1. “Investment in Transmission” Economics of Electricity Markets – IDEI Toulouse, 2-3 June 2005 Jon Carlton – Director of Network Strategy

2. Agenda  National Grid Transco  Who we are and what is our experience?  Drivers of Investment  Role of competitive markets and congestion  Technical rules vs Economic Assessment  Incentives for Investment and the Role of Independent Transmission –Consideration of some of the practical challenges  Summary and Conclusions

3. Who are National Grid Transco?  Formed in late 2002 through merger of Lattice Group and National Grid Group  International energy delivery business with market capitalisation of ~€20billion  Focused on ownership, operation, development of energy networks  Electricity and Gas  Principal Electricity Investments  TSO for England and Wales; SO for GB  Significant Transmission and Distribution Businesses in the Northeast United States

4. National Grid Electricity Transmission System  Operating voltages 400kV and 275kV  13,786 km of overhead line; 627 km of underground cable  Approx 330 substations  Maximum demand 54,400 MW  Units transmitted 308.5 TWh  Major power plants connected 84

5. Investment challenges for National Grid in the UK DRIVERS OF TRANSMISSION INVESTMENT  Ageing coal-fired generation  And tighter emissions limits  New gas-fired generation  Renewables  Especially wind power  Asset replacement  Driven by asset age and condition ASSET AGE PROFILE

6. Are competitive electricity markets conducive to network investment?  There is no automatic linkage between competitive markets and network security – some of the most secure networks are where unbundling and competition have been introduced.  Some transmission systems may have been designed to get output of a company’s own generation to its native load, rather than for trade in electricity – this is where investment may be most needed.  In some cases trade facilitated by excess capacity already inherent in transmission systems  In any event, effective investment incentives required looking forward

7. Does congestion provide the answer to where investment is required?  Can be a valuable signal to where investment is required and provide an economic justification  But patterns of congestion can change according to the disposition and operation of generation and be influenced by outage programmes  In practice there may be legitimate reasons why congestion revenues alone may be insufficient to fully remunerate required investment

8. Technical rules; do we need them and if so what is their place?  Need to ensure we understand what is actually required versus what engineers would ideally like to have!!  Market can largely ensure demands for energy are met, but there may be questions as to the temporal or geographical balance  Supply and demand have to be matched in real time  Reactive power for voltage control must be provided locally  Supply quality and reliability are important considerations  But market mechanisms can often be used eg to ensure economic provision of ancillary services (eg reactive power, response and reserve)

9. Transmission Investment requires….  Companies whose prime focus is transmission  New ways of:  Planning  Managing capital investment  Understanding asset performance and health  Effectively managing risk  Examples  Planning against a background of uncertainty  Advanced asset management techniques  “Just in time” asset investment, complemented by SO contracting options

10. Planning investment against an uncertain background  Location and timing of new projects which will actually proceed are uncertain  Need to avoid prospect of failure to provide capacity or be left with stranded assets  Hence need to adopt “just in time” investment; complemented by use of System Operator incentive schemes

11. Uncertainty in future generation pattern 1196 1988 5941 7716 6719 1200 2171 Background A GenerationDemand 1483 1988 3611 12027 9815 2200 3667 Background B

12. Effective regulatory incentives  Forward looking rather than based on historic view  Drivers to provide capacity when required  Combination of sound economics and pragmatism  Avoidance of undue complexity and cost  Need to consider how asset replacement is effectively incentivised, not just provision of new capacity

13. Some attributes of appropriate incentives  Investments which are customer driven  The role of capacity auctions  Recognition that Unit Cost Allowances will only approximate the cost of a specific project  Thus may need transportation charges to cater for under- or over-funding from auctions  Asset replacement  Sufficient returns to make this attractive to shareholders  But regulator must have assurance on outputs (ie that investments are efficient and timely)

14. Other Practical Challenges for Investment  Environmental challenges  Not just visual amenity –Flora –Fauna –Health concerns (eg EMFs)  Planning processes  Important that due process is seen to be followed  Objectors and interveners must be allowed a voice  Governments have a role in streamlining planning processes  Companies also need to be innovative  Getting more capacity out of existing assets obviates need for new build

15. TSO, SO, TO – Does the industry structure matter?  Transmission companies must be independent from market participation and possess financial strength  A real focus on transmission as a core activity  Cost efficiency  Innovation  Ability to respond to incentives  Strong incentivisation of system operator may require it to be backed by asset ownership  Efficiency of operation is facilitated by tight integration of SO and TO functions  ISOs and separate TOs may be dictated by inherited structures and property rights

16. Summary and Conclusions  Investment occurs where companies have transmission as a prime focus, not a subsidiary activity  Investment in an unbundled competitive market needs investment in new processes, new tools and good people  But this will only occur if the right financial (and hence regulatory) incentives are present  Market mechanisms have a key role in incentivising efficient operation and investment, complemented by sensible technical guidance  The debate on industry structures will continue, but incentivised and integrated TO and SO functions have demonstrable benefits