1. 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. Default cashout options and recommendation Review Group 029111 August 2010

2. Agenda  Actions from previous workshop  Quick Reminder  Refined Options  Recommendations?  Possible next steps  Objective of session is to land on RG 291 preferred option(s) to update fixed system marginal prices in UNC

3. Actions RG0291 006 and 007: ‘Linepack Build’  2009/10: 675MCM or 7,400GWh in Residual Balancing Actions  Gross trade value of £74M (Sell £42M, Buy £31M), net £12M  202 Trade days (Buys on 94, Sells 108), hence potential for build up of Linepack on 163 days  Total ‘build up’ on these non trade days = -12MCM  If ‘build up’ was bought / sold at SAP then ‘cost’ =~ £774k  i.e. £774k cost would be recovered via neutrality  However, NG is unlikely to trade exactly @ SAP thus there is a perceived inefficiency associated with NG’s balancing actions  If we assume “inefficiency” is difference between SMPs & SAP then potential inefficiency for market =~ £854k  Total potential net misallocation (when applying SMPs) = -£1.63M

4. Actions RG0291 006 and 007: Daily LP change between balancing actions Linepack alternately rises and falls

5. Action RG0291 009 – Update SMPs based on latest Hornsea Prices  2001: SMP Buy = 0.0287, SMP Sell = 0.0353  2010: SMP Buy = 0.0452, SMP Sell = 0.0442  All in pence per kWh

6. Actions RG0291 010 – ‘System Length vs SAP’

7. Actions RG0291 010 - continued

8. Action RG0291 011 – Update SMPs based on alternative flexibility proxys  Table below shows how SMPs could potentially be derived from annual Operating Margins costs  However, calculation is onerous, uses a number of assumptions, does not accurately reflect storage costs and potentially exposes commercial information not publicly available  National Grid does not recommend pursuing this option

9. Reminder – what’s the story so far?  May Workshop:  Background:  Default values still widely used approx 60% - 70% of days  Gross imbalance has reduced from ~7% of throughput in 2002 to ~2.5% in 2009  Current defaults set in April 2002 based on Hornsea storage prices as a proxy for within day flexibility  UK balancing used as benchmark in EU and further a field  June Workshop:  Idea Development  Rationalised / Refined six possible options to three  Including NTS baseline model to update based on as-is Hornsea prices  Began to develop operational cost model using compressor costs  Actions to further develop options to allow recommendation

10. Options  4 potential options to consider: 1.Removing fixed default System Marginal Prices 2.Updating existing methodology with either:  Up to date Hornsea prices, or  A ‘basket’ of flexible products 3.Introducing a % of SAP 4.Reflecting operational costs  In addition to the following common principles:  Methodology for calculating default SMPs published in UNC related doc  Annual review of default SMPs

11. Option 1 – Remove default SMPs  Cashout is SAP unless Market Balancing Action occurs  Background – Option developed on a number of assumptions;  Current default SMPs do not provide a meaningful incentive to balance  Not knowing when Market Balancing Actions may set SMPs is an incentive to balance  Could this option better facilitate the relevant objectives?  a) & b) efficient & economic operation of system  + Data supports that system length does not react to current defaults and may therefore introduce inefficient neutrality process  - May not reflect operational costs for managing the shippers imbalance  - Removing default may increase requirement for Market Balancing Actions  d) securing effective competition  - SAP cashout may reduce incentive to trade out imbalance  - Absence of true cost of flexibility may not apportion costs appropriately and cause cross subsidy through neutrality  - reduces market liquidity

12. Option 2 – Update using existing methodology  Cashout is an SMP based on proxy of GB Storage prices unless Market Balancing Action occurs  Key Features:  As – Is methodology  Storage prices act as a proxy for price of flexibility to deliver long & short  Could this option better facilitate the relevant objectives?  a) & b) efficient & economic operation of system  + Provides a price for the flexibility of gas within the GB  + Targets the flexibility costs to users of flexibility i.e. imbalanced shippers  - Does not necessarily reflect that day’s cost of flexibility so may not encourage efficient actions  d) securing effective competition  + Providing default price will provide incentive for shippers to trade out imbalances and hence encourage competition

13. Option 3 – Introducing a % of SAP  Default SMP Buy is the higher of 4% of SAP or highest priced Market Balancing Action  Default SMP Sell is the lesser of 5% of SAP or lowest priced Market Balancing Action  Key Features:  Restores default SMPs as relative % of gas price as introduced in 2002  Could this option better facilitate the relevant objectives?  a) & b) efficient & economic operation of system  + Provides a financial incentive for shippers to balance relevant to SAP (which will reflect market conditions and competing balancing products i.e. storage)  - May not reflect that day’s cost of flexibility & may not encourage efficient shipper actions  d) securing effective competition  + Providing dynamic price will provide incentive for shippers to trade out imbalances and hence encourage competition

14. Action RG0291 008 – ‘Refinement of Operational Costs’  What is the cost of NTS space and the cost to inject and withdraw gas from this space?  Space: 1.The cost (allowable revenue) for 1km of NTS pipe @ 70 bar cycled on a daily basis for 45 years = 0.0368p/kWh 2.The cost of the volume of gas available for ‘NTS Storage’ based on average daily pressure change within NTS = 0.736p/kWh, or 3.The portion of NTS system cost (allowable revenue) attributable to imbalance energy = 0.0285 (SO rev), 0.0530 (TO rev) or 0.0815p/kWh (TO & SO)  Injection & Withdrawal  Portion of Compressor Fuel cost attributable to imbalance energy = 0.0029p/kWh  Recommendation that this is considered ‘Option 4’ with possible default SMP of 0.053 (TO rev option above) + 0.0029 (SO Compressor Fuel cost) = 0.0559p/kWh

15. Option 4 – Reflect Operational Costs  Default & Marginal SMPs are set by the costs associated with managing a system that is out of balance;  Key Features:  Figures calculated using the cost of providing pipeline space and compressor costs  Could this option better facilitate the relevant objectives?  a) & b) efficient & economic operation of system  + Ensures SMPs reflect cost of managing shippers long & short positions  + No inefficient cross subsidy through neutrality  d) securing effective competition  + Will ensure shipper decisions are based on cost reflective signals

16. Options Summary SMP Buy (p/kWh)SMP Sell (p/kWh) Current0.02870.0323 Option 1 – Remove00 Option 2 – Hornsea0.04520.0442 Option 3 - % SAP*0.06310.0712 Option 4 – Ops Costs0.0559 *Optino 3 based on SAP on 2/08/2010 @ 1.488p/kWh

17. Recommendation  NTS recommendation is either;  Update with Operational Costs (Option 4), or  Update based on Hornsea prices  We are interested to hear RG 291 views / other recommendations