1. Connecting markets Pamela Taylor, Ofgem Gas Target Model, 3rd stakeholder workshop 11th April 2011, London

2. What are we trying to achieve? • Where technically feasible gas should flow to where it is valued most • Greater price convergence 2. Efficient use of cross-border infrastructure • Capacity hoarding must be avoided • Contractual congestion must be avoided • Amount of offered capacity must be maximised

3. Existing policy proposals –out for consultation • ACER’s Capacity Allocation Framework Guideline • - Auctions • Bundled products • European Commission’s proposals on Congestion Management Procedures • - Capacity overbooking – firm UIOLI • - Restriction of renominations Objective is for short term firm capacity to allow for more short term gas trading

4. What are we observing today? Source: http://ec.europa.eu/energy/observatory/gas/doc/qregam_2010_quarter3.pdf Markets are still not developed in all parts of Europe Progress has been made, but more needs to be done

5. Option 1: explicit, continuous • Explicit capacity allocation with continuous trading • Example for “overselling”: • Shipper A books 100 units of capacity • Shipper A nominates 50 units • TSO assumes that shipper A will not use remaining 50 units, TSO sells them day-ahead • Shipper B buys remaining 50 units off TSO • Shipper A has paid for 100, but only used 50 units • Capacity hoarding is a bad deal! • TSO takes a risk and needs appropriate incentives • Explicit auctions (CAM FG) • Bundled Products • No gate closure, no restriction of renomination rights • Overselling • Interruptible Use It Or Lose It • All capacity is financially firm (not necessarily physically firm) Has been effective in GB, but requires NRAs to set appropriate incentives

6. Option 2: explicit, gate closure • Explicit capacity allocation with gate closure • Example of Gate Closure with firm UIOLI or UIOSI • - Shipper A has 100 units in long-term contract • Shipper A nominates 50 units, it loses or is paid for the remaining 50 units (or a proportion thereof) • TSO sells shipper A’s remaining 50 units (or a proportion thereof) in day-ahead auction on a firm basis • Shipper B buys the 50 units, nominates only 20, so loses the remainder intraday • If shipper A wants to increase its nomination, it buys additional capacity intraday Gas day Long-term market (explicit capacity allocation) Nomination Intra-day shipper trading Use it or lose it: unused capacity is sold through auction or FCFS Firm day-ahead auction of any capacity that was not nominated (Use It Or Sell It) Gas trading would shift to where auction takes place, but can be adapted to allow for renomination during the gas day

7. Option 3: implicit auctions More efficient than explicit capacity auctions as it removes risk of separate transactions and allows markets to merge where no physical congestion

8. CWE market coupling in electricity Before CWE coupling After CWE coupling

9. What is needed for implicit allocation? • A party to do the coupling – exchange or TSO • Can be same party for both price areas (e.g. ITVC in electricity) • Can be two parties that cooperate (e.g. CWE in electricity) • Algorithm for determining flows and prices • Firm network capacity

10. Option 4: implicit, continuous • Can be used FCFS or implicit auctions • FCFS day-ahead not compatible with CAM FGs? • Series of implicit auctions may disperse liquidity but more auctions allow for flexibility • Arbitrages realised by the TSO from low price area to high price area with implicit allocation of capacity valued at the day-ahead price spread (GRTgaz-Powernext market coupling work) Auction gate closures Long-term market (explicit capacity allocation) Day-ahead/ intra-day Implicit allocation Continuous implicit allocation may be a solution to allow for efficient gas flows while keeping the flexibility provided by continuous trading?

11. Interactions with long-term gas trading • If short term capacity is freed-up, what should be the reserve price? • Zero reserve price allows capacity to be re-allocated at 0 cost if there is no congestion • If congestion, auction price will rise above zero • Will a zero reserve price change shippers behaviour and move markets towards the short term? • In non-peak periods maybe more reliance on short term • Peak period: long-term capacity still needed High revenues Congestion revenues Surplus inter-connection capacity 0 No interconnection High level of interconnection capacity Interconnection capacity Some markets have higher proportion of transit than others

12. Interactions with long-term gas trading Options for reserve prices for short term capacity 1. No reserve price (solution in electricity) but in gas domestic tariffs subsidise transit flows? 2. Set a reserve price to recover costs- impact on price convergence at congested points? 3. Set a reserve price at non-congested points but not at congested 4. No reserve price at interconnection points but a ’membership fee’ at end-user exit points a. Flat rate b. Based on flows Need a redistribution mechanism

13. Interactions with long-term gas trading How could a redistribution mechanism work? • Each NRA sets its TSO revenue requirements – identify how much needed for domestic network and how much for transit. • Country A – 400 Euros domestic, 100 Euros transit • Country B – 300 Euros domestic, 200 Euros transit • Each NRA sets membership fee to recover: a. Agreed amount form end-users for national network • Country A - to recover 400 Euros from end-users and • Country B 300 Euros from end-users b. Estimate amount from congestion revenues • Country A & B recover at the interconnected point 150 Euros in congestion revenues (300 Euros is needed for transit) c. Country A & B (or ACER) set a ‘membership fee’ to recover shortfall • 150 Euros d. Congestion revenues and membership fee combined and redistributed • 100 Euros to Country A and 200 Euros to Country B

14. Initial conclusions • Short term firm capacity is needed • Explicit continuous model has been successfully implemented in GB but needs incentivises for TSOs • Explicit gate closure may alter gas trading but will free up unused capacity and allows for renominations during gas day • Implicit auctions are worth exploring via pilot projects; more efficient than explicit auctions (electricity experience) • High proportion of transit capacity so pricing and redistribution of revenues is key for any model

15. Thank you for your attention! www.energy-regulators.eu