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Entry Capacity Substitution Workshop 6 – 7 th January 2009

Entry Capacity Substitution Workshop 6 – 7 th January 2009. Agenda. Timeline Update on pricing example Summary of Responses to options presented in workshop 5 Further review of options Next Steps. 07/11/09 Submit Pricing Changes for Approval.

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Entry Capacity Substitution Workshop 6 – 7 th January 2009

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  1. 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. 07/11/09Submit Pricing Changes for Approval 27/07/09Commence informal Consultation on Pricing Changes Approval of Pricing Changes Further development of Charging Methodology Develop Charging Methodology Changes at TCMF 07/12/09Approval of ECS 07/09/09Submit ECS for Approval 07/01/09Workshop 6 10/02/09Workshop 7 12/05/09Workshop 9 07/04/09Workshop 8 07/07/09Workshop 10 Impact Assessment as necessary 08/06/09 27/07/09 24/08/09Close formal consultation 31/03/09Progress report Start consultations Informal Formal S23 Notice 28D 14D Consult Report 21D 28D Consult Finalise Develop stage 2 Licence Changes Develop stage 1 Licence Direction/Changes Consult and Report (non-urgent) Develop UNC Mod Proposals 01/04/09Licence Changes Effective IT Systemsdevelopment 02/07/09Tx Workstream: present mods 19/11/09Mod Panel Decision 17/09/09Mods to Panel 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 07/12/09Approval of UNC Mods TCMF –Develop Charging Methodology / Pricing Options Draft Timeline – Development of Methodology

  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) 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 • With Substitution the obligated level at Hatfield Moor is reduced • Expect prices to be reduced but they increase • Without Substitution the obligated level at Hatfield Moor is unchanged • Expect 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 • 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. Summary of Responses to workshop 5 options

  9. Summary of Responses to workshop 5 options • Option • Total • Comments • 1) Draft Methodology • 56 • Basis of other options - retain • Worthy of progressing: mechanical process - development with option 6 • 2) Limits on Quantity • 76 • 3) National Grid Discretion • 57 • Park • 4) Ofgem Discretion • 76 • An add-on to the final solution – to be considered later • 5) Simple Economic Test • 64 • Part of option 6 • 6) Exchange Rate Cap / Economic Test Combination • 79 • Worthy of progressing • 7) Option Model • 56 • Fundamentally different approach: Worthy of progressing • 8) Sub-Reserve Prices • 55 • Park • 9) Early Warning System • 74 • An add-on to the final solution – to be considered later • 10) Two Stage Auction • 79 • Worthy of progressing • 11) BGT Proposal • 70 • Park: variant on option 10

  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.

  12. Would the option value ever exceed the bid value? Option 7: Option to Buy - example Ahead of QSEC auction shipper buys an option1 over a quantity of capacity at the desired ASEP 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” Shipper wants to protect baseline capacity at an ASEP, but is not ready to fully commit 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 isexercised 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. If the bid value is higher and the option is not exercised, the capacity is substituted. 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 quarter The above two conditions result in a minimum fee (payable irrespective of whether the option is exercised) of approx. £1k/mcm There will also be a choice to exercise, that will specify the quantity and reserve price The 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 capacity The option is valid for one year Unless the option is exercised, it provides no capacity rights to the holder

  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 1 QSEC auction held as now but for shortened duration. POST - STAGE 1 Incremental 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. [One week] between stages STAGE 2 “QSEC” reopened for one round of baseline only bids POST - STAGE 2 ASEPs with unsold baseline capacity identified. Substitution Methodology applied.

  18. Option 10: Two Stage Auction

  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 • Short term players – price sensitive • New supply projects – marginal fields • How difficult would it be to implement? • Systems impact? • Timelines? • Shipper processes? • National Grid processes? • How would this option be developed? • 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 • 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 • 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. Option 6: Combination: Economic Test

  26. Option 6: Combination: Economic Test

  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 • 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 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?

  30. Next Steps • Next Workshop • 10th February • 10am to 1pm • At Ofgem • Outstanding Pricing Issues • Further Working of Selected Options

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