PEA POTENTIAL FUTURE SCARCITY PRICING JUNE 2013 (UNFINISHED BUSINESS OF APRIL 2013) Drafter Lewis Evans

APRIL 2013 AGENDA JUNE Revised terms of reference 2. State of the market 3. Context 4. PEA thinking 5. In Progress: today finalisation? 6. Workshop Topics

System Evolution I (April 2013) Systems and Physical Capacity Pipe Utilisation point-to-point Gas Spot Market Separate from Transmission VIC/NSW Carriage Maui & Vector contract Point-to-point Shipping Maui & Vector contract with interruptible Nodal entry/exit transactions Input need not equal take System cost (&Functional Specialisation) Point-to-pointAs above + market pricing nominations Thursday, April 11, 2013 Panel of Expert Advisers 3

PEA On Progress (April 2013) Consider the effect on incentives on Vector (and MDL) and TSOs to manage for timely change in the presence of Part IV regulation More precision on form and pricing of nominations Panel of Expert Advisers 4 Thursday, April 11, 2013

PEA ( June 2013) The scarcity pricing issue Panel of Expert Advisers 5 Thursday, April 11, 2013 Price Nomination/shipping charge Demand capacity Clearing price Firm common/interruptible Nominations to be scaled

PEA (June 2013) A practical potential/feasible approach to pricing (frequent) scarcity Start with MPOC where Panel of Expert Advisers 6 Thursday, April 11, 2013 There are nominations required for all nodes (WPs) No historical-use grandfathering Nominations form the shipping contract AQ i is firm capacity held by shipper i, where sum AQ i = 70% of capacity Define AQ i capacity, to be the right to ship (i.e. nominate), but not the obligation to ship gas at a volume of AQ i.. AQ is tradable in any amount There are yearly auctions of a mix of (say) tranches of 1 and 5 year capacity (i.e. the AQ i )

PEA (June) A practical potential/feasible approach to pricing (frequent) scarcity Process I Panel of Expert Advisers 7 Thursday, April 11, 2013 All shippers nominate (say for the following day) n i Feasibility: If there is excess demand, sum n i > capacity and TSO scales back all nominations pro-rata. Produces adjusted feasible nominations n* i where - sum n* i = capacity - Payment under the shipping contract is shipping charge x n* i. Firmness: TSO then adjusts (pro rata) the n* i so that the firm AQ i can be satisfied. Call these adjusted nominations n** i. They are feasible and - Sum n** i = capacity - n** i meet firmness nominated: ≤ total potential firmness (capacity)

PEA (June) A practical potential/feasible approach to pricing (frequent) scarcity Process II Approach 1: that is the end of the story Approach 2: firm capacity buys its firmness from the infirm (sic) at say the spot price of gas (p g ) The feasible delivered nominations (n* i ) at the node have been adjusted pro-rata (to n** i ) so that the benefit of firmness is provided to those with AQ at that node then Shippers with AQ i pay p g x (n** I - n* i ) Shippers without AQ receive p g x (n* I - n** i ) And aggregate payments = aggregate receipts Panel of Expert Advisers 8

PEA (June) A practical potential/feasible approach to pricing (frequent) scarcity The Pros and Cons I Approach 1: determines prices of demand/supply of firmness at the time of the AQ auction in the context of potential excess demand for capacity. It does so in advance of shortages. It does not provide short run pricing that may be important within a year and as the market evolves Approach 2: also prices demand/supply of firmness in advance; but has an approximation to a spot market that reflects actual outturns. The ex ante cost of firmness(auction price) will reflect the expected level of payments at the spot price Thursday, April 11, 2013 Panel of Expert Advisers 9

PEA (June) The Pros and Cons II More on Approach 2: is it reasonable? The infirm: Have gas at that node bought from them under forced sale. It is reasonable payment would be the spot price of gas (they pay shipping to the node): i.e. the minimal return that the interruptible shippers might expect at that node The firm: Pays ex ante for the right of a forced purchase of gas at the spot price to achieve firmness. The AQ auction prices will reflect this, as will their downstream trades. The approach mirrors commodity markets where hedges (the AQ) are the norm and overs and unders are traded on spot Thursday, April 11, are 10

PEA (June) The Pros and Cons III NSW seems to use shipper bids in the spot as revealed preference for setting capacity charging. This could be a development, but it is unclear if it is a material advance. The auctioning of (AQ) ex ante firmness is important and likely to address problems identified with NSW and Vic: entry problems from volatility of charges and no long term price signals NZ gas spot market is proposed and would fit with the evolution of Approach 2 Induces utilisation of AQ or release (e.g. via nomination or sale of firmness) Thursday, April 11, are 11

PEA (June) Potential/Possible application in VTC Create welded points at least at capacity-critical nodes or in relation to them (virtual WPs) Nominations at welded points, be the basis for shipping charges Capacity contracts same in principle as AQ Grand fathering capacity doesn’t matter much since capacity is just AQ and shipping charge is on nominations: ie use it or lose it (shouldn’t expand GF) Auction capacity Move to a mix of contracts (say firm(70) : interruptible(30)) How to treat non-welded points? Perhaps zones behind constrained (virtual) WPs? Thursday, April 11, are 12