1. 1 Project Nexus Approach to modelling costs and benefits Cesar Coelho Ofgem Project Nexus UNC Workgroup 15 May 2012

2. 2 Agenda Overall approach to analysis and modelling Steps for conducting analysis Take-up scenarios Costs and benefits Competition and distributional impacts

3. 3 Where we are Project Nexus (PN) has the potential to deliver significant benefits for consumers At PNAG in March, Ofgem offered to help support the workgroup’s analysis We have developed an approach for modelling the costs and benefits of PN for discussion today We also intend to facilitate discussion on consumer issues Ofgem’s role

4. 4 Overall approach Standard approach to cost benefit NPV modelling costs and benefits –Decision on time horizon –Discounting Uncertainty –Scenario-specific uncertainty (e.g. specific to PN implementation) –Universal uncertainty (e.g. Magnitude of energy prices) Approach to questions: simplify so these do not need to reflect the detail of the modelling High-level principles TIME NPV

5. 5 Steps for conducting the analysis Step 1 Establish potential take-up scenarios Step 2 Estimate benefits, quantify where possible Compare Nexus implementation with counterfactual scenarios Assess any impacts on competition, distribution of costs & benefits High-level principles Establish how industry costs would change according to the level of take up Step 3 Step 4 Step 5

6. 6 Step 1 – Take-up scenarios Take-up scenarios drive: –Costs –Benefits –Impacts on competition Define: –Implementation scenario –Range of counterfactual scenarios

7. 7 Step 1 – Take-up scenarios – Settlements TIME Counterfactual: Maximum plausible take-up of DM settlement without Nexus implementation (LSP) 3 Counterfactual: Minimum plausible take-up of DM settlement without Nexus implementation (LSP) SETTLEMENT PRODUCTS – TAKE UP 100% 0% 3 1 2 4 3 3 3 Settlements implemented: Maximum plausible take-up of daily settlement products Settlements implemented: Minimum plausible take-up of daily settlement products

8. 8 Step 1 – Take-up scenarios – Settlements time reference TIME Milestone for framing stakeholder questions – Post-implementation SETTLEMENT PRODUCTS – TAKE UP 100% 0% 3 Time to be used as reference to frame questions: Need to understand current take-up (DM/NDM) Post implementation assumption: Daily meter data is available Post-2020 3 3 3 Milestone for framing stakeholder questions – Pre-implementation (central agent)

9. 9 TIME 3 Milestone for framing stakeholder questions – Post-implementation SETTLEMENT PRODUCTS – TAKE UP 100% 0% 3 1 2 4 3 3 3 Milestone for framing stakeholder questions – Pre-implementation Step 1 – Take-up scenarios – Settlements questions Question: Assuming that it is possible to access daily meter reads, what are minimum and maximum likely take-up scenarios for each settlements product (at milestone XX)? Bottom up + top down approach: Ask the group for a common view Ask individual stakeholders for view across their portfolio, weight by portfolio size

10. 10 Step 1 – Take-up scenarios – AQ, MPR frequency TIME 2 Milestone for framing stakeholder questions – Post-implementation Rolling AQ – TAKE UP 100% 0% 3 1 3 Rolling AQ/MPR implemented: Maximum plausible take-up Rolling AQ/MPR implemented: Minimum plausible take-up Time to be used as reference to frame questions: Post implementation assumption: Daily meter data is available Post-2020

11. 11 Step 1 – Take-up scenarios – AQ, MPR frequency questions TIME 2 Rolling AQ – TAKE UP 100% 0% 3 1 3 Question: Assuming that it is possible to access daily meter reads, what percentage of your portfolio would update the AQ/be reconciled on a monthly, quarterly, six monthly, annual basis (at milestone XX)? Bottom up + top down approach: Ask the group for a common view Ask individual stakeholders for view across their portfolio, weight by portfolio size For discussion: Frequency intervals Counterfactual

12. 12 Step 2 – A framework for costs – Applying a cost curve Take-up 100% AGGREGATE COST t Today’s level of DM-settlement take-up Increased take-up of DM settlement over time TIME NPV

13. 13 Step 2 – A framework for costs – Question on costs (1) 13 1 Take-up 100% AGGREGATE COST 2 Cost at maximum plausible take- up, post- implementation 3 Cost at maximum plausible take-up, counterfactual xx Question: What would your costs be to meet the take-up of DM settlement at (1), (2), (3) and at (4)? Cost at minimum plausible take- up, post- implementation 4 Cost at minimum plausible take-up, counterfactual xx

14. 14 Step 2 – A framework for costs – Question on costs (2) 14 1 Take-up 100% AGGREGATE COST 2 3 xx Question: Are there levels of take-up that would require you to make capital investment? If so, at what level of take up do these bite? How much additional capital investment is required? 4 xx 5 Additional detail on upgrade points and costs

15. 15 Step 2 – A framework for costs – Sensitivity analysis 15 1 Take-up 100% AGGREGATE COST 2 3 xx 4 xx 5 Sensitivities

16. 16 Potential benefits Accurate allocation of energy costs: –Lower balancing/settlements costs –Suppliers’ costs more accurately reflect customer usage Other benefits –Long term gas purchasing gains –Identify and reduce unallocated units –Efficiencies/cost savings Network benefits from Nexus –More accurate allocation of network costs –Better network planning –More accurate reporting of losses Step 3 – Assessing benefits

17. 17 Step 4 – Comparing costs and benefits (1) TIME Compare implementation costs and benefits...... with counterfactual scenarios and sensitivity testing.

18. 18 TIME PN Implemented NPV Net cost Net benefit Hurdle test Sensitivity testing High-level approach Quantitative modelling gets you so far Test is what then has to be delivered by non-quantified benefits to go ahead Apply this methodology to each counterfactual scenario / sensitivity Could derive from qualitative benefits Step 4 – Comparing costs and benefits (2)

19. 19 Competitive and distributional impacts Need to assess impacts on competitive position of market participants Quantify distributional effects / improvements in allocation –Allocation of charges –Charges effectively paid – reconciliation –Effects of meter reads submission on allocation and reconciliation Step 5 – Distributional effects

20. 20 Different rules for different segments NDM SSP –Allocation based on annual AQ –No reconciliation –Meter reads do not affect reconciliation; only affect AQ on an annual basis NDM LSP –Allocation based on annual AQ –Reconciliation once a meter read is submitted –Meter reads used for reconciliation; only affect AQ on an annual basis Step 5 – Distributional effects – Market segments

21. 21 Approach 2 sources for inaccuracy if daily meter reads are not used –allocation –reconciliation Bottom-up approach (zero-sum game between providers, but possibly not between segments of customers) –Assume error for allocation –Assume error for reconciliation –Possibility for using different profiles for errors Step 5 – Distributional effects – Approach

22. 22