1 IG Meeting Milan, 18 th July 2008 Cost of Firmness of Capacity

2 Context ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

3 Regulators are in the opinion that the criteria applied to compensate the PTR holder in case of curtailment do not reflect the real costs and consequently there is a lack of any solid economic rationale. –TSOs have not the right incentive to reduce the curtailments to the minimum; –The risks left on market players imposes extra costs to the system. At the end of 2007, the Regulators proposed the implementation of a market spread compensation scheme for the Italian-French and Italian-Austrian Interconnections considering the liquidity of the respective electricity spot market Alternative on Italian-French Interconnection (IFI) at the end of 2007: firm product - This possibility has not been put in place due to short time for implementation TSOs have been asked by Regulators to perform a study comparing financial vs physical firmness On the Spanish border, the Regulators ask informally also to work on spread compensation with caps Context

4 ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

5 Real Time reductions –After binding nominations for periodic PTRs (07:00 a.m. D-1 on all borders) or sending of capacity usage rights (04:00 PM in D-2 working days) on IFI in case of curtailments TSOs guarantee the realisation of Exchange Schedules. Scheduled Reductions –Only long term PTRs can be reduced (Daily PTRs are firm) before binding nominations or sending of capacity usage rights on IFI –In case of scheduled reduction, the PTR Holder is compensated at 110% of the price paid for the capacity on France-Italian Interconnection (IFI) direction France  Italy or reimbursed on all other borders and for the direction Italy  France –The PTRs curtailment for network security reasons is allowed up to 35 Equivalent Days (840 hours). Beyond that limit the assigned capacity rights are guaranteed even in case of physical interconnection capacity reduction. Auction Rules 2008 – Management of Curtailments

6  In case of real time reductions TSOs guarantee the realisation of Exchange Schedules.  These measures usually consist of redispatching activities and result in extra costs at TSO level.  In this case TSO activity is equivalent to guarantee firm capacity as it is transparent for Market players. Curtailments for real time reductions This extra costs at TSO level should be compensated by auction income according to EU-Regulation 1228/2003

7 To reduce the risk of curtailments, TSOs anticipate as much as possible the scheduling of maintenance periods of the interconnections to include them in the Products to be auctioned. The allocation of Yearly and Monthly PTRs are defined taking into account scheduled outages of interconnection lines defined:  on December of previous year for Yearly products and  before monthly auctions for Monthly products. In this way curtailments applied to Yearly and Monthly PTRs (before binding nominations/sending of capacity usage rights) are only due to unforeseen outages on the interconnections. Curtailments for scheduled reductions TSOs just curtail in case of absolute need and curtailments cannot be higher than 840 hours Beyond 840 hours, PTRs are firm

8 (*)Curtailments have not been applied because Yearly and Monthly PTRs have been assigned taking into account scheduled outages of interconnection lines defined: on December of previous year for yearly products and/or before monthly auctions for monthly products. (**) Curtailments have been applied for NTC reductions due to unforeseen outages of interconnection lines Big curtailments applied for scheduled NTC reduction due to unforeseen outages on the interconnections. Scheduled reductions north Italian interconnection Y ear 2008

9 Context ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

10 NOT FOR PUBLICATION In order to manage the financial risk due to spread compensations, Regulators have proposed to associate a cap on spread compensation mechanism Several types of cap were proposed : –Cap on duration : X hours –Cap on curtailments : X MW –Cap on spread : +/- X €/MWh –Cap on global amount : X MW/period Financial Firmness – Regulator’s proposal on Spain-France Interconnection X h No compensation Spread compensation X MW No compensation Spread compensation h1h2h3h4 … Spread used for compensation Spread between exchanges X €/MW.h M€ Period to consider Spread compensation No compensation

11 Type of CAPMarket playersTSOs Price difference (spread) Can be anticipated : MP may influence the spread if no cap No leverage action possible if no cap Duration (h)Difficult to anticipateLeverage action possible Depth (MW)Difficult to anticipateLeverage action possible Total amount (€) Can be anticipated : MP may influence the spread to increase the total Amount No leverage action possible if no cap Financial Firmness – Regulator’s proposal on Spain-France Interconnection Cap on duration and depth have been rejected by all the Parties during SWE SG meeting

12 Context ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

13 Physical Firmness products must be characterised as follows :  PTR without any curtailment during all the year  Firm product limited to a certain amount of the available NTC (to be defined)  Lower priority in case of curtailment Physical Firmness - IT/FR interconnection

14 Context ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

15 Comparison F inancial vs Physical Firmness Comparison of costs beard by TSOs for scheduled NTC reductions(*) due to the Venaus-Villarodin Outage occurred in June 2008 (700 MW for 144 h) based on the following hypothesis: Financial product Application of market spread compensation for the entire period on whole capacity curtailed Physical product MW assigned as firm and lower priority in case of NTC reductions 110% criteria is applied in case of curtailments on residual capacity 110% [K€] Firmness Financial Product [K€] Physical Product [k€] Costs for Firm Product [Redispatching costs] Costs of curtailments on residual capacity (110%) %: costs of curtailments according to ARs 2008 Physical product: NTC reduction has not an impact on firm product  No redispatching costs to keep it firm. Curtailment applied to the residual capacity (110% criteria) The example is not significant. In those days market spread between Powernext and Ipex was very small (*) Capacity guaranteed from the 31 st of May (when the outage occurred) till the 2 nd of June. TSOs performed counter measures (up to 700MW) for around MWh

16 Spread IPEX vs Powernext Winter (Oct 2007 – April 2008)

17 Spread IPEX vs Powernext Summer (July - Sept 2007, May – June 2008)

18 Spread IPEX vs Powernext August 2007

19 Comparison Financial vs Physical Firmness Comparison based on the following hypothesis: NTC reduction for the same amount and duration of the one we had in June 2008 (700 MW, 144 h) 110%: computed using average auction prices of last 12 months (Jul ‘07-Jun ‘08) Firm product (1000 MW firm and lower priority of curtailments in case of NTC reduction, 110% on residual capacity) Financial product: market spread computed using average market spread between Italy and France PXs of the last 12 months (Jul ‘07- Jun ‘08) Period110% [K€] Firmness Financial Product [K€] Physical Product [k€] Costs for Firm Product [Redispatching costs] Costs of curtailments on residual capacity (110%) Winter peak Winter off-peak Summer peak Summer off-peak Financial firm product: high and not easily manageable risk. Cap is needed. Physical firm product: small difference with 110% criteria currently applied – of course it depends on the amount of the firm product, the higher it is, the higher is the risk

20 Context ARs 2008 – Management of curtailments Financial Firmness Physical firmness Comparison Financial vs Physical Firmness Conclusion Agenda

21 Conclusion Is there a real need to apply such compensation scheme? Firmness for events that occur after nominations (or sending of usage capacity authorization) is already guaranteed with redispatching activities. For unforeseen events that occur before nominations (or sending of usage capacity authorization): –There are few reductions and they are due to unplanned events. –Risk transferred to TSOs who already ensure an efficient usage of interconnection. Moreover TSOs have no leverage to manage the risk. –Long Term products already have a degree of firmness - are firm after for curtailments higher than 840 hours. –Financial firmness : -High risks for TSOs (Compensation can significantly exceed the auction income). Cap is needed but it makes it difficult for market players to evaluate the right value to build their bids for the auctions. -Compensation at full market price spread reallocates the curtailment risk from traders to end consumers. Some traders already reduce the risk with appropriate hedging : many delivery contracts between Traders and consumers on the interconnections can be reduced with an early warning. -Curtailment risk is a market category and the costs of hedging it should be minimized through competition between traders, rather than by socializing them through network tariffs. –Physical firmness: -The risk depends on the amount of the firm product, the higher it is, the higher is the risk. Moreover on IFI, curtailments are quite volatile and depend on the asset concerned by the outage The end consumers of importing countries will bear the cost...