entry capacity substitution workshop 6 – 7 th january 2009

Entry Capacity Substitution Workshop 6 – 7th January 2009

2

Agenda

Timeline

Update on pricing example

Summary of Responses to options presented in workshop 5

Further review of options

Next Steps

3

TCMF – Develop Charging Methodology / Pricing Options

Further development of Charging Methodology

Develop Charging Methodology Changes at TCMF

07/11/09Submit Pricing Changes for

Approval

27/07/09Commence informal

Consultation on Pricing Changes

Approval of

Pricing Changes

Draft Timeline – Development of Methodology

Jan 09 Feb 09 Mar 09 Apr 09 May 09 June 09 July 09 Aug 09 Sept 09 Oct 09 Nov 09 Dec 09

Workshops

5 – Review status – explain risks/rewards process5 – High level options – work through of potential options6 – Industry options – review alternatives6 – Review all options – narrow down for development7/8 – Detailed options/examples9 – Finalised options/examples10 - Update industry following Informal Consultation

07/01/09Workshop 6

07/04/09Workshop 8

07/07/09Workshop 10

12/05/09Workshop 9

10/02/09Workshop 7

Develop stage 1 Licence Direction/Changes 01/04/09

Licence Changes Effective

S23 Notice

Develop stage 2 Licence Changes

07/09/09Submit ECS for Approval

07/12/09Approval of

ECS

27/07/09

Impact Assessment as necessary

28D 14DConsult Report

21D 28DConsult Finalise

Start consultationsInformal Formal

08/06/09 24/08/09Close formal consultation

Consult and Report (non-urgent)

Develop UNC Mod Proposals

07/12/09Approval of UNC

Mods

19/11/09Mod Panel Decision

17/09/09Mods to Panel

02/07/09Tx Workstream: present mods

IT Systemsdevelopment

31/03/09Progress

report

4

Substitution Example – Prices

At Substitution Workshop 3 on 11th June 2008 National Grid gave an example of the possible

impact of substitution on entry capacity reserve and incremental step prices. An update of

these prices was provided at workshop 5.

In the example 10mscmd of incremental capacity is allocated at Easington. This is achieved by

substituting capacity from other ASEPs:

• All available capacity from Hornsea, Hatfield Moor and Theddlethorpe;

• Some of the available capacity from Bacton.

Two issues were raised

• Before / after pricing tables should be supplemented with substitution / no substitution tables for the “after” scenario;

• Prices at Hatfield Moor increased despite a reduction in the obligated level.

A further example was requested

• Based on Teesside – to be presented at workshop 7.

5

Substitution Example – Prices (Sept 2008 basis)

ASEP

Initial Prices

p/kWh/dayChange in

obligated

level

mscmd

Post auction prices:

with Substitution

p/kWh/dayChange in

obligated

level

mscmd


with investment

p/kWh/day

P0 P20 P0 P20 P0 P20

Easington 0.0092 0.0134 + 10 0.0095 0.0141 +10 0.0095 0.0141

Hornsea 0.0090 0.0101 at P8 - 0.9 0.0090 0.0101 at P8 0 0.0090 0.0101 at P8

Hatfield Moor 0.0028 0.0033 at P5 - 0.8 0.0030 0.0035 at P8 0 0.0028 0.0033 at P5

Theddlethorpe 0.0082 0.0120 - 49.2 0.0063 0.0088 0 0.0082 0.0120

Bacton 0.0084 0.0141 - 41.7 0.0062 0.0106 0 0.0084 0.0141

NB – P20 step price relates to an incremental capacity of 50% of the obligated level. Hence, with the exception of Easington, the “new” prices relate (in the substitution example) to a smaller incremental quantity.

6

Substitution Example – Hatfield Moor

ASEP

Initial Prices

p/kWh/dayChange in

obligated

level

mscmd


with Substitution

p/kWh/dayChange in

obligated

level

mscmd


with investment

p/kWh/day

P0 P20 P0 P20 P0 P20

Easington 0.0092 0.0134 + 10 0.0095 0.0141 +10 0.0095 0.0141

Hatfield Moor 0.0028 0.0033 at P5 - 0.8 0.0030 0.0035 at P8 0 0.0028 0.0033 at P5With Substitution the obligated level at Hatfield Moor is reducedExpect prices to be reduced but they increase

Without Substitution the obligated level at Hatfield Moor is unchangedExpect prices to remain constant (possible slight reduction)

This does not occur because:The charging model reduced flow at Theddlethorpe to its revised obligated level and balances flows at Garton which is the nearest ASEP with spare capacity, (i.e. obligated - forecast).Increased Garton (and Easington) flow causes gas from Hatfield Moor deeper into the network.Despite a lower flow rate, greater penetration leads to higher prices.

7

Summary of Responses to workshop 5 options

Option

1) Draft Methodology

2) Limits on Quantity

3) National Grid Discretion

4) Ofgem Discretion

5) Simple Economic Test

6) Exchange Rate Cap /

Economic Test Combination

7) Option Model

8) Sub-Reserve Prices

9) Early Warning System

10) Two Stage Auction

11) BGT Proposal

In the draft Methodology Statement (option 1), shipper bids are the only determinant of shipper interest.

Non-market information could be used to determine how much should be reserved at each donor ASEP (option 2).

Constraints could be applied to the draft MS e.g. an economic test or exchange rate cap (options 5,6).

New mechanisms could be developed to enable shippers to prevent capacity from being substituted away from a donor ASEP, probably by requiring payment of a nominal fee (options 7,8).

Options 3 and 4 build on other options by providing a mechanism to reject substitutions deemed inefficient.

Options 9, 10, and 11 build on other options by providing additional information (or opportunities) to influence bidding strategies.

National Grid received no alternative suggestions after the workshop.

8


OptionResponses

A B C D E F G H I J Total

1) Draft Methodology 7 7 7 9 6 5 7 8 N 56

2) Limits on Quantity 10 11 11 7 10 8 11 8 N 76

3) National Grid Discretion 9 7 8 11 5 5 7 5 N 57

4) Ofgem Discretion 10 9 11 11 5 8 11 11 N 76

5) Simple Economic Test 8 7 9 7 8 8 8 9 N 64

6) Exchange Rate Cap /


10 10 11 7 11 8 11 11 Like Y 79

7) Option Model 8 8 7 7 3 9 7 7 Y 56

8) Sub-Reserve Prices 8 8 7 9 3 7 6 7 N 55

9) Early Warning System 8 11 11 9 10 5 11 9 N 74

10) Two Stage Auction 12 11 11 6 10 9 11 9 Best Y 79

11) BGT Proposal 6 9 10 9 4 9 10 13 Y 70

9


70

79

74

55

56

79

64

76

57

76

56

Total

Park: variant on option 10 11) BGT Proposal

Worthy of progressing10) Two Stage Auction

An add-on to the final solution – to be considered later9) Early Warning System

Park8) Sub-Reserve Prices

Fundamentally different approach: Worthy of progressing7) Option Model

Worthy of progressing6) Exchange Rate Cap /


Part of option 65) Simple Economic Test

An add-on to the final solution – to be considered later4) Ofgem Discretion

Park3) National Grid Discretion

Worthy of progressing:

mechanical process - development with option 6 2) Limits on Quantity

Basis of other options - retain1) Draft Methodology

CommentsOption

10

Summary of Responses: Further Development

Essentially three options to be considered.

Market based approach (option 7)

Option Model

Additional information approach (option 10)

Two stage auction.

Mechanistic approach (options 2/6) with

Limits on the quantity of capacity made available for substitution; and/or

A cap on the Donor ASEP: Recipient ASEP capacity exchange rate; and/or

An economic test

11

Option 7: Option Model

Where a Shipper values non-incremental capacity at an ASEP they can, for a price, reserve that capacity.

This option would not, necessarily, give the Shipper first option to buy the capacity, but would potentially reserve it at the relevant ASEP for any Shipper to obtain.

This option needs to be considered as a means to delay or prevent capacity being substituted from a particularly ASEP. If substitution does progress then this would be in line with option 1 and any chosen elements of option 6.

Advantages Concerns

Shippers can signal future requirements at lower exposure than with full commitment in QSEC auction.

Shippers will need to commit to costs before decisions on whether capacity is truly needed. But what are these costs? What do the costs buy?Options may block out other Shippers wanting obligated capacity at the same ASEP.Option prices need to be high enough to prevent spurious reservations but lower than reserve prices. Not feasible at all ASEPs.Regulatory treatment of option fees needs to be considered. Potential systems implications. What is required?

12

Option 7: Option to Buy - example

Shipper wants to protect baseline capacity at an ASEP,

but is not ready to fully commit

Notes:

1 The minimum price for the option will be 0.0001 p/kWh/d. The minimum duration that the option will cover is one quarterThe above two conditions result in a minimum fee (payable irrespective of whether the option is exercised) of approx. £1k/mcmThere will also be a choice to exercise, that will specify the quantity and reserve priceThe exercise will only apply to capacity that would otherwise be substituted, i.e. does not block out bids at the same ASEP.The quantities specified cannot be higher than available non-incremental capacityThe option is valid for one yearUnless the option is exercised, it provides no capacity rights to the holder

For any QSEC auction, where the capacity that would be substituted away is covered by an option, this capacity is put to the “back of the

queue”

Ahead of QSEC auction shipper buys an option1 over a quantity of

capacity at the desired ASEP

If the capacity that has been “put to the back of the queue” would still be used in the substitution the NPV value of the bids is compared to the option value

(option price * option quantity * duration).

If the bid value is higher and the option is not exercised, the capacity is substituted.

If the bid value is higher and the option is exercised the shipper with the option is allocated the

capacity at the reserve price and for the duration of the option.

If the bid value is lower the capacity will neither be

substituted nor will it be allocated to the Shipper with the option.

Would the option value ever

exceed the bid value?

13

Option 7: Option Model – Issues for Consideration

What does the Option provide? Does the Option prevent capacity from being substituted?...or

Does the Option put the capacity to the back of the queue for substitution?

What is the Option price (i.e. the price paid to create the Option)? Subject to question above.

Same for all ASEPs or linked to ASEP specific reserve price?

Is there an Exercise for the Option? If so, how is it effected? Automatic if ASEP identified as a donor ASEP for substitution?

Only if Shipper gives consent at the time that the ASEP is identified for substitution?

What is the Exercise price (i.e. the price paid to be allocated the capacity)?

Reserve price at the relevant ASEPs?

What duration does the Option cover? Minimum of one/four quarters?

Default lead time plus 1 year?

What is the life-time of the Option? For one year from one annual QSEC auction to the next?

14

Option 7: Option Model – Issues for Consideration (2)

How does an Option Model differ from single quarter booking?

May be cheaper to buy single quarter than an option at some ASEPs.

Obligation with single quarter booking is delayed into future.

Possible treatment of single quarter bookings.

Prevent: through UNC modification

Allow and prevents substitution

Allow, but permit substitution;

creates conflicting obligations for National Grid

regulatory treatment to be agreed.

15

Option 7: Option Model – Recap

Does an Option Model satisfy the main substitution criteria?

Does it offer the benefits of substitution?

Is it unduly restrictive?

Does it mitigate the risks presented by substitution?

New long term supply projects

Short term players – price sensitive

New supply projects – marginal fields

How difficult would it be to implement?

Systems impact?

Shipper processes?

National Grid processes?

How would this option be developed?

Which, if any, elements of option 6 should be considered with this option?

16

Option 10: Two Stage Auction

Several variations (inc. BGT proposal) where QSEC is run in two parts.

Baseline and incremental capacity can be obtained in the first phase.

Only baseline capacity can be obtained in the second stage.

This option needs to be considered as a means to prevent capacity being substituted from a particularly ASEP by allowing Shippers an opportunity to respond to perceived vulnerability of certain ASEPs.

If substitution does progress then this would be in line with option 1 and any chosen elements of option 6.

17

Option 10: Two Stage Auction - example

STAGE 1QSEC auction held as now but for

shortened duration.

STAGE 2“QSEC” reopened for one round

of baseline only bids

POST - STAGE 2ASEPs with unsold baseline

capacity identified.Substitution Methodology applied.

[One week] between stages

POST - STAGE 1Incremental bids identified.

ASEPs and quantities published1.

1 – It would be assumed that bids are valid andthat subsequent proposals to release incremental capacity would not be vetoed by Ofgem.

18

Option 10: Two Stage Auction

Concerns / Issues?

Complex – could add significantly to timelines.

Major change to QSEC auction (UNC) – impact on systems.

Shippers maystill have to commit earlier than they feel able to;be incentivised not to bid in first auction round;have governance issues where bids are required at short notice; andbe unable to accurately identify donor ASEPs prior to stage 2.

Shippers at “safe” ASEPs may see unsold capacity substituted due to stage 2 bids, e.g. Shippers at the most likely donor ASEPs may buy existing capacity so that no capacity is available to be substituted away. This means the second best donor ASEP will be used.

How would the process by applied for ad-hoc QSEC auctions for new ASEPs?

19

Option 10: Two Stage Auction – Recap

Does a Two Stage Auction satisfy the main substitution criteria?

Does it offer the benefits of substitution? Is it unduly restrictive?

Does it mitigate the risks presented by substitution? New long term supply projects



How difficult would it be to implement? Systems impact?

Timelines?

Shipper processes?



Which, if any, elements of option 6 should be considered with this option?

20

Option 6: Combination Mechanical ApproachCapacity Limits / Exchange Rate Cap / Economic Test.

Each substitution opportunity progresses subject to satisfying: Limits set on availability of capacity at potential donor ASEP

Recognises that unsold capacity is not the same as unneeded

What criteria should be used to exclude capacity from substitution?

An exchange rate cap: To avoid excessive capacity destruction at donor ASEPs Difficult to determine precise value when multiple donor ASEPs or mix of

investment and substitution.

What values should cap be set at?

An economic assessment: the value of capacity substituted from the donor ASEP should be compared

to the value of the incremental capacity allocated at the recipient ASEP

How should the test be applied?

21

Option 6: Combination: Limit Donor ASEP Quantity Available

Any others?

Preference?

Option Advantages Concerns

Increase quantity withheld from QSEC auction

Transparent and predictable.

Requires Licence change.Inconsistent with encouraging long term signalsLimited scope for flexibility / phasingInefficient: rule applies to all ASEPs

Substitute only above historic flows

Substitution is intended to utilise capacity at declining ASEPs. Historic flows do not reflect this.

Withhold a % of baseline from substitution

No Licence changeTransparent

Contradicts aim of Licence (10% rule)Inefficient: rule applies to all ASEPs

Withhold a % of unsold capacity from substitution

No Licence changeTransparent

Inefficient: rule applies to all ASEPs

Substitute only above [90%] TBE forecasts

Limits aligned to expected future requirements, not an arbitrary value.

Could undermine TBE process: potential for disputes over values used:forecasts could be wrong.

Other considerations:•All options could result in unnecessary investment if substitution opportunities are prevented•Any caps to be specified before the relevant auction•Scope for soft landing by decreasing quantity protected•Previous consultations revealed support for each option, particularly TBE.

22

Option 6: Combination: Exchange Rate Cap.

Exchange Rate Cap

Aims

To prevent overall loss of aggregate capacity within the system

Concerns

Could needlessly prevent unwanted capacity from being substituted, leading to uneconomic investment.

Can be difficult to determine with multiple donor ASEPs and combined substitution/investment scenarios.

Criteria

Must be simple to apply

Justifiable value

Over-whelming support for a low value; possible soft-landing (increase in future years).

Options

1:1

n:1 (n > 1)

No limit

23

Option 6: Combination: Exchange Rate Cap.

Exchange Rate Cap

Option Advantages Concerns

1:1 No loss of total system capacity Could prevent “sensible”

substitutions

n:1 Facilitates more substitution Arbitrary

Greater loss of total capacity

Others? ?? ??

Other considerations:•Any cap could result in unnecessary investment if substitution opportunities are prevented•Scope for soft landing by decreasing quantity protected•Previous consultations revealed support mainly for a low exchange rate cap although some preference for no cap was expressed.

24

Option 6: Combination: Economic Test

These tests are intended to measure and compare the value of capacity substituted from a donor ASEP and the value of the capacity released at a recipient ASEP.

Where the value at the donor ASEP is highest substitution should not be progressed.

25


Potential basis for determination of ASEP capacity “value”.

Recipient ASEP Donor ASEP

Actual auction bid value -

NPV of auction bid value -

Incremental capacity project value

(from charging model)

Project value to recover:

TBE level;

or pre-auction obligated level

Pre-auction P0 price * incremental capacity Pre-auction P0 price * substituted capacity

Licence Revenue Driver

(for incremental capacity)

Licence Revenue Driver

(to recover TBE / obligated)

OTHERS? OTHERS?

26


Thoughts and concerns?

Benefits of substitution are manifest when National Grid is not funded through the Licence Revenue Drivers for incremental capacity.

More complex options could increase post-auction analysis requiring increased default lead-times and UNC / Licence changes.

Can prevent capacity at high cost ASEPs being substituted to low cost ASEPs at low cost.

An economic test may only facilitate substitution from low to high priced ASEPs especially where combined with an exchange rate cap. Will not always prevent TBE forecast capacity needs being substituted away so Shippers may still have to commit earlier than they feel able to.

How would test work when recovering capacity at a previous donor ASEP (reverse substitution)?

Preference?

27

Option 6: Combination Mechanical ApproachCapacity Limits / Exchange Rate Cap / Economic Test – Recap

Does this option satisfy the main substitution criteria?

Does it offer the benefits of substitution? Is it unduly restrictive?

Does it mitigate the risks presented by substitution? New long term supply projects



How difficult would it be to implement? Systems impact?

Shipper processes?



Which elements of this option should be developed further?

28

Summary

Three options considered.

Market based approach

Option Model

Additional information approach

Two stage auction: substitution only triggered by stage one.

Mechanistic approach

Limits on available capacity for substitution

Exchange rate cap

Economic test

29

Summary

Each option has been reviewed against main criteria

Substitution benefits

Risk mitigation

Three classes of User

Implementation

How should these option be developed?

Which, if any, elements of the mechanistic approach (option 6) should be considered with the other options?

BenefitsRisk

mitigationImplementation

Option

2-stage

Mechanical

Limit

Xch rate

Eco test

30

Next Steps

Next Workshop

10th February

10am to 1pm

At Ofgem

Outstanding Pricing Issues

Further Working of Selected Options

entry capacity substitution workshop 6 – 7 th january 2009

Documents

substitution tables

increasewithout substitution

available capacity

review of options

spare capacity

mscmd of incremental

new prices

entry capacity reserve