Operating Margins UNC Sub Group Tuesday 4 th November 2008

2 Agenda OM Contestability Update UNC Section K: Operating Margins  How it works currently  What we are looking to change Next Steps  Business Rules and Legal drafting  Aim of Next Meeting

3 Competitive Provision of Operating Margins Change to National Grid Gas’s Transporter Licence which:  Introduced Special Condition C25 requires use of reasonable endeavours to promote competition in the provision of Operating Margins (OM) services by 1 st April 2009 Progress to date:  Initial consultation exercise March - May 2008 Detailed the need for the OM Service Considered options for further competitive provision of OM  Second consultation September 2008 Presented our conclusions on how the OM Service could be delivered by Potential Service Providers Considered the barriers to provision for each Potential Service Provider Considered how to procure the OM Service Looked at how to incentivise Operating Margins going forward

4 OM Contestability Update (1) ProviderSuitabilityNext Steps StorageAs current OM providers, new sites should be encouraged to consider OM provision LNG Importation As current OM providers, new sites should be encouraged to consider OM provision NTS Demand Potential OM providers. UNC changes required. Safety Case principles (for equivalent storage robustness) to be set out, but decisions on a case-by-case basis DNsPotential OM providers. UNC changes required. DN Safety Case changes required/principles (for equivalent storage robustness) to be set out. Offshore Supply/ Importation Unlikely OM providers – for supply, depends on load factor, offshore linepack and time of flight of product. For importation, significant legislative barriers Current and Potential OM Providers: National Grid Gas View

5 OM Contestability Update (2) ProviderSuitabilityNext Steps NTS Demand Most likely potential OM providers, although little interest expressed in providing service at this stage. Design of product will be key. DNsPotential OM providers. Numerous barriers to service provision. Limited response to DN interruption tenders does not bode well. Offshore Supply/ Importation Unlikely OM providers – respondents generally sceptical regarding ability or desire to participate in OM provision In light of consultation responses, initial focus from a service design perspective is on OM provision from NTS Demand Potential OM Providers: Consultation Responses

6 UNC Section K: Overview Currently, Section K: Operating Margins covers the following:  Sources of Operating Margins: Storage Sites & LNG Importation Terminals  Procurement Mechanisms Capacity arrangements (National Grid NTS holds capacity and gas for use when required); and Delivery arrangements (3 rd party holds capacity and gas for use when required)  Cost Recovery Mechanisms Value of gas-in-storage (for both capacity and delivery arrangements) Treatment of costs associated with OM utilisation

7 Operating Margins Sub Group Established to consider modifications to Section K:  Facilitate provision of the service from a wider pool of providers to open up more competitive and efficient procurement ; and  Add clarity to existing arrangements We are also in discussions with Ofgem regarding ‘Consent to Modify’  re: incorrect cross referencing in current Section K

8 What are Operating Margins (OM)? OM gas is only used in exceptional circumstances to:  Allow time for National Grid Gas to reconfigure the NTS or for the market to deliver additional supply  Protect against the need to declare emergency conditions so that normal commercial market operation can be maintained where possible Primarily, OM will be used in the immediate period following stresses/shocks:  Supply Loss  Unexpected pipeline and/or plant failure  Demand Forecast Error  Facilitate orderly rundown (partial or full)

9 Current OM Service Provision Service Characteristics  Physical change in gas offtake or delivery of gas onto the NTS  Rapid response  Measurable, demonstrable service  Must be available for NGG to call on at all times declared in advance (day or night) Current OM Service Providers:  Short Range Storage  Medium Range Storage  Long Range Storage  LNG Importation Terminals with Storage

10 Section K: Current Principles and Changes Required Determination of Operating Margins Requirements  National Grid determines its Operating Margins Requirements for each Storage Year using a combination of network simulation analysis and statistical techniques  The Operating Margins Statement published each year covers: The assumptions used in the determination of the OM Requirement The aggregate quantity of gas required for Operating Margins The amounts of deliverability and space in each storage location The Operating Margins Profile Changes required: To facilitate procurement from non-storage providers, certain references to ‘Storage Year’ will need to be amended to ‘Operating Margins Requirement Period’

11 Section K: Current Principles and Changes Required National Grid Gas currently has the ability to enter into and terminate the following arrangements to meet the OM Requirements:  Operating Margins Capacity Arrangements Whereby National Grid Gas holds Operating Margins Capacity and gas at Operating Margins Facilities which can be called upon when there is an OM event  Operating Margins Gas Delivery Arrangements Whereby a third party holds the OM gas at Operating Margins Facilities which National Grid can call upon when there is an OM event Operating Margins Facilities are currently defined as Storage Facilities and LNG Importation Facilities Changes required: Operating Margins Facilities will need to include Supply Side Facilities and Demand Side Facilities

12 Section K: Current Principles and Changes Required Operating Margins Capacity Arrangements: Managing gas held in storage  Within or before the Storage Year make arrangements for the re-profiling, procurement (Margins Gas Procurement Arrangements) and sale of gas: Sell gas in store via a Storage Gas Transfer Use a Storage Gas Transfer between OM Facilities Withdraw gas and sell at tender Buy and sell gas-in-store with other Relevant System Managers Withdraw from OM Facilities in ‘surplus’ and inject into OM Facilities in ‘deficit’ (Carry-Across Gas) Buy gas from Users and others in store or by making Acquiring Trade Nominations  Where the gas is bought out of store, the gas must be injected into the Operating Margins Space in line with the Operating Margins Facility Terms  Balancing the cost of such arrangements with the need to secure the availability of gas Changes required: Rationalise and simplify current arrangements Clarify the role of ‘Relevant System Managers’

13 Section K: Current Principles and Changes Required Procurement: Operating Margins Gas Delivery Arrangements:  Within or before the Storage Year make arrangements for the delivery of gas  Balancing the cost of such arrangements with the need to secure the availability and the delivery of the gas  Mechanism: Tender process leading to a contract with Users or others for the delivery of gas Changes required: None – current arrangements for Operating Margins gas Delivery Arrangements are flexible enough to deal with new service provider types

14 Section K: Current Principles and Changes Required Procurement Flexibility:  National Grid Gas is currently able to terminate Operating Margins Capacity Arrangements during a Storage Year and enter into Operating Margins Gas Delivery Arrangements as required  Also, National Grid Gas is currently able to terminate Operating Margins Gas Delivery Arrangements during a Storage Year and enter into Operating Margins Capacity Arrangements as required Changes required: National Grid Gas requires flexibility in the way it manages its OM holdings, whether that be by switching between different capacity arrangements, different delivery arrangements or between capacity and delivery arrangements. Following a switch from capacity arrangements, National Grid Gas may wish to terminate those capacity arrangements (hence relinquishing capacity) or sell on the capacity to a third party.

15 Section K: Current Principles and Changes Required Calculation of Costs associated with Operating Margins Capacity Arrangements:  Operating Margins WACOG Weighted average cost of gas-in-storage  Carry Over Gas Cost  Gas Procurement  Storage Gas Transfers  Transportation Charges  Balancing Charges  Injection Charges  User Agents Fees  Carry Across Gas & Withdrawal Cost  Net Margins WACOG As above but removes costs associated with transportation and injection of gas Changes required: None – current arrangements remain appropriate, however drafting could be simplified

16 Section K: Current Principles and Changes Required Calculation of Costs associated with Operating Margins Gas Delivery Arrangements:  Net Margins WACOG Weighted average cost of gas delivered to National Grid NTS for Operating Margins Purposes Principles set out in the Operating Margins Statement Changes required: None – current arrangements remain appropriate

17 Section K: Current Principles and Changes Required Treatment of costs and revenues associated with the Utilisation of Operating Margins  National Grid recovers from Shippers either the energy costs (for capacity arrangements) or the delivery fee (for gas delivery arrangements) when OM is utilised by inclusion of Daily Margins Recovery Amount into Balancing Neutrality Charges Changes required: None – current arrangements remain appropriate

18 Section K: Current Principles and Changes Required Closing Margins Adjustment Charge:  Applies only to gas sold that had previously been held in storage under Operating Margins Capacity Arrangements  Closing Margins Adjustment Charge is the sum of weighted average cost of gas in store (which includes the original cost of gas & putting it into store) and any cost of sale minus the revenues received on the sale of the gas  Recovered /paid by Users in proportion to their UDQIs and UDQOs Changes required: None – current arrangements remain appropriate

19 Next Steps Detailed Business Rules and Legal Drafting  Current Section K could be described as ‘convoluted’ and is a victim of a number of incremental changes Changes as a result of contestability work are essentially minor, however desire is to rationalise, simplify and clarify where possible Consequently, plan is to re-write Section K Aim to provide business rules and/or legal drafting in time for next meeting Aim of next meeting  To run through business rules in detail, in preparation for formally raising UNC modification