Entry Capacity Substitution Workshop 8 – 7 th April 2009

2 Agenda  Feedback from workshop 7  Timeline  Further refinement of options  Mechanical approach  Option model  Two stage auction  Worked examples  Next Steps

3 Feedback  At workshop 7 National Grid sought feedback on proposals presented and what was required for workshop 8, specifically:  What further information would be required to assess the options at this workshop?;  What examples should be considered?; and  Was the level of detail (in the workshop 7 presentation) adequate?  Responses  Only three responses received. Preference to avoid added cost and/or complexity; hence support for Mechanical Approach, but advantages of other approaches recognised; No direct responses to the questions posed.  National Grid has made slight developments to the options based on comments made in workshop 7. More support for 2-stage auction was expressed.  Worked examples have been developed on each proposal.

4 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

Entry Capacity Substitution Mechanical Approach

6 Mechanical Approach  Each substitution opportunity progresses subject to satisfying: Limits set on availability of capacity at potential donor ASEP (referred to in this presentation as “protected” capacity).  Use TBE peak forecast for beach terminals.  Need to consider treatment of Interconnectors, Rough.  Use maximum deliverability for storage sites and LNG.  Source of data to be considered.  Suitable alternative proposals could be considered.  Most LNG and storage ASEPs fall outside the scope for substitution because they have “incremental” capacity. When this capacity moves to “baseline” it may be made available for substitution.  Effectively limits substitution to specific beach terminals An exchange rate cap:  Suggest 5:1 An economic assessment:  Suggest no economic assessment in the mechanical approach.

7 Mechanical Approach Capacity available for substitution All ASEPs not included in the table have zero capacity available for substitution

8 Mechanical Approach

Entry Capacity Substitution Option Model

10 Option Model Capacity at an ASEP would be prevented from being substituted in response to an incremental signal elsewhere. This would be subject to an “option”. 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.

11 Option Model – What is the Option? Which “option” for the Option should be considered? Proposal - Simple option with no further rules e.g. no economic test: the option excludes the capacity from substitution processes thereby protecting capacity for the duration of the option; the option nominally applies in respect of Q3 Y+4, i.e. from the 42 month lead-time (or later if relevant incremental capacity is triggered from a later date). simple to apply, understandable, provides certainty Option is placed ahead of QSEC and applies for 12 months, i.e. only covers (normally) 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. 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 An exchange rate of 4:1 is proposed.

12 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. Propose that Option Price = Q x p/unit x 32 quarters and is the same for all ASEPs regardless of specific reserve prices. Example For an option over 10 mcmd at any specified ASEP: Option Cost = 10 * 10.8 * 10^6 (convert to kWh/day) * * 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. Refunds Given if the capacity covered by the option is sold for any quarter (at 42 months or more from QSEC), in the year covered by the option, to any Shipper. Given if the capacity covered by the option is bought by the User in any QSEC or AMSEC. Recurring option fees (multi-years) would all be refunded. Option Model – How Much? These criteria are National Grid’s initial Proposal and will be subject to consultation

13 Option Model - Option & Single Quarter Costs Option Price = £315,360 for 10 mcmd (may be subject to refund) ASEP Reserve Price p/kWh/D Cost for 10 mcmd for single quarter St Fergus0.0378£3,725,190 Teesside0.0083£817,965 Bacton0.0084£827,820 Isle of Grain0.0006£59,130 Burton Pt0.0001£9,855 Barrow0.0070£689,850 Theddlethorpe0.0082£808,110 Hatfield Moor0.0028£275,940 Avonmouth0.0001£9,855

14 Option Model.

Entry Capacity Substitution Two Stage Auction

16 Two Stage Auction This option needs to be considered as a means to prevent capacity being substituted from a particular ASEP by allowing Shippers an opportunity to respond to perceived vulnerability of certain ASEPs when incremental capacity has been requested elsewhere.  Baseline/obligated and incremental capacity can be obtained in the first stage.  Only baseline/obligated capacity can be obtained in the second stage.  Stage 2 will only be run where an incremental signal has been received in stage 1.  Stage 2 run using AMSEC functionality: so Pay as bid. Release to Y+15  Stage 2 available capacity As stage 1 minus any sold in stage 1 or previous stage 2 rounds. No pro-rating across stages / rounds. Three discrete rounds. No next-day withdrawal / revision of bids.

17 STAGE 2: 3 rounds Obligated only Two Stage Auction – March 2010 timeline 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 Stage 2 AMSEC opened Stage 2 closed Shippers review position

18 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. If capacity is to be protected full financial commitment from the Shipper is required. Hence a lower cap seems appropriate.  How will the process be applied to ad-hoc auctions? Run baseline auction (stage 2 with AMSEC functionality).  Major UNC modification. Re-design of auction processes.  Systems impact. Can use existing functionality but systems changes may be needed if single quarter bookings need to be prevented.  Possible licence change. Needs review, but may include alteration to IECR annual review dates.  Single Quarter Issue. Potential solution would be to allow “continuous”, but not discontinuous, bookings; e.g. must have one quarter same level in each of previous two years.

19 Two stage auction

Entry Capacity Substitution Examples

21 Substitution Example: Scenarios Consider the scenarios  Incremental signal at Barrow Likely donor ASEPs: Teesside / St Fergus  New ASEP in South East (e.g. Feeder 5 at Farningham offtake) Likely donor ASEP: Bacton Examples Focus on processes, impacted ASEPs Do not involve Network Analysis of exchange rates and precise impact on donor ASEP quantities.

22 Substitution Example: Data Provision  Pre-QSEC National Grid will issue the invitation letter. This will contain: Donor ASEP merit order and zones  Capacity is first substituted from all within zone ASEPs together (subject to satisfying exchange rate cap) then out of zone ASEPs in pipeline distance order (nearest first). For Mechanical Approach the protected quantity will be identified  Only capacity in excess of this level will be considered for substitution. Recipient ASEPBarrowSouth East Donor ASEPs in orderTeesside*Isle of Grain* *ASEPs within zone Some sold-out ASEPs or with zero baseline ignored Glenmavis*Bacton* St Fergus*Theddlethorpe FleetwoodHatfield Moor PartingtonGarton Burton PointPartington TheddlethorpeAvonmouth Burton Point

23 Substitution Example: Capacity Available for Substitution (Barrow) ASEPBaseline GWh/Day A Protected Capacity GWh/Day B Sold GWh/Day (2008 QSEC data used) C Capacity available for substitution. Mechanical Approach D 2-stage auction and Option Model E Barrow **0 Teesside* Glenmavis* St Fergus* Fleetwood0No data65000 Partington Burton Point **53 Theddlethorpe * Within zone ASEPs ** The lower value based on sold quantity would be used for Burton Point (and Barrow if a donor ASEP) under all options. A, B & C taken from slide 7. D = 90%A – B E = 90%A – C

24 Substitution Example: Capacity Available for Substitution (South East) ASEPBaseline GWh/Day A Protected Capacity GWh/Day B Sold GWh/Day (2008 QSEC data used) C Capacity available for substitution. Mechanical Approach D 2-stage auction and Option Model E South East00000 Isle of Grain* Bacton* Theddlethorpe Hatfield Moor Garton0No data42000 Partington Avonmouth Burton Point **53 * Within zone ASEPs ** The lower value based on sold quantity will be used for Burton Point under all options. A, B & C taken from slide 7. D = 90%A – B E = 90%A – C

25 Substitution Example: QSEC Results Assume incremental signals received at  Barrow for 215 GWh/D  South East for 175 GWh/D Both pass NPV test.  No additional allocations of obligated capacity at other ASEPs Consider Recipient ASEP with lowest revenue driver first.  Barrow then South East. In practice the order should be irrelevant as the two Recipient ASEPs are at different extremes of the NTS.

26 Substitution Example: Mechanical Approach Results Barrow as Recipient ASEP for 215 GWh/d. Note: Actual exchanges rate will be determined by network analysis. These will not vary according to the substitution methodology employed (i.e. same for mechanical, option and 2-stage approaches, but different values have been used in this example for illustration. Within zone substitutions calculated by pro-rating the available capacity at donor ASEPs. 1:1 exchange rate Quantity required for substitution = 215 5:1 exchange rate Quantity required for substitution = 1075 Donor ASEP Capacity substituted Teesside - 61Teesside - 91 St Fergus - 154St Fergus Quantity obtained by pro-rating on available capacity (D in slide 23) Burton Point - 53 Theddlethorpe Bacton Total substituted = 215 GWh/d from within zone. Requirements satisfied so 215 GWh/d incremental signal met by substitution. Max available to substitute = 953 GWh/d This equates to only 191 GWh/d at Barrow. Under current proposals partial substitutions would not be permitted. All 215 GWh/d would be funded.

27 Teesside Pricing Example: Based on Mechanical Approach with 5:1 Exchange Rate Impact on Teesside ASEP. Original conditionsAfter substitution Baseline P0P Assume in previous example that the substituted capacity satisfies the incremental demand at Barrow. Action required to recover Teesside baseline  Incremental signal needed91GWh/d  50% of project cost£14m u Step price = P p/GWh/d Cost to recover baseline at Teesside ASEP. Assume current sold levels i.e. cost includes buying up to revised baseline capacity Assume all capacity up to 385 GWh/d is sold Total cost £m6418 Cost per unit p/kWh/d For the 1:1 exchange rate example the baseline will fall to 415 GWh/d. To recover original baseline will require a smaller increment with a lower project cost; but the unit cost price will be broadly similar to the above example.

28 Substitution Example: Mechanical Approach Results South East as Recipient ASEP for 175 GWh/d. 1:1 exchange rate Quantity required for substitution = 175 5:1 exchange rate Quantity required for substitution = 875 Donor ASEP Capacity substituted Bacton Theddlethorpe - 58Theddlethorpe Burton Point – 53 Teesside – 91 St Fergus Total substituted = 175 GWh/d. Requirements satisfied so 175 GWh/d incremental signal met by substitution. Total substituted = 875 GWh/d. Requirements satisfied so 175 GWh/d incremental signal met by substitution.

29 Substitution Example: Option Approach  Assume that Teesside and St Fergus Shippers are aware of potential bids at Barrow and Bacton Shippers of potential South East bids. Shippers at other ASEPs are not aware or choose not to take out option.  Barrow for 215 GWh/d  South East for 175 GWh/D  Options taken out are such that protected quantities will be available in long term auctions; i.e. 10% baseline quantity withheld is not considered available. ASEPScenario AScenario B Do nothing Option quantity (B-C from slides 23/24) Option Cost Quantity of capacity that can be obtained at reserve price for one quarter for the option cost. TeessideNo option taken175 GWh/d£511,00067 GWh/d St FergusNo option taken800 GWh/d£2,336,00068 GWh/d BactonNo option taken593 GWh/d£1,731, GWh/d

30 Substitution Example: Option Approach Results  Barrow as Recipient ASEP – 215 GWh/d incremental Donor ASEP Capacity substituted Scenario A: No option Scenario B: Option to TBE at Teesside / St Fergus 1:14:11:14:1 Teesside Glenmavis St Fergus Partington Nil 172 Burton Point Nil 53 Theddlethorpe Nil 223 Total  To protect Teesside capacity no more than 91 GWh/d can be substituted away  To protect St Fergus capacity no more than 232 GWh/d can be substituted away  Under all examples sufficient capacity is available to allow substitution.  Note: Increase at Teesside in scenario B is due to effect of pro-rating a lower within zone aggregate available capacity with a greater proportion protected at St Fergus.

31 Substitution Example: Option Approach Results  South East Recipient ASEP – 175 GWh/d incremental Donor ASEP Capacity substituted) Scenario A: No option Scenario B: Option to TBE at Bacton 1:14:11:14:1 Bacton TheddlethorpeNil PartingtonNil 53 Total  To protect Bacton capacity no more than 117 GWh/d can be substituted away  Under all examples sufficient capacity is available to allow substitution.  This shows that under all scenarios considered an option is beneficial because Bacton is the only donor ASEP in the SE zone meaning that there are no other ASEPs to share the burden.

32 Substitution Example: 2-Stage Auction  Assume that Shippers see the incremental bids at Barrow and South East in stage 1 Barrow for 215 GWh/d South East for 175 GWh/D  and respond in stage 2 with capacity bids at Teesside, St Fergus, Bacton and Theddlethorpe. Shippers at other ASEPs choose not to take any further action. Stage 2 bids for obligated capacity (GWh/d) Scenario B cost for one quarter F*Res Price*90 Scenario B Additional cost to ensure single quarter is “continuous” ASEP Scenario A – no further bids Scenario B F (=B-C from slides 23/24) TeessideNil175 - bid up to TBE£1,325,406£1,726,815 St FergusNil800 - bid up to TBE£27,594,000£41,873,895 BactonNil593 - bid up to TBE£4,545,345£9,849,525 TheddlethorpeNil 160 – bid up to TBE plus Saltfleetby £1,197,200£2,050,205 “Continuous” requires at least one quarter in each of the previous two years to be at the scenario B level

33 Substitution Example: 2-Stage Auction Results  Barrow as Recipient ASEP – 215 GWh/d incremental Donor ASEP Capacity substituted Scenario A: No further bids Scenario B: Bids to TBE at Teesside/St Fergus 1:12:11:12:1 Teesside Glenmavis St Fergus PartingtonNil 18 Total  Under all examples sufficient capacity is available to allow substitution.

34 Substitution Example: 2-Stage Auction Results  South East Recipient ASEP – 175 GWh/d incremental Donor ASEP Capacity substituted Scenario A: No further bids Scenario B: Bids to TBE at Bacton 1:12:11:12:1 Bacton Theddlethorpe Nil Total  Under all examples sufficient capacity is available to allow substitution.

35 Substitution Example: Cost to Recover Baselines  Barrow as Recipient ASEP – 215 GWh/d incremental  South East Recipient ASEP – 175 GWh/d incremental  Basis – Shippers take no positive action / exchange rate 1:1 Donor ASEP Mechanical ApproachOption Approach & 2 Stage Auction Scenario A Incremental capacity required Project cost £m from charging model Incremental capacity required Project cost* £m from charging model Teesside St Fergus Glenmavis0N/A1410 Bacton Theddlethorpe58170N/A * Project costs are taken for the relevant incremental step so would not deliver the exact incremental capacity required.

36 Conclusions  General Pro-rating within zones has a deleterious effect on St Fergus. If pipeline distance is used within zone then St Fergus would normally be the last ASEP to be affected. The number of ASEPs within a zone is important as to the extent that a donor ASEP may be affected.  Mechanical Approach Limiting substitution at storage/LNG sites to protect “deliverability” significantly limits number of potential donor ASEPs.  But is this a bad thing? Setting constraints on TBE forecast levels limits total available capacity for substitution.  Again, is this a bad effect? Two moderately sized incremental capacity requests could remove all available capacity from the system (if actual exchange rates are 5:1 and the methodology cap is 5:1). Subject to exchange rates (actual and cap) an incremental signal on one extreme of the network could have an impact at other extremities Potential issues with “commercialising” TBE process and obtaining independent, reliable, source for Deliverability.

37 Conclusions  Options Approach A greater number of donor ASEPs can be affected  The extent to which they are affected can be limited by Shippers. Options allow Shippers to identify and protect their needs. Shippers need to have some awareness of market developments. Post-auction analysis may show that options were not required and were taken out unnecessarily.  Potential for refunds may make this less significant an issue. There is a knock-on effect where ASEPs without options get affected more. This is more pronounced with higher exchange rates. Need to agree option fee and scope / extent of refunds Single quarter booking may be more economical for ASEPs with low reserve price.

38 Conclusions  Two Stage Auction A greater number of donor ASEPs can be affected  The extent to which they are affected can be limited by Shippers. Two stages allow Shippers to identify vulnerabilities and to protect their needs. Shippers need to respond to post-stage 1 auction results. Post-auction analysis may show that stage 2 bids were not required and were made unnecessarily. There is a knock-on effect where ASEPs without stage 2 bids may be affected due to bids at other potential donor ASEPs. Full commitment required by Shippers Most likely option to encourage single quarter bookings

39 Summary  The cost of protecting capacity from substitution up to the TBE forecast levels for the ASEPs considered in the example would be:  The project cost (used in the NPV test) to recover, up to the protected level, capacity substituted away would be: ASEP Mechanical Approach Option Approach (may be refunded) Two-stage AuctionProject value* One quarter One “continuous” quarter Based on 1:1 exchange rate TeessideNil£511,000£1,325,406£3,052,221£nil** St FergusNil£2,336,000£27,594,000£69,467,895£nil** BactonNil£1,731,560£4,545,345£14,394,870£24m * Applies to Option Approach and 2-Stage Auction. For Mechanical Approach value is nil for all scenarios. ** Substitution does not take capacity below TBE level.

40 Summary  The Mechanical Approach protects capacity at all ASEPs to a pre-determined level without Shipper involvement (no User commitment). It is very restrictive and may prevent genuine opportunities for substitution being taken. Possible problems with base data (TBE needs to be benchmarked, deliverability defined). Should less stringent rules be applied? E.g. Protect to 90% TBE/deliverability.  The Option Model protects capacity, but only to the extent that it is genuinely needed as demonstrated by Shippers taking out options. A commitment is required from Shippers but this may be much lower than buying the capacity. But it will still be higher than for a single quarter booking for some ASEPs. National Grid is proposing that option fees are refundable if the capacity is ultimately bought by that Shipper thereby making the fee relevant only to speculative options.  The Two Stage Auction protects capacity, but only to the extent that it is genuinely needed as demonstrated by Shippers making capacity commitments. The commitment may be much greater than the option fee.  Would Shippers be encouraged to buy a discontinuous single quarter? It makes Shippers commit earlier than they want to. It provides certainty that capacity is available; it is a definitive allocation.

41 Next Steps  Next workshop  Tuesday 12 th May 2009  10am to 1pm  At Elexon  Is it needed? What further information is required?  Informal consultation due to commence 8 th June 2009 National Grid still expects to consult on three potential proposals.  Development of associated UNC modification proposals throughout May / June.