“Investment in Transmission”

Economics of Electricity Markets – IDEI Toulouse, 2-3 June 2005

Jon Carlton – Director of Network Strategy

Agenda

 National Grid Transco  Who we are and what is our experience?

 Drivers of Investment    Role of competitive markets and congestion Technical rules vs Economic Assessment Incentives for Investment and the Role of Independent Transmission – Consideration of some of the practical challenges  Summary and Conclusions

Who are National Grid Transco?

  International energy delivery business with market capitalisation of ~ €20billion  Formed in late 2002 through merger of Lattice Group and National Grid Group Focused on ownership, operation, development of energy networks  Electricity and Gas  Principal Electricity Investments   TSO for England and Wales; SO for GB Significant Transmission and Distribution Businesses in the Northeast United States

National Grid Electricity Transmission System

      Operating voltages 400kV and 275kV 13,786 km of overhead line; 627 km of underground cable Approx 330 substations Maximum demand 54,400 MW Units transmitted 308.5 TWh Major power plants connected 84

Investment challenges for National Grid in the UK DRIVERS OF TRANSMISSION INVESTMENT

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Ageing coal-fired generation

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And tighter emissions limits

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New gas-fired generation Renewables

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Especially wind power

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Asset replacement

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Driven by asset age and condition

1600 1400 1200 1000 800 600 400 200 0

ASSET AGE PROFILE

Are competitive electricity markets conducive to network investment?

 There is no automatic linkage between competitive markets and network security – some of the most secure networks are where unbundling and competition have been introduced.

 Some transmission systems may have been designed to get output of a company’s own generation to its native load, rather than for trade in electricity – this is where investment may be most needed.

 In some cases trade facilitated by excess capacity already inherent in transmission systems  In any event, effective investment incentives required looking forward

Does congestion provide the answer to where investment is required?

 Can be a valuable signal to where investment is required and provide an economic justification  But patterns of congestion can change according to the disposition and operation of generation and be influenced by outage programmes  In practice there may be legitimate reasons why congestion revenues alone may be insufficient to fully remunerate required investment

Technical rules; do we need them and if so what is their place?

 Need to ensure we understand what is actually required versus what engineers would ideally like to have!!

 Market can largely ensure demands for energy are met, but there may be questions as to the temporal or geographical balance   Supply and demand have to be matched in real time Reactive power for voltage control must be provided locally  Supply quality and reliability are important considerations  But market mechanisms can often be used eg to ensure economic provision of ancillary services (eg reactive power, response and reserve)

Transmission Investment requires….

  Companies whose prime focus is transmission New ways of:     Planning Managing capital investment Understanding asset performance and health Effectively managing risk  Examples    Planning against a background of uncertainty Advanced asset management techniques “Just in time” asset investment, complemented by SO contracting options

Planning investment against an uncertain background

 Location and timing of new projects which will actually proceed are uncertain  Need to avoid prospect of failure to provide capacity or be left with stranded assets  Hence need to adopt “just in time” investment; complemented by use of System Operator incentive schemes

Uncertainty in future generation pattern 1200 2200 Generation Demand 2171 Background A 3667 Background B 9815 6719 7716 5941 12027 3611 1196 1988 1483 1988

Effective regulatory incentives

     Forward looking rather than based on historic view Drivers to provide capacity when required Combination of sound economics and pragmatism Avoidance of undue complexity and cost Need to consider how asset replacement is effectively incentivised, not just provision of new capacity

Some attributes of appropriate incentives

 Investments which are customer driven   The role of capacity auctions Recognition that Unit Cost Allowances will only approximate the cost of a specific project  Thus may need transportation charges to cater for under- or over-funding from auctions  Asset replacement   Sufficient returns to make this attractive to shareholders But regulator must have assurance on outputs (ie that investments are efficient and timely)

Other Practical Challenges for Investment

 Environmental challenges  Not just visual amenity – Flora – Fauna – Health concerns (eg EMFs)  Planning processes    Important that due process is seen to be followed Objectors and interveners must be allowed a voice Governments have a role in streamlining planning processes  Companies also need to be innovative  Getting more capacity out of existing assets obviates need for new build

TSO, SO, TO – Does the industry structure matter?

 Transmission companies must be independent from market participation and possess financial strength  A real focus on transmission as a core activity    Cost efficiency Innovation Ability to respond to incentives  Strong incentivisation of system operator may require it to be backed by asset ownership  Efficiency of operation is facilitated by tight integration of SO and TO functions  ISOs and separate TOs may be dictated by inherited structures and property rights

Summary and Conclusions

 Investment occurs where companies have transmission as a prime focus, not a subsidiary activity  Investment in an unbundled competitive market needs investment in new processes, new tools and good people  But this will only occur if the right financial (and hence regulatory) incentives are present  Market mechanisms have a key role in incentivising efficient operation and investment, complemented by sensible technical guidance  The debate on industry structures will continue, but incentivised and integrated TO and SO functions have demonstrable benefits