RIIO-T1 impact on allowed revenues and network charges 6 September 2012

2 Introduction RIIO-T1 will set revenue controls for transmission network companies 1 April 2013 – 31 March 2021 July 2012: We published our Initial Proposals Engagement with stakeholders continues to be important to the process Today’s presentation and discussion aims to: –Focus on the specific RIIO impact set against the wider context –Outline the ways that we and NGG can help manage the impact on charges –Detail the way that revenue will be recovered by NGG including where it relates to a signal for extra capacity Consultation on Initial Proposals closes on 21 September 2012 We intend to publish updated licence drafting in Autumn 2012 Final Proposals December 2012

3 Context NGG’s obligations and allowed revenues are subject to economic regulation to ensure that energy consumers interests are protected To recover its allowed revenues NGG set charges consistent with its charging methodology statement. The methodology is subject to the governance procedures of the UNC and is subject to approval by Ofgem There are factors that affect the level and volatility of gas transmission commodity charges which are independent of our decisions in RIIO-T1 This presentation focuses solely on the expected impact of RIIO- T1

4 RIIO RIIO is different to our previous approach to setting transmission controls Differences include: –Onus is on network companies to develop well-justified business plans – including reflecting stakeholder input –Comprehensive set of outputs against which delivery will be monitored and in some cases financial incentives will be used to encourage higher quality performance –Treatment of capex and opex aligned so that companies choose the most appropriate solution – allowable costs treated as totex –Aims to match returns more directly to the company’s performance –Preset proportion of totex allowed in the year (“fast money”) with the remaining payments spread over life of asset (“slow money”)

5 OUR CONSULTATION ON WAYS TO MANAGE CHARGING VOLATILITY

6 Option Assessment against optimal risk allocation Assessment against other criteria Consultation view 1 Improved information Reduces risk to suppliers No additional cash-flow risk for NWOs Low cost Relatively easy to implement Likely to be beneficial 2 Restricting intra-year charge changes Reduces risk to suppliers Limited additional cash-flow risk for NWOs Reduces complexity Reduces administration costs Likely to be beneficial 3 Lagging incentive rewards / penalties networks recover via allowed revenues Reduces risk to suppliers Limited additional cash-flow risk for NWOs Potentially weakens the incentive regime and signals to investors Likely to be beneficial 4 Lagging adjustments to allowed revenues from uncertainty mechanisms Reduces risk to suppliers Potential additional cash- flow risk for NWOs Potentially weakens signals to investors Universal changes unlikely to be beneficial. May consider changes on mechanism-by-mechanism basis 5 Cap and collar allowed revenue changes Reduces risk to suppliers Potential material additional cash-flow risk for NWOs Introduces complexity to the regulatory regime Could weaken incentive regime and signals to investors Unlikely to be beneficial We consulted on 5 options for mitigating volatility

7 Applying to gas transmission Improved information –Recognise NGGT’s work to identify where stakeholders require better information, including forum such as these –150 days indicative notice period and relationship with annual iteration Restricting charges to 1 April change –Responses were supportive of all charge changes being 1 April, currently capacity charge setting linked to the gas year (from 1 October) –Welcome NGGT leading industry discussion on this Lagging incentives –Where financial incentives are applied, eg stakeholder satisfaction, natural lag built in as performance in year 1 reflected in charges in year 3 Lagging uncertainty mechanisms –Detailed design of mechanisms being finalised for RIIO-T1. Our initial assessment favoured no lag on adjustments but a consideration of individual mechanism requirements Caps and collars –Do not favour this option, and see no reason why our assessment of costs and benefits should be different from other network sectors

8 SETTING REVENUES

9 Setting revenue allowances for future years Licence model calculates allowed revenue for future years - ‘open’ for annual update of some variables Takes in actuals and compares with allowances Formally part of Licence regime reflecting Conditions and Handbook Annual Iteration Run in November each year (so values need to be agreed before) Uses data mostly from regulatory year just ended in March Calculates adjustment to be applied in following year through modification update licence term (MOD) MOD Sum of differences (time adjusted) between i) Recalculated base revenues for all 8 years using this year’s inputs and ii) recalculated base revenues for last year Reflects any changes/corrections to numbers previously used

10 There are two components of MOD. Changes from years prior to the current year which have WACC applied and an updated year t itself. These are added together and compared with FP to calculate MOD MOD term calculation xx + MOD overview

11 Revenue associated with new projects Comparing TPCR4 with NGG business plan and our Initial Proposals The next slide illustrates the different approaches to revenue recovery following NGG’s business plan proposal; our high level approach under our initial proposals; and TPCR4 Annual iteration process should not limit agreement/ signals For example under NGG’s proposal NGG will not be constrained from building in year 2017; at the worst case the funding will be received 1 year in arrears (with financing costs) Our IP approach excludes any financing costs due to NGG for earlier preconstruction expenditure Total revenue will vary each year from that in Final Proposals as we update for actual totex and revised allowances TOTEX approach works whatever the outcome of the current discussion about new commercial arrangements. We are not prejudging the outcome of that process

12 Potential revenue impacts of £50m project Delivery Initiation

13 FURTHER DISCUSSION AND QUESTIONS

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