1. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. 0504 -Development of a Demand Side Response Methodology 13 August 2014 Workgroup 2

2. 0504 Work Group Schedules 2 Time / DateVenueWorkgroup Programme 10:30 Wednesday 13 August 2014 31 Homer Road, Solihull B91 3LT (I6) - Option Fees (KA1&I2)- Eligibility rules (KA3) - Timescales of Service -process flow- interactions between three parties (KA5) - DSR Offer posting and Acceptance processes 10:30 Wednesday 10 September 2014 31 Homer Road, Solihull, B91 3LT (KA4 & I3) - Contractual Arrangements - (KA6) Service Fees – pricing offer (K9) – Payment, Cost, liabilities for failing to interrupt (KA8) Payment and settlement arrangements – including timescale between three parties 10:30 Monday 13 October 2014 31 Homer Road, Solihull, B91 3LT (I4) DSR Trial (I5 )OCM Platform 10:30 Tuesday 11 November 2014 31 Homer Road, Solihull, B91 3LT (KA7)DSR offer price feed into Cashout Review Draft Methodology and Business Rules 10:30 Wednesday 10 December 2014 31 Homer Road, Solihull, B91 3LT Outstanding issues Review and sign off Workgroup report ?

3. 3 AGENDA Development of a DSR Methodology 1.Workgroup Proposed schedules 2.Option Fees 3.DSR Mechanism process flow 4.DSR Posting and Accepting Offers 5.Eligibility Rules

4. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. Option Fees

5. Background  As part of SoS SCR Ofgem initiated a consultation in July 2013 on the development of a DSR Mechanism  Initially explored merits of developing a tender or auction based DSR Mechanism and the inclusion of option fees  In response to the consultation NG proposed a less complex market based solution for delivering a DSR Mechanism.  Poyry were commissioned to carry out cost/benefit analysis, to evidence the viability of developing each of suggested 3 DSR mechanism models and the viability of Option fees in each model. 5

6. 6 Option fees Pöyry study findings: Impact Assessment for Final Policy Decision on Gas Security of Supply SCR) Models based on Ofgem’s DSR tender consultation. Modelled three different DSR mechanism designs Design issueStrawman 2Strawman 3NGG option Pay-as-clear vs. pay- as-bid Pay-as-bid Exercise / Option feesExercise only Exercise and variable Option fee Exercise only Decision criteria Volume cap (modelled at 70%) N/A Contract durationOne year Varies (ie from year- ahead to real-time updating) FormatSealed-bid tender OCM-based platform

7. 7 Option Fees Pöyry study Net present value of benefits from each policy option compared to the current arrangements – SM3 Includes option fees Note: Pöyry acknowledged that these results are particularly sensitive to: the volumes of voluntary DSR thought to be available now the expected probability of an emergency

8. Option Fees Pöyry study 8 £MReformSM2 excl CCGTs SM2 incl CCGTs SM3 excl CCGTs SM3 incl CCGTs NGG Gone Green £0.0-£41.0 -£162.3-£91.3-£34.3 High Demand £2.7£20.5£30.8-£89.3-£35.5£37.5  The graph and table show the CBA of the three modelled DSR mechanism designs described on slide 6, with the inclusions or exclusion of CCGTs.  To perform the CBA Pöyry compared the probability –weighted benefits with the known costs. Then calculated an NPV(to 2030) of the expected benefit from adopting each of the policy options compared to the base case of the current arrangement, using a real discount rate of 3.5%.  All policy options under the ‘Gone Green’ scenario have a zero or negative NPV because there is no unserved energy and so the NPV represents only the current value of the future costs of implementing the policy option.  The NGG option shows the greatest benefit under the High Demand scenario at £37.5m.  SM3 excluding CCGTs performs less well once the annual costs of the option fees are taken into account since these costs will be incurred every year regardless of whether there is an emergency or not.

9. 9 Option Fees Costs and Benefit considerations Pöyry findings: Including Option fees produced net costs within each scenario. Costs incurred for services that had a very low probability of being exercised. Pöyry concluded that Option fees would be difficult to justify.

10. 10 Cost V Benefits BenefitsCosts Encourage additional volumes of DSR to be made available to the market. National Grid could inappropriately influence the commercial market for DSR Provides further system balancing options to National Grid if more DSR is available Could lead to National Grid extending its role as a regulated monopoly beyond what is required to provide a route to market Provides National Grid with a clear view of available DSR volumes prior to entering into a GDW Creates unnecessary risks of preventing a competitive DSR market between shippers and consumers becoming established Not economic or efficient, and may lead to inappropriate costs being passed on to consumers especially due to the nature of the event.

11. 11 DSR PrinciplesDo option fees meet the DSR Principles E) Promote, and further facilitate, parties making Demand Side Response Offers to the Licensee through open and transparent market-based arrangements The inclusion of option fees goes beyond this DSR Principle, and could lead to us extending our role, as a regulated monopoly, beyond that which is necessary to provide a route to market. F) Not unduly preclude the emergence of commercial interruption arrangements The inclusion of option fees within the centralised DSR mechanism could be viewed as inappropriately influencing / occupying an area of the commercial market for DSR products and would create unnecessary risks of preventing the competitive DSR market between shippers and consumers becoming established. G) Minimise distortions and unintended consequences on existing market arrangements and the principles of parties balancing their own positions in the wholesale gas market As outlined above the inclusion of option fees may influence the commercial market for DSR products that currently exists and also prevent a wider market becoming established therefore impacting existing market arrangements. H) Ensure that Demand Side Response is procured in a manner consistent with the Licensee’s duties under the Act and, in particular, the Licensee’s obligation to operate the pipe-line system to which this licence relates in an efficient economic and coordinated manner Based on quantitative analysis undertaken by Pöyry consulting it could be argued that the inclusion of option fees would not be economic or efficient and would lead to inappropriate costs being passes onto consumers. Based on the extremely low likelihood of this event it is difficult to justify the annual payment of option fees. DSR Principles

12. 12 Relevant ObjectivesDo option fees meet the Relevant Objectives A) Efficient and economic operation of the pipe-line system Based on quantitative analysis undertaken by Poyry consulting it could be argued that the inclusion of option fees would not be economic or efficient and would lead to inappropriate costs being passes onto consumers. Based on the extremely low likelihood of this even it is difficult to justify the annual payment of option fees. B) Coordinated, efficient and economic operation of the combined pipe-line system, and/ or the pipe-line system of one or more other relevant gas transporters As outlined above C) Efficient discharge of the licensee's obligations. Ofgems proposed licence condition SC8I sets out eight principles which NG must meet when developing the DSR Mechanism with the industry. As can be seen on the previous slide, the inclusion on option fees within the DSR Mechanism prevents NG from meeting four of these principles. Therefore NG would also not meet this relevant objective. D) Securing of effective competition: between relevant shippers; between relevant suppliers; and/or between DN operators (who have entered into transportation arrangements with other relevant gas transporters) and relevant shippers As outlined previously, in general it is beneficial for NG to minimise their residual balancer role in order to maximise the opportunity for non-monopoly parties to compete and innovate. The inclusion of option fees within the centralised DSR Mechanism could see NG go beyond this role which could limit the opportunity for a competitive DSR market between shippers and consumers becoming established. Relevant Objectives

13. Summary In conclusion, National Grid’s current view is that Option Fees would not be consistent with either the DSR principles or the relevant objectives outlined above, due to;  Inappropriate costs being passed to consumers, especially due to the extremely low likelihood of this event  Preventing a competitive DSR market becoming established  NG extending its role beyond that which is required to provide a route to market for DM customers 13

14. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. DSR Mechanism Process Flow

15. DSR Mechanism Process Flow: Off till instructed on (offer price paid throughout or up to zone isolation) Shipper/Supplier & End User agree contract to post DSR offer GDW Declared GDE Stage 1 Declared Site Firm Load Shed GDE Stage 3 Declared DSR offer posted by Shipper/Supplier posted year ahead upto DSR offer accepted by NG Accepted DSR offer exercised DSR offer not accepted & involuntary DSR Accepted offer price for accepted volume settled (paid to Shipper) (normal settlement period) Accepted offer price settled for accepted volumes (paid to shipper) GDE Stage 2 Declared Both accepted offer DSR volumes & Involuntary DSR settled @ 30 day av SAP Settlement period M+4M Paid upto zone isolation Settlement period M+23 stack order lowest price accepted first Notification lead time [specified on offer} May withdraw offer

16. Shipper/Supplier & End User agree contract to post DSR offer DSR Mechanism Process Flow: Off till instructed on (offer price paid upto FLS) GDW Declared GDE Stage 1 Declared Site Firm Load Shed GDE Stage 3 Declared DSR offer posted by Shipper/Supplier DSR offer accepted by NG Accepted DSR offer exercised DSR offer not accepted & involuntary DSR Accepted offer price for accepted volume settled (paid to Shipper) @ M+23 (normal settlement period) Accepted offer price settled for accepted volumes GDE Stage 2 Declared Both accepted offer DSR volumes & Involuntary DSR settled @ 30 day av SAP price. Settlement period M+4M Paid upto zone isolation Settlement period M+23 stack order lowest price accepted first Notification lead time [specified on offer} posted year ahead upto May withdraw offer

17. Settlement to End Consumer  Pre GDE stage 2 - settlement of payment for accepted DSR Offers will be in accordance with existing Market Balancing Action settlement timescales:  M+23 payment to shipper  Post GDE Stage 2 settlement of payment for accepted DSR Offers / Firm Load Shedding:  M+4M (in accordance with timescales and provisions prescribed in the SCR SoS Legal text section 6.4 - DSR Payments) 17 Passing on of involuntary DSR Payments to End Consumer will be in accordance with the provisions set out in the proposed modification to the Shipper Licence Condition 15A and the Gas Supply Licence 19D. These proposed Licence modifications may require further revisions to include payment arrangements for voluntary as well as involuntary DSR Payments.

18. Passing on payment to End Consumer- Gas Supplier licence Gas Suppliers licence proposed Modification in respect of SCR SoS revisions, Section 19D - Commercially Firm Customers: ‘19D.1 The licensee must include in each of its Contracts for the supply of gas to premises with a Commercially Firm Customer that it enters into or has entered into, terms which give effect to the matters set out in paragraph 19D.2. 19D.2 The Contracts referred to in paragraph 19D.1 must ensure that: (a) in the event that gas supplies to a Commercially Firm Customer are curtailed by a Gas Transporter as a result of Firm Load Shedding due to a Gas Deficit Emergency, the licensee will pay to the Commercially Firm Customer, in consideration for the provision of an involuntary demand side response service by that customer, a DSR Payment; and (b) the licensee will make the DSR Payment as soon as reasonably practicable after receiving from the Relevant Gas Shipper a payment of the same amount. 19D.3 In the event that gas supplies to a Commercially Firm Customer are curtailed by a Gas Transporter as a result of Firm Load Shedding due to a Gas Deficit Emergency, the licensee must take all reasonable steps to notify the Commercially Firm Customer that it will be paid a DSR Payment pursuant to the terms of its Contract.’ 18

19. Passing on payment to End Consumer- Shipper licence Shipper Licence in respect of SCR SoS revisions, proposed new Standard Licence Condition 15A – ‘Payment received in relation to Demand Side Response’: ‘15A.1. Any DSR Payment made to the licensee shall be paid, as soon as reasonably practicable after its receipt, to the relevant supplier. 15A.4 In this condition: DSR Payment means a credit made by National Grid NTS to the licensee:  a. for the provision of an involuntary demand side response service provided by a customer to a relevant supplier; and  b. made pursuant to Transportation Principal Document Section Q of the Uniform Network Code; Firm Load Shedding has the meaning given in Transportation Principal Document Section Q of the Uniform Network Code; involuntary demand side response service means the curtailment of gas as a result of Firm Load Shedding due to a Gas Deficit Emergency;’ 19

20. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. Posting and Accepting DSR Offers

21. Special Condition 8I: Development and implementation of a DSR methodology for use after a GDW 21 (d)be compatible with existing market arrangements setting out how any Demand Side Response Offers accepted by the Licensee are to be treated as Eligible Balancing Actions and included in the System Clearing Contract, System Marginal Buy Price and System Marginal Sell Price; (e)promote, and further facilitate, parties making Demand Side Response Offers to the Licensee through open and transparent market-based arrangements; (f)not unduly preclude the emergence of commercial interruption arrangements; 8I.4 The Demand Side Response Methodology must:

22. Posting a DSR Offer Po22 End consumer Shipper/Supplier National Grid OCM Market Operator Confirms offer and places on OCM DSR platform Accepts offer on OCM DSR Platform Offer Details: Volume, lead time, price, Site details [number of days] Day Volume or reducing volume over 24hrs (D) What else? Contractual agreement to participate DSR mechanism OBO Instruct DSR offer to be placed Maintains all DSR offer on DSR Platform Instruct withdrawal of DSR offer Revises/withdraws Offer on OCM DSR Platform (Post GDW) [All Posting actions taken prior to GDW, or D-1 of NG accepting for withdrawing a DSR offer]

23. Accepting DSR Offer 23 End consumer Shipper /Supplier National Grid OCM Market Operator Notifies Shipper of accepted trade Accepts offer on OCM DSR Platform (in price order) Calculates reduction base on number of hours left in D & lead time Reduces offtake to reflect DSR Volume accepted (EoD) Processes accepted offer & registers trade proration over hours remaining in day calculated All accepting actions taken between GDW & end of GDE Stage 1 Revises cashout prices realtime Revises Shipper balance position Notifies & confirms End Consumer of accepted DSR offtake reduction, lead time & [duration] etc (EoD requirement) Timescales for this interaction? Built in lead time? Register a physical re-nomination at relevant supply point Processes physical re- nomination

24. Posting and Accepting Areas that require further consideration  Freezing DSR Offer at GDW  Posting for Day, Multi-Day, Off till instructed on:  Affects offer strategy. Will need to agree Exercise duration and Service Fees (DSR Payments) in Stage 2+  Notification Periods:  Could agree to incorporate into Lead-time agreed between User and Shipper prior to posting?  Out of Hours arrangements  May be addressed through DSR platform design, the bid could be offered for period only within office hours?  Contractual relationship – agreement between Shipper and User? 24

25. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. Exercising DSR Trades

26. Duration DSR trade is exercised Over what period should an accepted DSR trade be exercised?  Day  Multi-day  Applied for each day upto NG instructing back on 26

27. Duration of DSR Trade Exercise: Pros and Cons 27 ProsCons Day – Offer posted and accepted and exercised on a daily basis. Daily DSR Offer will not be accepted by NG once entered into GDE stage 2 as NG ceases taking Market Balancing Actions at this point. Aligned with other OCM platformsUncertainty associated with resumption of offtake on D+1, day after DSR trade accepted, particularly in respect of managing system. Increased workload to process offers of a daily basis through the three parties. Increased risk of shipper uncertainty of balance position Multi-day – Offer Posted accepted and exercised for a specified number of days, not greater than 7 days (existing functionality) Existing functionality available on OCM post GDW Uncertainty associated with offtake reductions increasing on the day after multiday trade has lapsed. Complexity in managing various Multi-day durations and probability calculations Off till instructed on – Offer posted, accepted and exercised for the day, and continues to be exercised for every day up to NG instruction that trade contract has ceased and the site may continue offtaking. Certainty and clarity that DSR volume made available to NG for the duration that the system is in stress. Simple communication between NG, shipper/supplier and Consumer to turn down until further notice. Uncertainty as to when consumer may resume offtake Workgroup to consider Pros & Cons?

28. Exercising a DSR Trade for D+ (off till advised on contract) 28 End consumer Shipper /Supplier National Grid OCM Market Operator Process Trade info Duplicate DSR Trade for following day + Nominations, OPNs and daily processes reflect reduction in Offtake Maintains offtake reduction for each day to reflect DSR offer volume Notifies of Trade End Consumer notified. May resume offtake at [D+1] Revises cashout prices Revises Shipper trade balance position Received DSR trade information Notify that DSR trade contract complete, may resume offtake at [D+1] Notify End Consumer may resume offtake Timescales?

29. DSR Service Fees (duration of payments at the accepted DSR Offer Price)  DSR Service Fees to be discussed next month  The question of appropriate duration for payment at the DSR Offer price would not apply to a daily offered DSR product, as there will be no accepted DSR Offers beyond Stage 2, as NG ceases taking Market Balancing Actions.  The duration of payment DSR service fees at the DSR Offer price is an issue associated with ‘Off till instructed on’, or possibly ‘Multi- day’ products, as exercising such bids can continue into and through out GDE stage 2. 29 Issue: Consider whether the VoLL is only paid prior to NEC control, post this point should SoS SCR compensation apply?

30. Duration of Payment at DSR Offer Price 30 Off till instructed on Day Multi-day Paid at offer price for day Paid at Offer price for each day in specified duration on a probability calculation Paid at DSR Offer price upto FLS, then at 30 day average SAP Paid at DSR Offer price for each day for duration of curtailment or

31. Duration of payment for DSR trade at DSR Offer price: Approaches to consider 31 Initial Views Approach 1: Pay consumer at the accepted DSR offer price x accepted volume for the duration upto NG instructing that they may resume offtake Could be viewed as appropriate way of treating DSR offers as eligible balancing actions (DSR principle 4) May encourage consumer to participate, facilitating a route to market (DSR principle 5) Approach 2: Pay consumer at the accepted DSR offer price x DSR volume upto Firm Load Shedding of site. Presents greater consistency with existing market arrangements, limiting distortion and unintended consequences (DSR principle 3) Introduces the DSR mechanism as an alternative route to market,that does not compromise the development of other DSR commercial arrangement or existing route to market (DSR principle 6) Multi-day trade – Pay consumer for accepted DSR multi day trade price x volume (existing functionality) May retain some benefits with Approach 2: consistency with existing markets arrangements, whilst encouraging participation and treating offers as balancing actions of Approach 1. Workgroup to consider Pros & Cons for next meeting?

32. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. Eligibility Rules

33. 33 Licence Principles  The proposed licence condition sets out a number of principles which any DSR methodology needs to meet.  The principles relevant to eligibility are:  b) set out the criteria for determining that particular “DMC” Supply Point Components are “DMC” Supply Point Components in respect of which a party may not make Demand Side Response Offers;  g) minimise distortions and unintended consequences on existing market arrangements and the principle of parties balancing their own positions in the wholesale gas market;

34. Ofgem Final Policy Decision  Ofgem viewed that:  DSR could aid the commercial interruption market to develop;  DSR should provide a route to market for those without sufficient current route;  Gas fired generators already have a route to market and optimise their gas requirements;  Inclusion of Gas fired generators poses a risk to liquidity on the OCM. 34

35. Eligibility  Based on principle (b) the baseline for eligibility is:  Any point classed as a DMC Supply point component:  Therefore any offtake with a AQ > 2m therms / annum  However, principle (g), coupled with views expressed by Ofgem in the Final Policy Decision, suggest we need to look at options to exclude Gas fired generation from the DSR methodology. 35

36. Gas Fired generation  One option to define this could be:  Link to the definition of ‘BM Unit’ in the BSC  ‘means a unit established and registered (or to be established and registered) by a Party in accordance with Section K3 or, where the context so requires, the Plant and/or Apparatus treated as comprised in or assigned to such unit for the purposes of the Code;’  Would this be an acceptable approach and meet the principles set out?  Any other ideas on how this could be achieved? 36

37. Eligibility  However, eligibility needs to be reassessed once the final product design is concluded  Design and compensation arrangements may lead to comfort around principle (g)? 37

38. Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. Next Steps

39.  DSR expressions of interest Feedback Survey to be published to End Consumers next week.  Volumetrics analysis for September WG3  September agenda:  (KA4 & I3) - Contractual Arrangements - (KA6) Service Fees – duration DSR offer price applies  (K9) – Payment, Cost, liabilities for failing to interrupt  (KA8) Payment and settlement arrangements – including timescale between three parties  Any further views/issues/concerns you may wish to discuss further please get in touch: Claire.l.thorneywork@nationalgrid.comClaire.l.thorneywork@nationalgrid.com Tel : 01926 656383: or Darren.lond@nationalgrid.com Tel:01926 653493Darren.lond@nationalgrid.comTel:01926

40. Key areas of the DSR Methodology 1.Eligibility rules for Participation in the DSR Tender Process 2.Definition of DSR product and service 3.Timescales of the DSR service 4. DSR Process - contractual arrangements 5.DSR Mechanism submission process and operational arrangements: -DSR Offer posting process -DSR Offer acceptance process 6.DSR Service Fees 7.DSR offer price feed into daily Cashout price 8.Payment and Settlement arrangements; -Pre Stage 2 -Post Stage 2 (including settlement process for DSR offers not that were not accepted through the DSR mechanism) 9.Payments, Costs, Expenses and Liabilities for failing to interrupt 40 Development of key areas must comply with key principles set out the DSR Licence Condition

41. Key Issues identified by the Industry I1DSR productTurn down to / Turn down by I2Eligibility rulesGas Fired Generation eligibility and interaction with Electricity Market Reform I3Contractual Relationships Define contractual arrangements between Shipper/Supplier and end consumers facilitating transactions, contractual relationships, liabilities and how contracts should be reported on under existing regulatory requirements I4DSR TrialDefine trial success criteria, volumetrics will need to be established to ensure viability of mechanism I5OCM platformNeed to understand the costs associated with OCM development and implementation I6Option Fees 41 Resolution of these Issues must be compliant with the key principles set out the DSR Licence Condition

42. Special Condition 8I: Development and implementation of a DSR methodology for use after a GDW 42 8I.4 The Demand Side Response Methodology Principles are that the Demand Side Methodology must: (a) ensure that any party making a Demand Side Response Offer is a party to the Uniform Network Code; (b) set out the criteria for determining that particular “DMC” Supply Point Components are “DMC” Supply Point Components in respect of which a party may not make Demand Side Response Offers; (c) allow the Licensee to accept Demand Side Response Offers only where a Gas Deficit Warning is in place or within Stage 1 of a Gas Deficit Emergency; (d) demonstrate compatibility with existing market arrangements by setting out the manner in which any Demand Side Response Offers accepted by the Licensee are to be treated as Eligible Balancing Actions and included in the System Clearing Contract, System Marginal Buy Price and System Marginal Sell Price; (e)promote, and further facilitate, parties making Demand Side Response Offers to the Licensee through open and transparent market-based arrangements; (f) not unduly preclude the emergence of commercial interruption arrangements; 3 of 5 (g) minimise distortions and unintended consequences on existing market arrangements and the principle of parties balancing their own positions in the wholesale gas market; and (h)ensure that Demand Side Response is procured in a manner consistent with the Licensee’s duties under the Act and, in particular, the Licensee’s obligation to operate the pipe-line system to which this licence relates in an efficient, economic and co-ordinated manner.