GRI NW Investment WorkshopChris Logue, European Policy Manager, 4th June 2010The Hague

2

Life Before Long Term Auctions

“Transco” undertook centralised system planning – TBE Process – continues today

Obligation to sell entry capacity to Seasonal Normal Demand +10%

System built to deliver 1:20 peak

From this planning and scenario analysis, Investments were put to the regulator

Industry perception of “Gold Plated” system

Investments made under: Statutory (1:20), Power, Flexibility, Emissions or Other (primarily replacement) categories

3

Auctions

Long term auctions began in 2003

Auctions provided

Equal opportunity to obtain capacity

Price discovery

Simple allocation process (at least to start with)

Mechanism to manage entry capacity constraints

4

Quarterly System Entry Capacity

QSEC (Quarterly System Entry Capacity)

Held every March

Offers capacity from 18 months out for 15 years (i.e. Sept’08 offer capacity for April 2010 to March 2025).

Cleared price auction

Reserve Price (P0) and up to 20 incremental price steps – up to 150% of baseline

Potential for incremental signals (i.e. release new capacity)

To release new capacity, bids must pass an NPV test in accordance with the Incremental Entry Capacity Release Statement (IECR)

5

Quarterly System Entry Capacity

If a new system point is required then National Grid will work closely with users in the build up to QSEC to determine the viability of a new capacity point to bid upon

If the regulator agrees then it will determine the Unit Cost Allowance in conjunction with National Grid

If bids for this new point, or an existing point are above Baseline (baseline of new points will equal zero), an economic test is undertaken to determine any need for new investment in the Transmission system

6

Quarterly System Entry Capacity – The Economic Test

If bids are above Baseline capacity:

Incremental Entry Capacity Release (IECR) test undertaken

Is the Net Present Value (NPV) of bids over an 8 year period higher than 50% of capitalised Unit Cost Allowance?

If so, Baselines are permanently increased

This may involve capital investment

If not, National Grid may wish to consider releasing non obligated entry capacity

Incremental capacity release has a 42 month lead time

Incentives to reduce lead time

Opportunity to extend lead time e.g. in case of planning/construction issues

7

2006 Regulatory Decision – The Story

National Grid had committed initial St Fergus capital based upon signals and market assessment in 2002 – then completed the Investment by 2005

Ofgem accused NG of placing insufficient weight on “important new information on the location of large new sources of gas supply” during their “go / no go” review in 2003

Initially, £75m of NG’s capex was excluded from the RAV

8

2006 Regulatory Decision

Ofgem believed NG had not provided adequate justification for the expenditure incurred

They concluded that, since this project was initiated in the early days of the new entry regime, it would be inappropriate to exclude it from the RAV altogether

The effect of this is to allow £56 million to enter the RAV at the time at which the expenditure was incurred

9

2007 – Further Regime Changes

Introduction of baseline substitution

substitute capacity from another ASEP

Introduction of trade and transfer

capacity moves to those who value it most

New form of revenue driver introduced

Old form still exists for previous releases

Automatically becomes baseline after 5 years

10

2007 – Further Regime Changes

Opportunity for accelerated release

Release in 6 months prior to incremental obligated

National Grid NTS keep 100% of revenue

Permits

National Grid can “play” a permit if investment period cannot be met (42 months on entry)

Can “gain” a permit if can deliver earlier (and signal received)

Investment buyback incentive

11

Summary

Constant regime change

Regulatory intervention has led to investment processes using quantifiable and auditable methodologies

Economic test has become the “only show in town”

more cautious investment

associated pros and cons

Long Term auctions do not necessarily provide long term signals….

Users may take a commercial view not to signal

Original regulatory intentions get lost and changed

Selling so far out makes regime change more difficult/complex