GRI NW Investment Workshop Chris Logue, European Policy Manager, 4 th June 2010 The Hague

2 Life Before Long Term Auctions  “Transco” undertook centralised system planning – TBE Process – continues today  Obligation to sell entry capacity to Seasonal Normal Demand +10%  System built to deliver 1:20 peak  From this planning and scenario analysis, Investments were put to the regulator  Industry perception of “Gold Plated” system  Investments made under: Statutory (1:20), Power, Flexibility, Emissions or Other (primarily replacement) categories

3 Auctions  Long term auctions began in 2003  Auctions provided  Equal opportunity to obtain capacity  Price discovery  Simple allocation process (at least to start with)  Mechanism to manage entry capacity constraints

4 Quarterly System Entry Capacity  QSEC (Quarterly System Entry Capacity)  Held every March  Offers capacity from 18 months out for 15 years (i.e. Sept’08 offer capacity for April 2010 to March 2025).  Cleared price auction  Reserve Price (P0) and up to 20 incremental price steps – up to 150% of baseline  Potential for incremental signals (i.e. release new capacity)  To release new capacity, bids must pass an NPV test in accordance with the Incremental Entry Capacity Release Statement (IECR)

5 Quarterly System Entry Capacity  If a new system point is required then National Grid will work closely with users in the build up to QSEC to determine the viability of a new capacity point to bid upon  If the regulator agrees then it will determine the Unit Cost Allowance in conjunction with National Grid  If bids for this new point, or an existing point are above Baseline (baseline of new points will equal zero), an economic test is undertaken to determine any need for new investment in the Transmission system

6 Quarterly System Entry Capacity – The Economic Test  If bids are above Baseline capacity:  Incremental Entry Capacity Release (IECR) test undertaken  Is the Net Present Value (NPV) of bids over an 8 year period higher than 50% of capitalised Unit Cost Allowance?  If so, Baselines are permanently increased  This may involve capital investment  If not, National Grid may wish to consider releasing non obligated entry capacity  Incremental capacity release has a 42 month lead time  Incentives to reduce lead time  Opportunity to extend lead time e.g. in case of planning/construction issues

Regulatory Decision – The Story  National Grid had committed initial St Fergus capital based upon signals and market assessment in 2002 – then completed the Investment by 2005  Ofgem accused NG of placing insufficient weight on “important new information on the location of large new sources of gas supply” during their “go / no go” review in 2003  Initially, £75m of NG’s capex was excluded from the RAV

Regulatory Decision  Ofgem believed NG had not provided adequate justification for the expenditure incurred  They concluded that, since this project was initiated in the early days of the new entry regime, it would be inappropriate to exclude it from the RAV altogether  The effect of this is to allow £56 million to enter the RAV at the time at which the expenditure was incurred

– Further Regime Changes  Introduction of baseline substitution  substitute capacity from another ASEP  Introduction of trade and transfer  capacity moves to those who value it most  New form of revenue driver introduced  Old form still exists for previous releases  Automatically becomes baseline after 5 years

– Further Regime Changes  Opportunity for accelerated release  Release in 6 months prior to incremental obligated  National Grid NTS keep 100% of revenue  Permits  National Grid can “play” a permit if investment period cannot be met (42 months on entry)  Can “gain” a permit if can deliver earlier (and signal received)  Investment buyback incentive

11 Summary  Constant regime change  Regulatory intervention has led to investment processes using quantifiable and auditable methodologies  Economic test has become the “only show in town”  more cautious investment  associated pros and cons  Long Term auctions do not necessarily provide long term signals….  Users may take a commercial view not to signal  Original regulatory intentions get lost and changed  Selling so far out makes regime change more difficult/complex