTS transportation charges • The Licence requires that the charging methodology 1. Reflects the cost incurred 2. Takes account of developments within the transportation business, and 3. Facilitates effective competition between gas shippers and between gas suppliers

11. Determination of Commitment Method A - 1 • To determine a cost reflective charge National Grid has estimated the avoided costs of entry capacity substitution. • If incremental capacity is released in a QSEC auction this results in incremental revenue and a cost to industry. • Substitution avoids this cost. • The potentially avoided cost has been estimated from the average of the capitalised revenue drivers from the two ASEPs where capacity has been released during the present price control. • Have only considered the potential SO allowed revenue over 5 years which is the minimum value. • Capital investment would result in TO allowed revenue for a further 40 years • Dividing by the maximum substitutable quantity gives a unit Retention Charge Rate (p/kWh)

12. Determination of Commitment Method A - 2

13. Determination of Commitment Method A - Issues • This calculation would result in an initial rate for the NTS Entry Capacity retention charge of £175,111 for each mscm/d of capacity retained. • This calculation • has used a forward projection of historic costs and as such is not strictly reflective of the costs incurred; • requires a probability of whether incremental capacity would indeed be signalled and whether it could be met by substitution; and • The avoided costs assume all substitutable capacity is retained. If only half is retained substitution could still occur.

14. Determination of Commitment Method B • So National Grid has considered an alternative approach which would comply with the other relevant conditions. - takes account of developments within the transportation business; and - facilitates effective competition between gas shippers and between gas suppliers.

15. National Grid’s Proposal (Draft) • National Grid’s proposal (draft) • Methodology B is recommended, which uses the minimal capacity charge rate of 0.0001p/kWh/day applying over 32 quarters. • This results in a Retention Charge for retaining 10mscm at an ASEP of £321,200. • This should provide suitable encouragement to purchase a retainer whilst providing an appropriate level of commitment to the industry. • Any revenue streams relating to retention charges would be treated as TO revenue and adjustments to the TO commodity charge would result as necessary.

16. Summary The Retainer Approach protects capacity, but only to the extent that it is genuinely needed, as demonstrated by Shippers taking out Retainers. • A commitment is required from Shippers but this may be much lower than buying the capacity. • National Grid is proposing that retainer charges are refundable if the capacity is bought in later QSEC/AMSEC auctions. The Retainer Approach allows and encourages Shippers to identify and protect their needs. The amount of protected capacity is determined by Shipper actions not National Grid assumptions.

17. Methodology Statement: Retainers Transmission Workstream – 6th August 2009

18. The Retainer Window • It is proposed that: • The Retainer Window will be open for 2 “bid days” from 8am to 5pm; • There will be one day between the bid days; • Retainer requests will not be visible within the bid window but those granted shall be published before 7pm on the bid day; • This will consist of relevant ASEP and quantity. • The same data on retainers granted will be included in the QSEC invitation letter. • Retainers will be requested via fax. A pro-forma will be developed. • Any retainers requested cannot be removed or amended except where the request submitted is identified by National Grid as blatantly erroneous and is rejected. • National Grid will accept no liability in respect of erroneous applications, but will endeavour to resolve errors within the bid day. Those not resolved or rejected by 5pm will be accepted as submitted. • Any pro-rating due to retainers exceeding available capacity will be carried out at the end of each bid day. • The Retainer Window will be run in January (see timeline). • Avoid clash with AMSEC in February.

19. Retainer Approach: Timeline for 2010 QSEC Mid Jan Retainer Window. 2 days plus 1 day between Early June Ad hoc invoice for retainers as required (and refunds in future years) Mid Nov 2 month notice of charges* Mid Mar QSEC Mid Feb QSEC invitation letter Mid Dec Invitation letter for retainers issued Feb AMSEC 4 tranches with 2 days between Apr / May Bids Allocated - 2 months – as defined in UNC section B 2.6.7 7 Dec Approval of Methodology Statement Charging Proposals and UNC Mod Proposal N Grid Analysis N Grid Governance Ofgem Governance Mid Jan Notice of QSEC charges Precise dates for QSEC auction to be confirmed * Notice conditional upon approval of charging proposals

20. Retainers: QSEC Capacity Allocation • Allocations in the year a retainer is taken out:- • Unprotected capacity will be allocated first, then the retained capacity will be allocated • The maximum quantity of capacity at the relevant ASEP is retained and therefore not substituted.

21. QSEC Capacity Allocation - In the year a retainer is taken out Post-auction allocations Pre-auction capacity Unprotected capacity will be allocated first, Capacity Baseline capacity then capacity under Retainer. Withheld from QSEC Withheld from QSEC 90% baseline Retained Quantity Retained Quantity New Sold Capacity Refund triggered Unsold Capacity “Unprotected” New Sold Capacity “Unprotected” Sold Capacity Existing Sold Capacity

22. Retainers: QSEC Capacity Allocation • Allocations in subsequent auctions for refund allocation • Retained capacity will be allocated first, then unprotected will be allocated • Therefore the maximum quantity of retained capacity at the relevant ASEP is allocated in order to trigger a refund.

23. QSEC Capacity Allocation - In terms of calculating refunds Allocations in subsequent auctions Post-auction capacity in year Retainer applies (Oct 2013 – Sept 2014) Retained capacity will be allocated first, then unprotected and withheld capacity. Capacity Baseline capacity Withheld from QSEC Withheld from QSEC 90% baseline Retained Quantity “Unprotected” Unsold Capacity Retained Quantity Capacity sold in 2011 Refund triggered “Unprotected” Capacity sold in 2010 Existing Sold Capacity Capacity sold pre-2010

24. Retainers: QSEC Capacity Allocation…Effect of Permits • Substitution opportunities are assessed from a 42 month default lead time • Except for when an incremental signal is received and accepted earlier than the default. • e.g. for March 2010 QSEC, allocations from July 2013. • Substitutable capacity is calculated as the smallest unsold/un-retained quantity from the permit start date • For delaying permits, or requests for incremental capacity later than 42 months, substitutable capacity is still determined post-42 months. • Hence permits should not increase the quantity of capacity substituted from a donor ASEP.

25. retained capacity allocated (all Shippers) retained capacity (all Shippers) Shipper A retained capacity retained capacity (all Shippers) Retainers: Refunds • Refunds are triggered solely by the allocation of capacity in the period 42-54 months forward from QSEC when the retainer is taken out and will be paid after the final opportunity to obtain capacity, within the QSEC and AMSEC auctions, for this period has passed. • Applies regardless of which Shipper is allocated capacity – need for capacity proven. • Full allocation of capacity = full refund. • Extent of refund is triggered by extent of allocated capacity, not the price for allocated capacity. Price of capacity and retainer charge are not related. • Refunds will be pro-rated if not fully allocated. • Refunds will be pro-rated if more than one Shipper has relevant retainers, and the capacity is not fully allocated, irrespective of individual Shipper allocations. • Refunds will be determined on the basis of the quarters (or months) of maximum capacity allocation before and after the auction. This identifies the maximum quantity of retained capacity that is subsequently allocated. See later slide. For each ASEP, refunds will be allocated, according to the formula; e.g. for Shipper A * * Retainer fee (all Shippers)

26. Retainer Fee Refunds Refund if capacity obtained for any month in this period Retainer taken QSEC auction Period covered by Retainer • For a retainer taken out in 2010 a refund may only be triggered by capacity allocation for Q4 2013 to Q3 2014 made pursuant to a QSEC or AMSEC auction. • Why limit to QSEC / AMSEC? • Reserve price applies to these auctions so capacity retained cannot be obtained for zero cost. • Does not apply to RMTTSEC due to interaction with Transfer and Trades. • Why limit to Q4 2013 to Q3 2014? • Default date for release of incremental capacity and hence substitution. • To use a longer period would increase the duration over which retainers need to be tracked and more interacting auctions would need to be considered.

27. Retainer Fee Refunds Refund if capacity obtained for any month in this period Option taken QSEC auction Period covered by Option Period covered by QSEC 11 QSEC 11 Period covered by QSEC 12 QSEC 12 • When can a refund be triggered? • Whenever capacity is allocated for Q4 2013 to Q3 2104 in a QSEC / AMSEC • Hence, can only be in QSEC March 2011 or March 2012; or • AMSEC February 2013 or February 2014. • NB 2014 AMSEC can only allocate capacity for Q2/Q3 2014. Period covered by AMSEC 13 AMSEC 13 Period covered by AMSEC 14 AMSEC 14

28. Refunds - example E.g. Retainer taken in 2010. Applicable period for refunds is Q4 2013 to Q3 2014. The refund will be determined from peak sold level after auction minus peak sold level before auction (capped at retained quantity). Capacity Baseline capacity Withheld from QSEC Withheld from QSEC Withheld from QSEC Withheld from QSEC 90% baseline “Unprotected” “Unprotected” “Unprotected” “Unprotected” Shipper commitment Retained Quantity Retained Quantity Retained Quantity X Retained Quantity Capacity up to 2010* Peak sold before auction Capacity up to 2010* Capacity up to 2010* Capacity up to 2010* Q4 2013 Q1 2014 Q2 2014 Q3 2014 * And including QSEC 2010

29. Refunds - example E.g. Retainer taken in 2010. Allocations made in QSEC 2011 or later. The refund will be determined from peak sold level after auction minus peak sold level before auction (capped at retained quantity): Y - X Capacity Baseline capacity Withheld from QSEC Withheld from QSEC Withheld from QSEC Withheld from QSEC 90% baseline “Unprotected” “Unprotected” “Unprotected” “Unprotected” Retained Quantity Retained Quantity Actual Shipper booking Y Capacity sold 2011 Capacity sold 2011 Retained Quantity X Capacity sold 2011 Retained Quantity Capacity up to 2010* Peak sold after auction Capacity sold 2011 Capacity up to 2010* Capacity up to 2010* Capacity up to 2010* Q4 2013 Q1 2014 Q2 2014 Q3 2014 * And including QSEC 2010

30. UNC Modification Proposal Transmission Workstream – 6th August 2009

31. UNC Modification Proposal • What does the proposal do? • The proposed entry capacity substitution methodology will introduce a new charge: the “NTS Entry Capacity Retention Charge”. • The proposed UNC modification will create the new charge within UNC. • Why do we need a modification to UNC? • The Retention Charge is a Transportation Charge “in respect of transportation arrangements under the Code” – UNC TPD Section B1.7.1(a)(i). Hence to enable National Grid to invoice for the charges they need to be defined in UNC. • Defining the charge as a Transportation Charge enables treatment of retainer charge revenues within the appropriate transportation revenue streams.

32. UNC Modification Proposal: Relevant Objectives • How does the proposal better facilitate the achievement of the Relevant Objectives? • Standard Special condition A11 (c) • Promotes the efficient discharge National Grid’s Licence obligations by facilitating the introduction of entry capacity substitution as required by Special Condition C8D paragraph 10 • Standard Special condition A11 (a) • Promotes efficient and economic operation of the pipeline system by facilitating the introduction of entry capacity substitution thus reducing the need for investment to meet the demand for incremental entry capacity. • Standard Special condition A11 (f) • Promotes efficiency in implementation of UNC as it facilitates administration of charges for retainers. • Disadvantages? • None identified; if substitution proposals are not approved it is expected that the Authority would reject this proposal.

33. UNC Modification Proposal: Other Impacts • Impact on Security of Supply • Whilst concern has been expressed at the possible effect of substitution on security of supply these concerns do not apply to this modification proposal which, in itself, only introduces a new transportation charge. • IT Systems • No impact on IT systems is envisaged. Charges would be invoiced, and refunded, via ad-hoc invoice functionality. A specific invoice charge item could be created in future if necessary.

34. UNC Modification Proposal: Timetable • Aim to align consultation on Modification Proposal, Methodology Statement and Charging Consultation as much as is practicable. • Aim to have all three proposals with the Authority prior to, or very soon after, commencement of Ofgem’s Impact Assessment.