Managing the Costs of New Developments Initial Proposals on Transmission System Operator Internal Costs from 1 st April 2007 Update from National Grid – Transmission (17 December 2006)

Managing the costs of New Developments  Ofgem’s Initial Proposals for NGG (transmission) and NGET System Operator Incentives from 1 st April 2007 were published on 5 th December  these include proposed allowances for Transmission System Operator Internal Costs  the allowances are based on Ofgem’s review of National Grid’s business plan, provided as part of the Transmission Price Control Review (TPCR)  The consultation (question 14 in both sections 2 & 3) also seeks views on  whether to handle new industry development costs via National Grid’s proposal or  via the existing Income Adjusting Event (IAE) provisions The deadline for responses is 16 th January 2007

Why have National Grid proposed a new mechanism?  Significant industry developments are anticipated over the next transmission price control period (2007/08 to 2011/12) which will impact on National Grid’s processes  some changes are known but un-scoped,  many are not yet even envisaged, and  their overall implementation cost is unknown at this time  We have not included these costs in our baseline expenditure plans and allowances because  this approach does not properly align to the industries interest to efficiently develop the commercial framework  the uncertainty would have required us to include a large risk margin  We believe that improved assurance of efficiency in development costs can be provided through  enhanced, regular cost and progress reporting  use of Industry Panel expertise  building a regular, systematic process for the review and recovery of necessary costs

What does it involve?  National Grid will continue to provide forecasts of its costs to implement modification proposals but clearly identifying the incremental costs beyond our base allowance  These forecasts will be taken into account by the relevant working group or panel in developing its recommendations  We will report the forecast costs regularly and then report final actual costs on completion of work  Subject to approval, and materiality tests, we would recover the incremental costs incurred via a term in our internal incentives  The costs, and working group or panel assessment of them, can be factored into Ofgem’s efficiency assessment at the next price review

What does it involve?  The baseline SO allowances include £0.25m for electricity and £0.25m for gas  Our reporting will monitor the cumulative spend for electricity and gas each year, including approved changes and those being assessed  This will help the industry working groups and panels to monitor how much market-driven change is being progressed and proposed.  If the spend exceeds any baseline allowance, then this will be fed into the incentive charges for the following year.

We think that adoption of this proposal is essential to our continued positive contribution to industry development. It will provide improved transparency of National Grid’s expenditure on behalf of the industry clearer accountability for and to industry panels and working groups flexibility to fund, and plan for, industry development We believe continued industry development is foreseeable and so the costs should be managed through a regular systematic process Income Adjusting Events are a means of catering for exceptional events and thus it is not the most appropriate way of dealing with this issue – we should be implementing a simple new process focussed on routine industry decision making. Next Steps  The Transmission System Operator Initial Proposal consultation closes on 16 th January 2007 and we would urge you to consider our proposal and respond positively to the consultation  National Grid’s response will follow these lines If you have any comments or want more information contact National Grid’s panel representative or Kevin Broadbent ( )