Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. PARCA: Incentive Arrangements

2 Purpose  To detail our initial thoughts and seek your views on potential incentive arrangements under a PARCA solution  These initial thoughts are based upon our May 2012 RIIO business plan submission  Annex B delivering Connections and Capacity  The following slides cover the following:  Capacity Delivery Incentive (to replace the permits scheme)  Pre-capacity Allocation Proposal  We believe that the incentive arrangements detailed in these slides compliment the PARCA solution and bring additional benefits to industry  We do not consider that the PARCA solution is reliant on revised incentive arrangements Note: The following slides do not indicate the acceptance or otherwise of the RIIO final proposals by National Grid NTS

3 Capacity Delivery Incentive - initial thoughts (1)  We recognise that a customer may value both:  the early delivery of incremental capacity against default lead times  an appropriate risk versus reward balance being applied where National Grid NTS consider delivery of incremental capacity in excess of default lead times  The PARCA solution currently being discussed has the potential to result in allocation of Capacity much closer to the capacity delivery date  Planning activities occur prior to Capacity allocation under the PARCA solution  The Capacity allocation becomes the trigger for starting any required reinforcement  We therefore believe it is appropriate to reduce the licence defined capacity delivery lead times to 24 months (from the October following capacity allocation). This lead time would be applicable to:  the post-capacity allocation activities of the proposed PARCA solution, and/or  incremental capacity made available in the QSEC auction and Enduring Exit Applications (where no revenue driver is required)

4 Capacity Delivery Incentive (2)  We are therefore seeking your views on our initial thoughts for a Capacity Delivery Incentive as an alternative to the permit scheme arrangements  The scheme would incentivise National Grid NTS to meet a customers request for early Capacity delivery where possible and apply an appropriate risk / reward balance  The scheme would incentivise National Grid NTS to carefully consider delivery of Capacity, reserved through a PARCA, outside of default lead times and apply an appropriate risk / reward balance  We do not believe that an incentive scheme should allow National Grid NTS to extend project specific lead times beyond [12 / 24] months without requiring Ofgem consent

5 Capacity Delivery Incentive (3)  Accelerating capacity delivery quicker than the default obligated lead time, is likely to have an associated cost  Based on prior experience of accelerating projects we believe it costs ~10% of total construction costs to accelerate a reinforcement project by one year  We have reviewed several large reinforcement projects, comparing their construction costs and additional capacity generated to calculate a monthly acceleration cost per GWh/d  This has concluded that on average the cost of accelerating a project is ~£10,000 per GWh/d per month (09/10 prices) and that £10,000 per GWh/d per month is appropriate as the value of the incentive  These costs have been calculated based on the cost of acceleration, however we also consider that the incentive scheme should be symmetrical  Equal values would apply as the penalty for extending lead times beyond the later of the default or that requested by the customer

6 Capacity Delivery Incentive Proposal (4)  Our initial thoughts on the scheme parameters are:  Zero target  No upfront cash allowance enables the incentive to be applied on a project specific basis  100% sharing factors on National Grid  We believe that as this incentive is within our control, we should be exposed to 100% of the costs  100% upside creates an appropriate tension between cost recovery and out-performance  No caps and collars  The benefits of this incentive should not be limited  We do not anticipate unlimited risk  The number of projects on an annual basis is limited  £10,000 per GWh/d per month delayed or accelerated

7 Capacity Delivery Incentive Proposal (5)  Initial Thoughts (continued):  Proposed for the remainder of the RIIO-T1 period from April 2014  The incentive would be cashed out annually  This is in line with RIIO incentives detailed in Final Proposals  Incentive would be ‘played’ prior to the formal capacity application method i.e. we would indicate our ability to deliver in the invitation letter for the relevant auction/application window  The incentive would only apply where the customer values it or where we cannot meet the obligated lead time, or a later date requested by the customer  The incentive would only apply where:  The customer wants the capacity early and we have committed to this  The customer wants the capacity from the default lead time or later and we are unable to commit to this  The following diagrams demonstrate the application of the proposal

8 Illustrations 1 24 months Capacity allocationDefault capacity delivery Incentive earned NGG agrees to deliver capacity Customer wants capacity  INCENTIVE Incentive penalises NGG agrees to deliver capacity Customer wants capacity 24 months Capacity allocationDefault capacity delivery (b) (a)

9 Illustrations 2 Incentive penalises NGG agrees to deliver capacity Customer wants capacity 24 months Capacity allocationDefault capacity delivery  INCENTIVE Incentive penalises NGG agrees to deliver capacity Customer wants capacity 24 months Capacity allocationDefault capacity delivery (c) (d)

10 Illustrations 3 No incentive applies 24 months Capacity allocationDefault capacity delivery NGG agrees to deliver capacity Customer wants capacity No incentive applies 24 months Capacity allocationDefault capacity delivery NGG can deliver capacity Customer wants capacity (e) (f)

11 Capacity Delivery Incentive (9)  Where a PARCA has been agreed, we would indicate our ability to deliver at the conclusion of Stage 1a  This indication may suggest earlier or later than the obligated timescales  For capacity signalled through the QSEC / Enduring Exit applications we would indicate our ability to deliver early in the invitation letter prior to the auction/application window (as per permit arrangements)  Where lead times have been adjusted under the proposed incentive and we are unable to deliver within these adjusted obligated lead times, the buyback regime principles would apply (see illustrations (g) & (h))  Where a customer is not ready to deliver or offtake gas, we would not be obliged to buyback, as per current UNC principles

12 Proposal Illustrations 4 Incentive earned NGG actually delivers capacity Buyback NGG agrees to deliver capacity Customer wants capacity 24 months Capacity allocationDefault capacity delivery Incentive penalty NGG agrees to deliver capacity Customer wants capacity 24 months Capacity allocationDefault capacity delivery Buyback NGG actually delivers capacity (g) (h)

13 Pre-capacity Allocation Reporting  In our May 2012 business plan submission we considered that a reputational incentive is initially appropriate for the Cap/con pre capacity allocation activities  We continue to believe that National Grid NTS should be obliged to make information available to industry with respect to these activities and welcome views on this  is it appropriate?  should this be a reputational incentive in the licence, or a reporting obligation in the UNC or both?  We believe that a reporting obligation under the UNC in relation to the time taken to progress through pre-capacity application activities has merit  allows change through the UNC governance process  licence and UNC change not dependant on each other  This would oblige us to report on the time taken to progress through the key stages of the PARCA process to the point where we provide a formal capacity signal  This reporting would include the timescales relating to:  Identification of preferred route corridors  Completion of the Environmental Impact Assessment  Stakeholder engagement activities  The submission of a Development Consent Order (where required)  Any others?  A mid-term RIIO-T1 review may be appropriate, to consider the form of future incentives around planning activities

Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. PARCA – Proposed Licence Changes

15 PARCA Solution – Funding (1)  3 different funding mechanisms applicable to the PARCA  Schedule 1a  Pre-Capacity Allocation Revenue Driver  Post-Capacity Allocation Revenue Driver  Works for Schedule 1a are proposed to be treated as Excluded Services and can be covered by the Special Condition 11C – Services to be treated as Excluded Service  This could be achieved by one of the existing categories or some text included to add clarification relating to PARCA works  We also need to consider how a potential reservation fee may impact the licence.  We intend to share our further thoughts on the reservation fee next month

16 PARCA Solution – Funding (2)  Generic revenue driver methodology would detail the process of how the revenue drivers are calculated  Licence would need to recognise two revenue drivers for each project  Add the principles underpinning the phasing of the two stage Revenue Driver (pre & post-capacity allocation) as proposed under the terms of the PARCA to the licence  Under current RIIO Licence drafting Revenue Drivers are funded:  Special Conditions 5F (Entry) and 5G (Exit)  20% in year y-2  80% in year y-1  1% in year y and any subsequent formula year to the end of the RIIO-T1 period  Updates would be required to these conditions to include the Pre Capacity and Post Capacity Allocation Revenue Driver phasing to replace the 20% and 80% with those profiles proposed

17 PARCA Solution – Funding (3)  Termination Credit due to Termination of PARCA  It is proposed that a new term is introduced to Special Condition 2A of the Licence to allow the Allowed Revenue to be adjusted to compensate industry for any monies already recovered from Transportation charges following Termination of the PARCA  The term would adjust the next available years revenue following receipt from the PARCA signatory terminating the contract

18 PARCA Solution – Lead Time  As aforementioned, we believe it is appropriate to reduce the licence defined capacity delivery lead times to 24 months (from the October following capacity allocation). This lead time would be applicable to:  the post-capacity allocation activities of the proposed PARCA solution, and/or  incremental capacity made available in the QSEC auction and Enduring Exit Applications (where no revenue driver is required)  This could be applied through licence change

Place your chosen image here. The four corners must just cover the arrow tips. For covers, the three pictures should be the same size and in a straight line. PARCA – Anticipated Timeline & Next Steps

20 Time line