Environmental priorities, transmission access issues and implications for

wholesale market competition

Stephen SmithManaging Director, Networks

Regulatory Policy InstituteAnnual Competition and Regulation Conference

16 September 2008

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Content

1. The 2020 challenge – Government targets2. The case for reform of transmission access arrangements3. Transmission access: key issues and principles4. Impacts on wholesale competition

Two important messages:

(1) To make the case for radical reform of access arrangements and to set out the key principles for a new regime(2) To expose the potential implications for wholesale market competition and need for potential remedies

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The 2020 challenge

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“Renewable energy is key to our low-carbon energy future. We need to radically reduce greenhouse gas emissions, as well as diversify our energy sources. Last spring we agreed with other Member States to an EU-wide target of 20% renewable energy by 2020. The UK’s proposed share would be to achieve 15% of the UK’s energy from renewables. That is almost a ten-fold increase in renewable energy consumption from where we are now. It will involve all of us in a revolution in how we use and generate energy”

John Hutton, Secretary of State, Government Renewable Energy Strategy , June 2008

Impact on electricity sector will depend on success in energy efficiency, transport and heat but likely to require 30-40% renewable

energy compared with current 4%

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GB transmission network will need to connect a substantial volume of new generation

• The existing GB transmission system connects c80GW of generation to meet around 60-65GW peak demand

• To meet 2020 targets will require an additional 60GW+ of renewable capacity plus: – thermal (fossil) back up plant given intermittency– new nuclear generation– around 20GW of existing generation is expected to close by 2020 and

distributed generation will also have an impact

• Majority of new connections for onshore and offshore wind, but also nuclear, (clean) gas and coal. Connections may be remote from the existing network resulting in potential planning difficulties

Longer term targets create major uncertainties and challenges for Ofgem, HMG and companies . This isn’t just a renewables issue.

Significant queue of generators already waiting to connect. Transmission investment lags behind generation investment. NG currently quoting 2022 as earliest available

connection dates

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Transmission access demand - 120+GW by 2017?

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

GW

Built Under construction Consent approved Awaiting consent Scoping Unknown Consent refused

Key factors/assumptions

• Closures of existing plant not notified – this will reduce capacity

• Many new generators awaiting planning consents and may fail

• New nuclear not included

• More generation needed to back up renewables

• Normal demand growth assumed - may be offset by distributed generation

• Security standards maintained as present

• Current overbooking of capacity in Scotland with constraint costs

• Transmission build underway for new generators with connection agreements (see appendix)

Contracted background by generator status

Source: National Grid

Unprecedented uncertainty and speed of change

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The case for reform of transmission access arrangements

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Transmission Access: Problems with the current arrangements

• Current network is designed for large scale conventional generation connection and planning standards reflect this– Current planning standards say build more capacity for renewables,

nuclear as they connect• Building new infrastructure capacity

– Expensive - large new generators in remote locations– Slow – North Yorkshire line 10 years, Beauly-Denny x years?– Not sustainable – carbon footprint, losses, visual amenity

• In future will need to:i. Build substantial infrastructure andii. Make better use of existing/new infrastructure

Sharing network capacity including innovative techniques/technologies

Running the existing network harder but accepting increasing operational costs or greater risk of a loss of supply?

These issues aren’t new and major reform was tried unsuccessfully in early 2000 but brought into sharper focus by renewables challenge

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Barriers to effective transmission access

• Existing ‘first come first served’ connection approach does not prioritise connection – projects without consent ahead of those with consent in the queue

• Planning consents for major infrastructure projects can take years to obtain (Government is addressing this)

• Existing generators have little incentive to trade/release capacity or signal future capacity needs to transmission companies

• Processes for changing the relevant industry codes have been cumbersome and slow (Code Governance Review will address some of the issues) and allow incumbents to filibuster?

And evidence that current arrangements don’t promote competition:(1)Evergreen access rights despite lack of any financial commitment?(2)Ability to use credit ratings to effectively “landbank” connection offers at negligible costs?(3)Discriminatory treatment of new v existing generators?

Price control funding for new transmission investment is not the issue, but planning constraints for generation and transmission are slowing investment

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Transmission access reform: key issues and principles

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The issues we identified in the course of te Transmission Access Review

• Approach to access has historically been successful in accommodating >25GW of new generation and closure of 20GW, but can not cope with the scale or pace of change

• Maintaining investor confidence is important and a lack of firm, credible connection dates is a key issue

• The current regime does not provide incentives for Transmission companies to take on more risk (or be rewarded) if they believe there is the potential to connect more generation

• Existing system capacity is under-utilised but rights oversold in some locations giving rise to significant constraint costs

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Vision for Transmission Access Reform

• New generation projects should be offered firm connection dates, reasonably consistent with the development time of their project

• Access rights need to be more clearly defined and all generators need to be offered choice about how they access the system (firm/interruptible and short term/long term)

 • Generators wanting long term, financially firm access to the system need to make

long term financial commitments backed with appropriate credit arrangements • Transmission companies need to have appropriate financial incentives to respond

to the long term demand for access signalled by generators and to take on more risk

 • In order to make more efficient use of existing and new capacity there needs to

be better arrangements for trading/sharing of transmission capacity

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Ofgem’s views on reform• Protecting customers’ interest is vital

- Long term user commitment from generators is key to avoids transfer of stranding risk to customers and improve information to transmission companies of future demand

• Existing generators do not have “evergreen” rights to the system

• It is important to have long-term tradable rights- Users should be able to sell rights on a permanent/temporary basis allowing lower

carbon to replace existing technologies, and reallocation of spare capacity

• Overselling capacity/connect and manage should be considered- based on proper assessment of costs (e.g. constraints) and benefits (e.g. lower

carbon emissions)

- In future transmission companies will need to be more innovative• Technical: new technologies, greater capacity sharing and run the system hardeR• Commercial: new products, overselling, new financial settlement – more reward for

more risk e.g. more speculative investment

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The TAR package

Enduring access arrangements

(20GW+ of new connections from 2010)

• NGET’s CUSC and charging methodology amendment proposals already in the industry process

• Modular approach, capable of delivering a range of different regimes: auctions, connect and manage, existing generators retain current rights

Short term measures[0.7-1GW connected in

next 2 years?]

• Improved access queue management• Measures to release and utilise the full capacity of the system• Review of the transmission security standards• Scope to connect more generation through derogations

Longer term measures [50GW+ by 2020 targets]

• Reform Transmission/System Operator incentives• TSOs will publish a major technical study within 6 months

setting out the options for transmission investment• TSOs will come forward with proposals for new investment

incentives so they can invest now and take some of stranding risk for higher reward

Designed to ease transmission bottleneck to renewable deployment short term and long term

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Impacts on wholesale market competition

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Potential impacts on wholesale market competition

So what has all of this got to do with competition policy?

1. Whither competition with c40% of generation market subsidised?

2. Transmission access reform: creating a level playing field?

3. The scope and incentives for market abuse in the wholesale market and transmission access reform?

Is competition law sufficient to manage the issues and protect electricity customers?

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Whither competition?

Government yet to announce outcome of Renewable Energy Strategy but vital they learn from mistakes of the past

• Impact on competition if c40% of generation is subsidised?

• Design of subsidy mechanism?

– History does not give cause for optimism

• Original subsidy mechanism: Renewable Obligation Certificate(ROC)– Scored well on minimising distortions to market (single price and

technology neutral) but– Very poor value for money in face of planning and transmission

constraints

• Recent reform– Sacrificed neutrality – banding could be used to “pick winners”– Failed to address cost issue because of “headroom” adjustments

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Transmission access reform – creating a level playing field

And also to avoid simply shifting all the risk to customers!

• Strong argument that existing arrangements do not promote competition

– Existing generators have free option to extend rights each year but can (and have) walked away at one year’s notice

– Large companies with strong credit ratings can effectively “landbank” expansion rights at minimal cost stifling new entry

– New users required to provide financial security against full costs of network expansion costs even if lower risk than existing generators

• Transmission access reform must create a level playing field– Existing generators arguing strongly that they have “evergreen”

rights – Impact on new entry if they hold rights on constrained system?

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The scope and incentives for market abuse

Does scale of renewable build and risk of transmission constraints mean it is time to revisit the question?

• Concerns about “special features” of wholesale electricity markets due to inelastic demand and supply well known

– Exploiting transmission constraints often cited as a prime example

• Limits to effectiveness and timeliness of Competition Act as an enforcement tool?

– Establishing dominance; and– 4 years plus to prosecute a case vs magnitude of harm to

competition/customers

• Ofgem argued (unsuccessfully) for a Market Abuse Licence Condition for generation market in 2000 – rejected by Competition Commission

• Since decision, wholesale market conditions relatively benign and so question of whether Ofgem or CC was right remains unanswered

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The scope and incentives for market abuse

Does scale of renewable build and risk of transmission constraints mean it is time to revisit the question?

• Concerns about “special features” of wholesale electricity markets due to inelastic demand and supply well known

– Exploiting transmission constraints often cited as a prime example

• Limits to effectiveness and timeliness of Competition Act as an enforcement tool?

– Establishing dominance; and– 4 years plus to prosecute a case vs magnitude of harm to

competition/customers

• Ofgem argued (unsuccessfully) for a Market Abuse Licence Condition for generation market in 2000 – rejected by Competition Commission

• Since decision, wholesale market conditions relatively benign and so question of whether Ofgem or CC was right remains unanswered

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Time to revisit MALC?

Is some form of Market Abuse Licence condition a necessary safeguard if we want to sell transmission capacity more aggressively to promote renewables?

• Over last 5 years costs of system operation have risen from c£500m to c£1bn – constraint costs now approaching £200m

• Risk of “exploitative abuse” rises rapidly under transmission access if we oversell capacity and operate the system harder

• Ofgem launched Competition Act case this year against SP/SSE in response to formal complaints

“The CC’s decision not to support the introduction of the MALC in 2001 seems well-justified by subsequent market developments in Great Britain. Equally, however, Ofgem’s view that such powers can be necessary in some circumstances also seems to be supported by subsequent developments overseas.” Competition Commission, January 2008

• An anecdote – September 2008 – NG faced with risk of an £80m bill to constrain 850MW of wind overnight due to non-economic “sleeper bid”

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Conclusions

• A combination of the new renewable targets, replacement of nuclear and older conventional plant creating a “perfect storm”

• Existing transmission access arrangements need radical reform to deal with this

• Reform needs to enable faster access but also deal with the anti-competitive nature of the existing arrangements to promote new entry

• Reform of subsidy mechanisms needs to provide better value for money and reduce distortions to the wider wholesale market

• Desire to push the transmission system harder to enable more/faster renewable connection significantly increase risk of market power abuse

• Is Competition Act upto the job of dealing with this or are new regulatory powers required?

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