1. Entry Capacity Substitution Workshop 9 – 7 th July 2009 DRAFT PRESENTATION

2. 2 Overview After the informal consultation Ofgem has made clear, in their letter of 3 rd July, that they would not approve an Entry Capacity Substitution methodology based on future forecast flows, i.e. the Mechanical Approach. National Grid has therefore reviewed the remaining two options. Unfortunately National Grid does not believe that the Two-Stage Auction can be implemented for March 2010. Hence National Grid is proposing to put forward the Option Approach for formal consultation.

3. 3 Agenda  Review / further development of proposals  Two-stage Auction  Option Approach  Next Steps

4. Entry Capacity Substitution Two Stage Auction

5. 5 National Grid views Two-stage Auction Full User commitment required (or possibly no User commitment if no incremental signal).  Assumes unsold = unwanted  Forces Users to commit earlier than they may feel able Particularly relevant to short-term players, marginal fields. Implementation is highly complex and uncertain (see timeline)  Alters QSEC processes by reducing number of bid windows  Uses mixture of auction functionality  Depends on a major change to UNC (i.e. credit) to be implemented. Since this proposal was first considered new “credit” arrangements have been proposed which would adjust the QSEC timeline to make implementation of 2-stage auction more challenging.  Systems implication of credit interactions need to be confirmed, e.g. to remove stage 2 allocations if credit check fails.  Further UNC change may be required to accommodate credit processes for stage 2. Hence we do not intend to pursue this approach for March 2010.

6. 6 STAGE 2: 3 rounds Obligated only Two Stage Auction – Proposed March 2010 timeline 1234567891011121314 STAGE 1: Five rounds Obligated & incremental Stage 1 closed Allocations made on Gemini Stage 1 QSEC opened NPV test Incremental capacity identified Info published for each ASEP: Total sold & quantity passing NPV test 1516171819202122232425262728293031 Stage 2 opened Stage 2 closed Earliest start date. AMSEC run in Feb. Latest end date. 42 month lead time starts. Shippers review position Reduced from current 10 rounds. Min 5 requested.

7. 7 STAGE 2: 3 rounds Obligated only Two Stage Auction – Proposed March 2010 timeline Potential Impact of Entry Credit Mod Proposals 1234567891011121314 Stage 1 closed Stage 1allocations made on Gemini Stage 1 QSEC opened NPV test Incremental capacity identified Info published for each ASEP: Total sold & quantity passing NPV test 1516171819202122232425262728293031 Stage 2 opened Stage 2 closed Shippers review position Potential discontinuity Credit proposals are subject to Ofgem Impact Assessment which is not expected to conclude until late August. Hence the Two-Stage auction presents a challenge to accommodate within the available time. One day after each bid window for credit checks. STAGE 1: Five rounds Obligated & incremental

8. Entry Capacity Substitution Option Model

9. 9 National Grid views Option Approach. A good compromise between the two extremes. Requires User Commitment  May be considered too small at some ASEPs.  Or too high at others (where reserve price is low).  But, could be zero cost if capacity is booked. Relies on Shippers’ assessment of needs not National Grid judgement. Relatively simple to implement.  No impact on QSEC processes for Shippers. Except for participation in the earlier Options Window  No major impact on QSEC processes for National Grid. Allocations rules / process need to be managed; “Tracking” of Options will be required: Both may require future IT development.  Further clarity on how the Option process would work has been provided (see subsequent slides).

10. 10 Option Approach Capacity at an ASEP would be prevented from being substituted in response to an incremental signal elsewhere. This would be subject to a signal and commitment from Shippers by way of 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.

11. 11 Option Approach – What is the Option? It is proposed that the Option: identifies and excludes capacity from substitution processes thereby protecting capacity for the duration of the Option; nominally applies in respect of Q3 Y+4, i.e. from the default 42 month lead-time, for the purposes of defining refunds; will still prevent capacity being substituted away if the incremental capacity is allocated earlier or later than the default lead time; is placed ahead of QSEC and applies for 12 months, i.e. covers (normally) one QSEC and any ad-hoc QSECs before the next option window. will be subject to a one-off Option Fee. This will be a fixed price per unit of capacity and will be the same for all ASEPs. The Option Fee shall be:  £32,120 per mcmd of capacity covered by the Option.  This is derived from minimum reserve price * 32 quarters. i.e. 1 mcmd * 11 * 10^6 (convert to kWh/day) * 0.0001 p * 365 * 8 / 100 (convert p to £) will be pro-rated if available capacity is exceeded.

12. 12 Option Approach – What is the Option? The Option will not: prevent other Shippers (or the relevant Shipper) buying capacity at that ASEP in the period covered by the Option; be sold in quantities above the quantity available in QSEC (usually 90% baseline – sold); be available to non-Users. This is due to complications with potential refunds. However, extending the process to non-Users could be an option to be considered for 2011.

13. 13 90 % of baseline capacity. (May be higher if incremental capacity has previously been released). Time Diagram 1: Capacity Available for Substitution at Donor ASEPs Option Approach Capacity release date at recipient ASEP (usually 42 months) Sold capacity Capacity. Option quantity Available capacity for substitution

14. 14 Diagram 2: Capacity Allocation at ASEPs with Options Existing Sold Capacity “Unprotected” Options Quantity Post-auction allocations Sold Capacity Options Quantity “Unprotected” 90% baseline Capacity Pre-auction capacity Withheld from QSEC Baseline capacity Unsold Capacity New Sold Capacity Withheld from QSEC Unprotected capacity will be allocated first, then capacity under Option. New Sold Capacity NB: In respect of subsequent QSEC and AMSEC auctions the Shipper taking out an Option will be allocated the protect capacity, thereby triggering the refund.

15. 15 The Option Window It is proposed that: The Option Window will be open for 2 “bid days” from [8am to 5pm].; There will be one day between the bid days; Option requests will not be visible within the bid window but Options granted shall be published before [7pm] on the bid day;  This will consist of relevant ASEP and quantity.  The same data on Options granted will be included in the QSEC invitation letter. Options will be requested via fax. A pro-forma will be developed. Any Options requested cannot be removed or amended except where the request submitted is identified by National Grid as blatantly erroneous and is rejected.  National Grid will accept no liability in respect of erroneous applications, but will endeavour to resolve errors within the bid day. Those not resolved or rejected by 5pm will be accepted as submitted.  Any pro-rating due to Options exceeding available capacity will be carried out at the end of each bid day. The Option Window will be run in January 2010 (see timeline).  Avoid clash with AMSEC in February.

16. 16 Diagram 3: Option Approach – Timeline for 2010 QSEC Mid Dec Invitation letter for Options issued 7 Dec Approval of Methodology Statement Mid Jan Option window. 2 days plus 1 day between Mid Mar QSEC Apr / May Bids Allocated - 2 months – as defined in UNC section B 2.6.7 Feb AMSEC 4 tranches with 2 days between Early June Ad hoc Invoice for Option if required DEC 09JAN 10FEB 10MAR 10APR 10MAY 10JUN 10JUL 10 Mid Feb QSEC invitation letter Mid Jan Notice of charges N Grid Analysis N Grid Governance Ofgem Governance Precise dates for QSEC auction to be confirmed

17. 17 Option Fees It is proposed that: The Option Fee will be £32,120 per mcmd irrespective of ASEP; The Option Fee shall be invoiced via an “ad-hoc invoice” after capacity allocations are confirmed; i.e. June 2010. In the event that capacity covered by an Option is allocated in the same year as the Option is taken out then the Option will be revoked, the Option Fee will not apply and no invoice will be raised. The Option Fee shall not be subject to additional credit or security.  Amounts involved are relatively small  Impact in event of default is/may be unnecessary investment due to missed substitution opportunity. However, the risk of default is highest where there are no incremental capacity requests. Option Fees will be refunded where capacity is subsequently allocated (see next slide for details).  Refunds will be credited in June 2010. Treatment of Fees National Grid’s current view is that Option Fees will be offset against TO Entry Commodity Charges (and refunds treated accordingly). National Grid anticipate raising a Charging Consultation on the treatment of Option Fees following September TCMF.

18. 18 It is proposed that the Option Fee will be refunded where the relevant Shipper is subsequently allocated, in a QSEC or AMSEC auction, the capacity covered by the Option. In these auctions the minimum reserve price will apply to the allocated capacity. For the refund to apply the capacity must be obtained for one or more months for the designated year covered by the Option. For an option taken out in Jan 2010 capacity must be allocated for October 2013 to Sept 2014. The refund amount will equal the charge for the capacity allocated but will be capped at the Option Fee. In the event that the capacity covered by the Option is allocated in the QSEC in the year in which the Option is taken out, to the relevant Shipper or to another Shipper, the Option will be revoked. The Option Fee will not be invoiced. Note that in this QSEC auction all Shippers (including the relevant Shipper) will be allocated unprotected capacity before that covered by the Option. The Option will be revoked (in part or whole) after all unprotected capacity has been allocated. Option Fee Refunds

19. 19 Option Fee Refunds Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Option taken QSEC auction Period covered by Option Period covered by QSEC 11 Period covered by QSEC 12 QSEC 11 QSEC 12 AMSEC 13 Period covered by AMSEC 13 AMSEC 14 Period covered by AMSEC 14 Refund if capacity obtained for any month in this period Auctions where capacity can be obtained that may trigger a refund. Relevant Shipper must be allocated capacity to get refund. Option Fee not raised if any Shipper is allocated capacity in this QSEC National Grid will track Options from January 2010 until February 2014. If a refund has not been triggered the Option will fall away and the Option Fee retained. Substitution will be allowed in QSEC 11 from 42 months (Q4 14) unless a further Option is taken out in Jan 11.

20. 20 Option Approach – Associated Issues Informal consultation respondents mostly favoured a low exchange rate cap. Several see exchange rate caps as being a soft landing tool that can be reviewed and relaxed after experience of substitution is gained. National Grid is proposing an exchange rate cap of 3:1  This is significantly lower that the cap applied to Transfer and Trades.  With Shippers having an opportunity through the Options to protect capacity, an additional constraint by way of 1:1 exchange rate cap would seem inappropriate. Partial substitutions will be progressed Entry Zones are proposed to be used for selecting potential donor ASEPs. Within zone, donor ASEPs would be selected on the basis of best exchange rate. This should provide the most economic outcome. Out of zone, donor ASEPs would be selected on the basis of shortest pipeline distance from the recipient ASEP.

21. 21 Option Approach.

22. 22 Summary The Option Approach 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. National Grid is proposing that Option Fees are refundable if the capacity is ultimately bought (see slide 18) thereby making the fee relevant only to speculative Options. The Option Approach allows and encourages Shippers to identify and protect their needs. Shippers may benefit from awareness of market developments but this is not essential. The amount of protected capacity is determined by Shippers actions not National Grid assumptions. Options (and existing sold capacity) will quantify reasonable and foreseeable future capacity demands which should be excluded from substitution.

23. 23 Next Steps  Formal consultation  24 th July 2009  Closes 21 st August 2009  Proposed methodology statement submitted to Authority by 4 th September 2009  Ofgem Impact Assessment To follow submission of proposed methodology statement Subject to Licence change to allow additional time between submission of methodology statement and deemed approval to facilitate IA time table.

24. 24 Consultation and reporting Develop Treatment of Option Fees 07/11/09 Submit Charging Proposals for Approval Approval of Charging Proposals Timeline – Development of Options Approach Jan 09Feb 09Mar 09Apr 09May 09June 09July 09Aug 09Sept 09Oct 09Nov 09Dec 09 07/01/09 Workshop 6 07/04/09 Workshop 8 07/07/09 Workshop 9 10/02/09 Workshop 7 Develop Licence Change 01/09/09 Licence Changes Effective 07/09/09 Submit ECS for Approval 07/12/09 Approval of ECS 24/07/09 Impact Assessment as necessary formal consultation 08/06/09 21/08/09 informal consultation 03/09/09 TCMF