1. Entry Capacity Substitution Workshop 7 – 10 th February 2009

2. 2 Agenda  Timeline  Further review of options  Mechanical approach  Two stage auction  Option model  Next Steps

3. 3 TCMF – Develop Charging Methodology / Pricing Options Further development of Charging Methodology Develop Charging Methodology Changes at TCMF 07/11/09 Submit Pricing Changes for Approval 27/07/09 Commence informal Consultation on Pricing Changes Approval of Pricing Changes Draft Timeline – Development of Methodology Jan 09Feb 09Mar 09Apr 09May 09June 09July 09Aug 09Sept 09Oct 09Nov 09Dec 09 Workshops 5 – Review status – explain risks/rewards process 5 – High level options – work through of potential options 6 – Industry options – review alternatives 6 – Review all options – narrow down for development 7/8 – Detailed options/examples 9 – Finalised options/examples 10 - Update industry following Informal Consultation 07/01/09 Workshop 6 07/04/09 Workshop 8 07/07/09 Workshop 10 12/05/09 Workshop 9 10/02/09 Workshop 7 Develop stage 1 Licence Direction/Changes 01/04/09 Licence Changes Effective S23 Notice Develop stage 2 Licence Changes 07/09/09 Submit ECS for Approval 07/12/09 Approval of ECS 27/07/09 Impact Assessment as necessary 28D 14D Consult Report 21D 28D Consult Finalise Start consultations Informal Formal 08/06/09 24/08/09 Close formal consultation Consult and Report (non-urgent) Develop UNC Mod Proposals 07/12/09 Approval of UNC Mods 19/11/09 Mod Panel Decision 17/09/09 Mods to Panel 02/07/09 Tx Workstream: present mods IT Systems development 31/03/09 Progress report

4. 4 Summary of workshop 6 Option 1) Draft Methodology 2) Limits on Quantity 3) National Grid Discretion 4) Ofgem Discretion 5) Simple Economic Test 6) Exchange Rate Cap / Economic Test Combination 7) Option Model 8) Sub-Reserve Prices 9) Early Warning System 10) Two Stage Auction 11) BGT Proposal  After consideration of the 11 options it was agreed that we focus on:  A Mechanical Approach (options 2 and 6);  Two Stage Auction;  Option Model.  All options build upon the draft methodology as the starting point.

5. 5 Base Methodology

6. Entry Capacity Substitution Mechanical Approach

7. 7 Mechanical Approach  Each substitution opportunity progresses subject to satisfying: Limits set on availability of capacity at potential donor ASEP  Use TBE as criteria to exclude capacity from substitution.  Alternatives considered, historic, % baseline, % unsold. An exchange rate cap:  Suggest 5:1  As TBE peak forecast should protect all foreseen developments a high exchange rate cap should be appropriate and its inclusion ensures that capacity is efficiently re-allocated. An economic assessment:  Suggest no economic assessment in the mechanical approach.  The mechanical approach uses simple physical rules. “Economic” criteria lie with the economic “options model”.

8. 8 Mechanical Approach Uses the maximum TBE Forecasts and an XR cap to place limits on substitution Invitation to contain statement that TBE values are not subject to challenge. Storage sites to be based on Max Deliverability. References to capacity above TBE mean above sold level if higher. Exchange rate cap to be proposed at 5:1

9. 9 Mechanical Approach Maximum TBE Forecasts (storage sites use Max deliverability)

10. Entry Capacity Substitution Option Model

11. 11 Option Model (Basic) Capacity at an ASEP would be prevented from being substituted in response to an incremental signal elsewhere. This would be subject to an “option”. But what exactly is the option? The option is a means to delay or prevent capacity being substituted from a particularly ASEP. The option  does not give rights to the Shipper to use the capacity covered by the option;  does not give the Shipper first option to buy the capacity; but  it would reserve capacity at the relevant ASEP for any Shipper to obtain at a later auction.

12. 12 Option Model – What is the Option? Which “option” for the Option should be considered? a) Proposal - Simple option with no further rules: i.e. the option excludes the capacity from substitution processes. It is valid for 1 year covering all auctions (including ad-hocs) and protects capacity for the duration of the auction period; simple to apply, understandable, provides certainty b) Variant - Option with an economic test: i.e. the option excludes the capacity from substitution processes only if the value of the “protected” capacity is greater than the incremental capacity; more complex, may not provide the protection expected, hence may have no value, nature of the test needs consideration. c) Rejected - Option and exercise: i.e. if the “protected” capacity is identified for substitution the User may exercise the option and buy the capacity; would extend post-auction timelines to exercise option, would require full commitment from User before being ready to commit.

13. 13 Option Model – Possible Timeline for Options (assuming March QSEC) FEBMARCH Option window Timing of Option Window QSEC invitation letter QSEC auction starts Shippers need to know how much capacity is available to have an option over: Hence the option window would follows the QSEC invitation. Option invitation (part of QSEC invite) Option window open two weeks after invitation Open for three days Options placed are not transparent to other Users NG publishes option information: ASEPs, aggregate option quantity

14. 14 Option Model – How Much? How much should the Option cost? Needs to be high enough to discourage speculative options, but not too high that it encourages discontinuous single quarter bookings. As the option protects for the full auction and is valid for a year; what could we link the option price to? The NPV test is assessed over 32 quarters and can be used with the minimum capacity reserve price. Propose that Option Price = Q * 0.0001p/unit x 32 quarters.

15. 15 Option Model – How Much? How much should the Option cost? Propose that Option Price = 0.0001p/unit x 32 quarters. 32 quarters represents 8 year NPV test period. Example For an option over 10 mcmd at any specified ASEP: Option Cost = 10 * 10.8 * 10^6 (convert to kWh/day) * 0.0001 * 365 * 8 / 100 (convert p to £) = £315,360 This value seems appropriate as it is of the same order as a PWA required to progress works for a year for delivery of incremental capacity.

16. 16 Option Model – Further Rules Option Rules Option is placed ahead of QSEC and applies for 12 months, i.e. covers one QSEC and any ad-hoc QSECs before next option window. Option does not prevent other Shippers (or that Shipper) buying capacity at that ASEP. Option fees are non-refundable. Options permitted only up to the quantity available in QSEC (usually 90% baseline – sold). Fixed option price: options pro-rated if available capacity is exceeded. Exchange Rate Cap It is within the Shipper’s ability to define the required level for the option, but as it requires an element of financial commitment a slightly lower exchange rate cap may be appropriate. An exchange rate of 4:1 is proposed.

17. 17 Option Model – Economic Test (assuming March QSEC) MARCHAPRIL Assume a March QSEC QSEC auction QSEC analysis NPV test QSEC analysis Find donor ASEPs Test applied: requires exchange rate Capacity release notice to Ofgem What is the test? The test is intended to measure and compare the value of capacity substituted from a donor ASEP and the value of the incremental capacity released at a recipient ASEP. Where the value at the donor ASEP is higher substitution should not be progressed. The test needs to be predictable for Users. It should be simple, transparent and have minimal (or no) impact on post QSEC analysis. Needs to be non-discriminatory. Shipper options placed NG quantifies option value NG quantifies increment value

18. 18 Option Model – Economic Test Propose to use Licence Revenue Drivers. NG determines value of capacity at recipient ASEPs Using incremental bid quantity and relevant revenue drivers. NG determines value of capacity at donor ASEPs Where no option in place value is zero, otherwise Using quantity of capacity covered by option(s) and relevant revenue drivers and the maximum exchange rate. Q * RD * XR max If a simple economic test is used there should be no impact on post-auction timelines. A more complex test may require Licence / UNC changes.

19. 19 Option model with economic test

20. 20 Option Model – Further Issues Issues Is the pricing methodology fair / discriminatory / effective? Treats all ASEPs alike, significant cost but not excessive. When is the option cost paid? Pay post QSEC, in capacity invoice. Needs commitment, “security” issue, want to avoid need for refunds if capacity substituted. Would this option encourage single quarter bookings? 32 * cost of single quarter, immediate financial commitment. Should rules be introduced to limit single quarter bookings? Can existing systems be used for placing options? Consideration of “options” functionality on Gemini needed. Do options impact on use of Permits? NG may identify opportunity to release capacity early; would options affect NG’s analysis that leads to this decision? Can options be made available to Developers?

21. Entry Capacity Substitution Two Stage Auction

22. 22 Two Stage Auction This option needs to be considered as a means to prevent capacity being substituted from a particularly ASEP by allowing Shippers an opportunity to respond to perceived vulnerability of certain ASEPs when incremental capacity has been requested elsewhere.  Baseline and incremental capacity can be obtained in the first phase.  Only baseline capacity can be obtained in the second stage.

23. 23 Two Stage Auction – Timeline STAGE 1 Five rounds Invitation letter – unchanged But will include substitution information, e.g. entry zones and distances. Shippers bid for unsold obligated and incremental. MTWTFSS Auction closed Issues  Auction open at start of month to create time for analysis. May require Licence changes.  Are five rounds enough?  Stability measure retained. Auction opened

24. 24 Two Stage Auction – Timeline STAGE 1 Five rounds NG identifies valid incremental and publishes ASEPs and quantities. Shippers bid for unsold baseline and incremental. MTWTFSSMTWT F SSMTWTF Auction closed Allocations made on Gemini Issues  Allocations are made without Ofgem approval. No history of Ofgem rejection. Would require allocations to be backed out if Ofgem reject.  Assessment of “vulnerable” ASEPs lies with Shipper based on information provided. Auction opened Invitation letter – unchanged But will include substitution information, e.g. entry zones and distances. Incremental capacity identified NPV test Info published for each ASEP: Total sold NPV pass quantity Info published

25. 25 Two Stage Auction – Timeline NG identifies valid incremental and publishes ASEPs and quantities. MTWTFSSMTWT F SSMTWTF  Stage 2 will only be run where an incremental signal has been received in stage 1.  Stage 2 run using AMSEC functionality Possible IT issue.  Stage 2 rules Pay as bid. Release to Y+15 Available capacity is same as stage 1 minus any sold in stage 1. No pro-rating across stages. Three discrete rounds. No next-day withdrawal of bids. NPV test STAGE 2 Three rounds Shippers bid for unsold baseline only. Shippers identify vulnerable ASEPs / capacity. Auction reopened Allocations made on Gemini Info published Auction closed Shipper review

26. 26 Two Stage Auction – Timeline MTWT F SSMTWTF Submit incremental release letter to Ofgem Stage 2 allocations to be made within 2 months of close of QSEC. Ofgem 28 day veto period Post-auction processes STAGE 2 Three rounds Auction reopened Auction closed If Ofgem veto stage 1 incremental release then the incremental allocations need to be backed out. [No history of Ofgem veto].

27. 27 STAGE 2: 3 rounds Obligated only Two Stage Auction – March 2010 timeline 12345678910111213141516 STAGE 1: Five rounds Obligated & incremental Stage 1 closed Allocations made on Gemini Stage 1 QSEC opened Pre-auction activities include invitation letter / notice of prices / IECR Invitation letter – essentially unchanged, but will include substitution information, e.g. entry zones and distances. Incremental capacity identified NPV test Info published for each ASEP: Total sold & quantity passing NPV test 171819202122232425262728293031 Stage 2 AMSEC opened Stage 2 closed Shipper review

28. 28 Two Stage Auction – Issues  Exchange rate cap set at 2:1 The two stage option does not protect donor ASEP capacity to the extent of the Mechanical Approach. Unlike the Option Model it requires full financial commitment from the Shipper if capacity is to be protected. Hence a lower cap would be appropriate.  How will the process be applied to ad-hoc auctions? Run baseline auction (AMSEC functionality)  Major UNC modification. Re-design of auction processes  Systems impact. Use of existing functionality being considered  Possible licence change.  Developers cannot place capacity bids.

29. 29 Two stage auction

30. 30 Recap of all options. Do they offer the benefits of substitution? Is it unduly restrictive?  Do they mitigate the risks presented by substitution? New long term supply projects Short term players – price sensitive New supply projects – marginal fields  How difficult would they be to implement? Systems impact? Shipper processes? National Grid processes? Three options considered. Mechanical Approach  TBE  Exchange rate capped at 5:1 Option Model  With / without economic test  Exchange rate capped at 4:1 Two stage auction:  Exchange rate capped at 2:1 Do the options satisfy the main substitution criteria?

31. 31 Next Steps 1) Provide any initial comments on proposed options, and views on bullets 3 to 5, by 20 th February 2009; to andrew.fox@uk.ngrid.com cc box.transmissioncapacityandcharging@uk.ngrid.com 2) For the next workshop National Grid will amend the options and add further detail as appropriate. 7 th April 10am to 1pm At Elexon (to be confirmed) 3) What information would you require to assess the options at the next workshop? 4) What examples should we consider? 5) Is the level of detail right?