1. The Entry Capacity Substitution Regime Transmission Workstream 7 th February 2008 Thoughts for discussion

2. 2 Introduction  Last PCR introduced several fundamental changes to the entry regime:  Adjustment of baselines  Substitution  Trade and Transfer  Reduction to 10% of capacity held back for short term  Permits / accelerated release  The intended aims of the policy measures were to ensure:  Baselines better reflect physical capability  Build periods reflect the new planning reality  Spare capability is not sterilised  Capacity is booked longer term

3. 3 What specific elements need to be addressed? Implementation of:  Trade and transfer (in progress)  Baseline re-consultation (in progress)  Substitution Potential further steps:  Alternative incremental capacity release test  Review of zero price discounts

4. 4 Substitution  General industry concern with policy, but why?  Potentially forces shippers to book long term (but how long?) their peak capacity requirement at each entry point. But what is their capacity requirement 4+ years out?  Problem exacerbated by reduction to 10% capacity held back to the short term.  If this fundamental concern is addressed, concerns with policy should change to a technical debate about how to implement.

5. 5 Substitution – Principal Issue (1)  What should the approach be?  What is sterilised capacity?  Unsold capacity which National Grid is obliged to make available at an ASEP that could, if the obligation is removed, be used to support incremental demand at a different ASEP. (Ofgem: Baseline workshop 17/08/07)  How much capacity should be held back?  Currently 10%  Two options A. All capacity that is not booked (excluding the 10%) is sterilised and can be substituted. 10% (or lower) held-back from QSEC, B. Only capacity above forecast levels is sterilised and can be substituted. 20% held-back from QSEC.

6. 6 Substitution – Principal Issue (2) Option AOption B Strengthens User commitment Encourages long term bookings Increases economic use / development of the NTS Users have greater access to capacity short-term Long term bookings are for base needs Short term bookings meet peak or changing requirements More capacity available for new / fast-track entry developments Users have more certainty of availability of capacity Reduced risk in respect of “over-booking”. but what if Users don’t book long term?but Up to 90% of capacity will be substituted away Users may not have access to the NTS Inter-connectors may not flow LNG shipments may go elsewhere. Security of Supply impact Price volatility / increase Greater risk of sterilisation remaining due to forecast error. Undermines the principle of a strong User commitment Does little to encourage long term bookings Forecasts become political Undermines TBE process Mitigating Measures Transfer and Trades (effect unknown) Compromise on quantity held-back Remove the pricing incentive (i.e. zero reserve prices) to book capacity short term.

7. 7 Analysis for BACTON ASEP

8. 8 Issues with Substitution (1) Capacity Availability  Users have expressed concerns at the lack of capacity available for short-term auctions  See previous slides Single Quarter Problem  Short-term distant booking would prevent substitution  Scope for Users to prevent capacity substitution  Could undermine substitution principles  Options  Accept that these bookings are genuine and limit scope for substitution.  Alter capacity booking rules to prohibit short-term bookings: could be complex with major IT issues.  Introduce a mechanism for capacity to be surrendered: complex and scope for gaming.  Increase buy-back incentive to cover the risk of substituting and retaining the short- term booking.  Put a time limit on substitutions so that capacity reverts back to the donor ASEP.

9. 9 Issues with Substitution (2) Lower NPV Test for Substitution  Should a lower NPV test apply for substitution?  Industry views vary  NG believes it should not.  The test is not intended to under-write investment.  Test reflects value of capacity. If a lower test applies  What should the value be?  What about partial substitution?  How would a lower test be applied?  Separate auction or analysis round: Complex, time/ resource intensive  Refund / price discount: Requires over-writing User bids: liabilities, precedent  How should competing bids be prioritised?  Substitution test before investment test?  Ranking of bids passing lower (substitution) test but failing higher (investment) test.  Based on actual % NPV of specific bids  Value of bids  Exchange Rate

10. 10 Issues with Substitution (3) Exchange Rate Cap.  Previous consultation provided a range of views.  Generally at low limit (1.5:1) due to concern at potential for excessive capacity destruction.  But any limit would restrict the amount of substitution undertaken so runs counter to the aim of substitution (i.e. minimise sterilisation / investment)  10:1 proposed for Transfer and Trade.  But this is for a limited (1 month) duration.

11. 11 Issues with Substitution (4) Availability (Timing) of Capacity for Substitution  When can substitution be applied?  Substitution minimises investment so logically should apply from 42 months, but  if substitutable capacity is available why not apply from 18 months? …….but….  Is it acceptable to reduce available capacity at donor ASEPs 18 month out?  How will Users signal incremental request at 18 months?  Capacity ONLY available if substitution opportunities exist.

12. 12 Related Issues (1) Alternative Economic Test / User Commitment  Should the NPV test be replaced?  If so, what with?  Four year commitment, similar to exit; but two years for substitution?  Entry requirements are seasonal; slight variation required?  New User Commitment must be a simplification over existing process.  And when?  Would more change be welcome at this time?  Difficult to implement for September 2008 QSEC, but possible for April 2009 QSEC.

13. 13 Related Issues (2) Reserve Price Discounts  Provide incentive for short term bookings.  Contrary to aim of substitution.  Should discounts by removed?  Discussion document raised by National Grid in May 08.  Mixed response - conclusions on National Grid web-site.  National Grid considering approach to take.

14. 14 Related Issues (3) New Entry Points  New ASEPs may have first access to substitutable capacity (summer 2008).  This may include first access to revised baseline quantity  If revised baselines / re-scheduled QSEC not aligned.  It may be possible to identify substitution opportunities in advance for these, single ASEP, auctions.  Are these benefits to new ASEPs undue discrimination?  Should new ASEPs be excluded from substitution?  Until the first QSEC after revised baselines apply?  Indefinitely?

15. 15 Implementation Requirements  Key Licence deliverables are;  Entry Capacity Substitution Methodology Statement  Incremental Entry Capacity Release Methodology Statement  Submit to Authority for approval by 19 th May 2008 (IECR 1 st July)  Problems with 19 th May deadline  Limited time to fully develop solutions (formal consultation due from Apr 2008)  Deadline aligns to Sept QSEC; potentially no longer relevant  New IECR being developed whilst, potentially, existing IECR being used in Apr 2008 QSEC – could create confusion  Advantages of postponing obligation to [January 2009].  Allows greater industry development time.  Scope for Ofgem to undertake impact assessment.  Aligns to a potential April 2009 QSEC.

16. 16 Current timeline Support for mod 189 (QSEC) 7 Feb Workstream. Discussion and options paper. 2 Jun Substitution Methodology in force 19 May Methodology Statements submitted to Ofgem Ofgem deliberation 7 April Consultation on ECS and IECR Ofgem unsupportive of moving Substitution obligation to April 2009 and / or mod 189 not implemented in 2008. Current Timeline 6 March Workstream NG initial proposals Industry comments to NG Sept 08 Entry Capacity Substitution effective from QSEC auction

17. 17 Possible timeline Policy / process development Ofgem support for moving Substitution obligation to April 2009 June / July Workshops as necessary Early Sept* Consultation on ECS and IECR Mid Oct Methodology Statements submitted to Ofgem Mid Dec Statements approved and in force April 09 Entry Capacity Substitution effective from QSEC auction Ofgem deliberation Potential Timeline 7 Feb Workstream Discussion paper. * Scope for 2 month extension for additional development time or Ofgem Impact Assessment End Feb Licence direction on IECR / ECS Support for mod 189 (QSEC)

18. 18 Next Steps  Respond to National Grid discussion document:  No later than 26 th February  National Grid to outline initial proposals  At Transmission Workstream on 6 th March  Unless substitution delayed.