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RIIO-T1 impact on allowed revenues and network charges 6 September 2012 Introduction • RIIO-T1 will set revenue controls for transmission network companies 1 April 2013 – 31 March 2021 • July 2012: We published our Initial Proposals • Engagement with stakeholders continues to be important to the process • Today’s presentation and discussion aims to: – Focus on the specific RIIO impact set against the wider context – Outline the ways that we and NGG can help manage the impact on charges – Detail the way that revenue will be recovered by NGG including where it relates to a signal for extra capacity • Consultation on Initial Proposals closes on 21 September 2012 • We intend to publish updated licence drafting in Autumn 2012 • Final Proposals December 2012 2 Context • NGG’s obligations and allowed revenues are subject to economic regulation to ensure that energy consumers interests are protected • To recover its allowed revenues NGG set charges consistent with its charging methodology statement. The methodology is subject to the governance procedures of the UNC and is subject to approval by Ofgem • There are factors that affect the level and volatility of gas transmission commodity charges which are independent of our decisions in RIIO-T1 • This presentation focuses solely on the expected impact of RIIOT1 3 RIIO • RIIO is different to our previous approach to setting transmission controls • Differences include: – Onus is on network companies to develop well-justified business plans – including reflecting stakeholder input – Comprehensive set of outputs against which delivery will be monitored and in some cases financial incentives will be used to encourage higher quality performance – Treatment of capex and opex aligned so that companies choose the most appropriate solution – allowable costs treated as totex – Aims to match returns more directly to the company’s performance – Preset proportion of totex allowed in the year (“fast money”) with the remaining payments spread over life of asset (“slow money”) 4 OUR CONSULTATION ON WAYS TO MANAGE CHARGING VOLATILITY 5 We consulted on 5 options for mitigating volatility Option Assessment against Assessment against optimal risk allocation other criteria Reduces risk to suppliers 1 Improved information 2 Restricting intra-year charge changes 3 Lagging incentive rewards / penalties networks recover via allowed revenues 4 5 Lagging adjustments to allowed revenues from uncertainty mechanisms Cap and collar allowed revenue changes No additional cash-flow risk for NWOs Reduces risk to suppliers Low cost Relatively easy to implement Reduces complexity Limited additional cash-flow Reduces administration costs risk for NWOs Consultation view Likely to be beneficial Likely to be beneficial Reduces risk to suppliers Potentially weakens the incentive regime and signals Limited additional cash-flow to investors risk for NWOs Reduces risk to suppliers Potential additional cashflow risk for NWOs Reduces risk to suppliers Potentially weakens signals to investors Likely to be beneficial Universal changes unlikely to be beneficial. May consider changes on mechanism-by-mechanism basis Introduces complexity to the regulatory regime Potential material additional Could weaken incentive cash-flow risk for NWOs regime and signals to investors Unlikely to be beneficial 6 Applying to gas transmission • Improved information – Recognise NGGT’s work to identify where stakeholders require better information, including forum such as these – 150 days indicative notice period and relationship with annual iteration • Restricting charges to 1 April change – Responses were supportive of all charge changes being 1 April, currently capacity charge setting linked to the gas year (from 1 October) – Welcome NGGT leading industry discussion on this • Lagging incentives – Where financial incentives are applied, eg stakeholder satisfaction, natural lag built in as performance in year 1 reflected in charges in year 3 • Lagging uncertainty mechanisms – Detailed design of mechanisms being finalised for RIIO-T1. Our initial assessment favoured no lag on adjustments but a consideration of individual mechanism requirements • Caps and collars – Do not favour this option, and see no reason why our assessment of costs and benefits should be different from other network sectors 7 SETTING REVENUES 8 Setting revenue allowances for future years • Licence model calculates allowed revenue for future years - ‘open’ for annual update of some variables • Takes in actuals and compares with allowances • Formally part of Licence regime reflecting Conditions and Handbook Annual Iteration • Run in November each year (so values need to be agreed before) • Uses data mostly from regulatory year just ended in March • Calculates adjustment to be applied in following year through modification update licence term (MOD) MOD • Sum of differences (time adjusted) between • i) Recalculated base revenues for all 8 years using this year’s inputs and ii) recalculated base revenues for last year • Reflects any changes/corrections to numbers previously used 9 MOD overview 2015-16 MOD term calculation • • There are two components of MOD. Changes from years prior to the current year which have WACC applied and an updated year t itself. These are added together and compared with FP to calculate MOD. 2014 2015 Recalculated Base Revenue (2016) 2016 203.78 Recalculated Base Revenue Change 1.80 0.73 WACC-based carrying factors 1.21 1.10 x "Catch-up" lump sum x 2.98 + Recalculated Base Revenue for 2016 203.78 Base Revenue for 2016 206.76 Less FP Base Revenue 203.07 MOD for 2016 FP Base Revenue MOD Base Revenue for charging 3.69 2014 2015 2016 169.11 186.27 203.07 - - 3.69 169.11 186.27 206.76 10 Revenue associated with new projects Comparing TPCR4 with NGG business plan and our Initial Proposals • The next slide illustrates the different approaches to revenue recovery following NGG’s business plan proposal; our high level approach under our initial proposals; and TPCR4 • Annual iteration process should not limit agreement/ signals • For example under NGG’s proposal NGG will not be constrained from building in year 2017; at the worst case the funding will be received 1 year in arrears (with financing costs) • Our IP approach excludes any financing costs due to NGG for earlier preconstruction expenditure • Total revenue will vary each year from that in Final Proposals as we update for actual totex and revised allowances • TOTEX approach works whatever the outcome of the current discussion about new commercial arrangements. We are not prejudging the outcome of that process 11 Potential revenue impacts of £50m project 2014 Allowed revenue IP 2015 736.7 Initiation 2016 2017 2018 2019 2020 2021 724.5 745.3 769.4 818.5 792.2 814.3 842.0 NGG proposal Additional allowances (£m) 1 2.5 2.5 2.5 17.5 23 1 Assumed spend 1 2.5 2.5 2.5 17.5 23 1 Change in revenue 0.0 0.5 0.5 0.6 2.5 3.9 2.2 2.2 % change on base 0.0% 0.1% 0.1% 0.1% 0.3% 0.5% 0.3% 0.3% 10 40 IP Interim approach Additional allowances (£m) Assumed spend Delivery 1 1 1 10 37 Change in revenue 0.0 0.0 0.3 1.6 5.6 2.1 1.1 2.2 % change on base 0.0% 0.0% 0.0% 0.2% 0.7% 0.3% 0.1% 0.3% 10 40 2.4 4.8 4.8 0.3% 0.6% 0.6% TPCR4 system Assumed capex (£m) Change in revenue % change on base 0.0% 0.0% 0.0% 0.0% 0.0% 12 FURTHER DISCUSSION AND QUESTIONS 13 14