1. 1 The Regulatory Approach to Fostering Investment David Halldearn Ofgem 28 September 2006

2. Context  EU action on a number of fronts moving towards single energy markets eg. –Green Paper – Commission Strategy Paper expected December –Competition cases – ongoing merger cases and Sectoral Enquiry –Regional Initiatives  Political drivers: Competitiveness, Security of Supply and Climate Change

3. Importance of Infrastructure  Successful response to all aspects depends upon developing an integrated grid – the fundamental basis for a single market  Grid infrastructure must come from private companies – Govts should not “pick winners”  Therefore, creating environment for investment is vital

4. The scale of the task  Commission Green Paper – “around 1trillion euros will be needed over the next 20 years”  Commission report on TEN-energy, Oct. 2005 – €100bn needed to 2023 in gas infrastructure: –€48bn in transmission systems –€22bn in storage –€6 in future interconnections –€23bn in import pipelines and LNG terminals –€1bn in existing import projects

5. Financing Infrastructure Investment  Companies need: –Clear, long term market signals –Regulatory certainty –Fair rate of return  Neither currently exists for cross-border investments

6. The theory – how to pay for infrastructure  Two approaches possible: –“Fully Regulated” Investments –“Contract” investments  Both feasible, and necessary, within competitive single market: –but both must meet above 3 criteria ie. transparency and certainty leading to fair returns

7. The “Regulated” approach:  TSOs invest to meet required security/operating standards  Investment in “regulated asset base” (if efficient) earns a fair rate of return through tariffs paid by network users, who therefore bear costs (and risks)  Works well where users are the direct beneficiaries of investment  Robust regulatory framework must exist for RTPA and RPI-X price control regulation to be applied

8. “Contract” / “Merchant” investment  Long term contracts represent a commitment of a forward income stream against which capital markets will invest  Competition concerns must be addressed, but the circumstances vary from market to market  Conditions on contracts must trade off certainty (cost of capital) with pro-competitive access measures – such as open season, third party access reservations, limits on contract duration  Conditions must reflect local circumstances

9. The practice: how does it work on the ground?  Electricity: –Regulation of natural monopolies works within Member States –But TSOs “use” each others networks, so ITC scheme invented –Extra-EU issues not resolved (eg SEE)  Gas –Regulation works within Member States –TSOs “use” each others networks (and other upstream infrastructure too). No regulatory mechanism for cost recovery or cost allocation – Accepted industry practice based on long term contracts to support extra-TSO network investment –No viable alternative has been promoted, despite serious competition concerns

10. The way forward?  Current EU legislative framework does not create environment for investment – because focus is within national markets not between them  Therefore cannot create effective single market  Action needed to facilitate both types of cross-border investment  Further EU legislation necessary

11. Regulated Approach at EU level: TSO Responsibilities  National TSOs have national rules for building and operating their networks. We need European rules  A ‘European Grid Code’ must have: –European security standards, especially at borders –Joint system planning arrangements –Provision for co-operation between TSOs for operation of the networks and emergency arrangements –Proper oversight  Do we need a “European Centre for Energy Networks” organisation to manage all this? –No - but greater co-ordination is required through eg. GIE

12. Regulated Approach at EU level: Regulators’ Responsibilities  National Regulators to look at the interests of European consumers not just national consumers  Regulators need to ensure that TSOs have certainty about the return on their cross border investments, just like national ones  Costs and risks need to be allocated fairly for cross border investments. The Inter-TSO Compensation Mechanism (ITC) goes some way to achieving this in electricity. But what about gas?  Proper unbundling remains an essential prerequisite for an efficient European (or even national) grid.  Do we need a European regulator? Probably not - but greater co- ordination is required through eg. ERGEG+?

13. Contract Approach at EU level: Guidelines  Europe’s gas supplies depend on ‘merchant’ investment in pipes and LNG infrastructure to bring gas to Europe’s borders  Long term contracts need a framework so investors can rely on them without precluding competition eg. consistent principles for TPA exemptions  Guidelines should be developed  Recent case law should be enforced (Decision C-17/03)

14. Summary  Infrastructure investment central to single energy market, and therefore to meeting political drivers  Current legislative framework not creating environment for investment  Both “regulated” and “contract” investment necessary at EU level  But requires new legislation (on TSOs and Regulators) and guidelines (on contracts) to balance certainty with competition

15. Promoting choice and value for all gas and electricity customers