Managing the Costs of New Developments

1. Managing the Costs of New Developments Initial Proposals on Transmission System Operator Internal Costs from 1st April 2007 Update from National Grid – Transmission (17 December 2006)

2. Managing the costs of New Developments • Ofgem’s Initial Proposals for NGG (transmission) and NGET System Operator Incentives from 1st April 2007 were published on 5th December • these include proposed allowances for Transmission System Operator Internal Costs • the allowances are based on Ofgem’s review of National Grid’s business plan, provided as part of the Transmission Price Control Review (TPCR) • The consultation (question 14 in both sections 2 & 3) also seeks views on • whether to handle new industry development costs via National Grid’s proposal or • via the existing Income Adjusting Event (IAE) provisions The deadline for responses is 16th January 2007

3. Why have National Grid proposed a new mechanism? • Significant industry developments are anticipated over the next transmission price control period (2007/08 to 2011/12) which will impact on National Grid’s processes • some changes are known but un-scoped, • many are not yet even envisaged, and • their overall implementation cost is unknown at this time • We have not included these costs in our baseline expenditure plans and allowances because • this approach does not properly align to the industries interest to efficiently develop the commercial framework • the uncertainty would have required us to include a large risk margin • We believe that improved assurance of efficiency in development costs can be provided through • enhanced, regular cost and progress reporting • use of Industry Panel expertise • building a regular, systematic process for the review and recovery of necessary costs

4. What does it involve? • National Grid will continue to provide forecasts of its costs to implement modification proposals but clearly identifying the incremental costs beyond our base allowance • These forecasts will be taken into account by the relevant working group or panel in developing its recommendations • We will report the forecast costs regularly and then report final actual costs on completion of work • Subject to approval, and materiality tests, we would recover the incremental costs incurred via a term in our internal incentives • The costs, and working group or panel assessment of them, can be factored into Ofgem’s efficiency assessment at the next price review

5. What does it involve? • The baseline SO allowances include £0.25m for electricity and £0.25m for gas • Our reporting will monitor the cumulative spend for electricity and gas each year, including approved changes and those being assessed • This will help the industry working groups and panels to monitor how much market-driven change is being progressed and proposed. • If the spend exceeds any baseline allowance, then this will be fed into the incentive charges for the following year.

6. Next Steps • The Transmission System Operator Initial Proposal consultation closes on 16th January 2007 and we would urge you to consider our proposal and respond positively to the consultation • National Grid’s response will follow these lines • We think that adoption of this proposal is essential to our continued positive contribution to industry development. It will provide • improved transparency of National Grid’s expenditure on behalf of the industry • clearer accountability for and to industry panels and working groups • flexibility to fund, and plan for, industry development • We believe continued industry development is foreseeable and so the costs should be managed through a regular systematic process • Income Adjusting Events are a means of catering for exceptional events and thus it is not the most appropriate way of dealing with this issue – we should be implementing a simple new process focussed on routine industry decision making. If you have any comments or want more information contact National Grid’s panel representative or Kevin Broadbent (01926 656027)