Competitive Tenders for Onshore Transmission - Allen & …

1 Competitive Tenders for Onshore Transmission January 2016. 2 UK Electricity Market Reform: The draft Energy Bill Competitive Tenders Onshore Transmission | January 2016. Contents Key Issues 1. Introduction 1. Investment Opportunity 1. Generator Interface 2. CATO Revenue and Regulation 2. Existing Transmission Owners/System Operator Interface 4. Summary of Proposals 5. Background 5. Identifying projects to be tendered 5. Structure of the tender process 6. CATO revenue regulation 6. Managing conflicts of interest 7.

2 CATOs vs OFTOs 9. Key Contacts 11. Allen & Overy LLP 2016. Competitive Tenders for Onshore Transmission | January 2016. Key Issues Introduction The proposals to introduce competitively appointed Transmission owners (CATOs) were outlined in further detail by the Office of Gas and Electricity Markets (Ofgem) in the 19 October 2015 consultation on Extending competition in electricity Transmission : arrangements to introduce Onshore Tenders ' (the Onshore Tenders Consultation). On 21 January 2016, the Department of Energy and Climate Change published the draft primary legislation to be used to implement CATOs in its Draft Legislation on Energy (the Draft Legislation).

3 The Draft Legislation is facilitative and provides for the detail of the CATO mechanism to be provided for in secondary regulations, the details of which have not yet been published. As well as facilitating CATOs, the Draft Legislation would allow for the potential of future competition for distribution licences, depending upon the issue of further secondary regulations. Interestingly, the Draft Legislation would also extend the current mechanisms for statutory transfer schemes to include provision for the statutory transfer of assets to a Transmission owner of last resort (which will have implications for existing offshore Transmission owners as well as CATOs).

4 Further consultations are expected in 2016. The CATO opportunity is similar to the well-known offshore Transmission owner (OFTO) model that has been used previously, with, but with one major difference. That is, the CATO has to build the Transmission assets not buy them post commissioning. Investment Opportunity The opportunity to become a CATO is proposed to apply to new, separable and high value Onshore electricity Transmission assets. The first tender exercise is expected to take place in 2017. The first projects to be tendered are to be taken from the strategic wider works 1 (SWW) identified by existing Transmission owners (TOs) and Ofgem expects to confirm which of those projects will be available for Competitive tender as a priority after further discussions with the incumbent TOs.

5 (The first Networks Options Assessment Report is due to be published in March 2016.). In the case of assets scheduled to commence construction after 1 April 2021, Ofgem expects to tender all new, separable assets with a capital value of 100 million or above, including generator connections. The proposal is that the CATO should receive a regulatory revenue stream for a period of 25 years, based on the revenue stream bid during the Competitive tender process, which is partially indexed and subject to certain limited adjustment mechanisms.

6 The CATO structure bears a number of similarities to the OFTO structure, with which many investors will now be familiar. However since the CATO will need to construct the assets for which it would receive its revenue stream, it will be required to assume construction risks which are significantly different from those which have applied to previous OFTO projects. (There has not yet been a pure OFTO Build' project to come forward under the OFTO. enduring regime.). 1. 1. Competitive Tenders for Onshore Transmission | January 2016.

7 Generator Interface For generators, these proposals mean that the option for a generator to manage the construction of its own sole-user connection assets (as happened with OFTOs) may be restricted in the case of projects with a value of 100 million or more. The generator would have to consider how to gain the same degree of confidence in the ability of a special purpose vehicle CATO to construct the connection on time, as it would for construction by itself, or by an existing Onshore TO with its more extensive asset base, reputation and past experience.

8 Therefore Ofgem's proposals on CATO delivery incentives will be an important area of focus for generators, who may for example be more concerned to see substantive liquidated damages for delay. Helpfully, the generator's grid connection charges such as Transmission Network Use of System Charges (TNUoS) do not seem to be intended to be affected in the same direct way by the CATO revenue stream as for OFTOs (where the OFTO revenue steam is passed into the offshore local substation tariff), although this would be useful to clarify.

9 Separately, albeit that the Draft Legislation provides for a statutory transfer scheme to a CATO of last resort, it is not clear that the generator would be able to apply for a statutory transfer scheme to trigger the transfer of assets to a CATO of last resort if the generator is not the owner of the assets in question at the relevant time. CATO Revenue and Regulation For a CATO its revenue steam is intended to be for a 25 year period after completion of the assets (compared to the 20 year period for OFTOs) which is proposed to balance the expected asset life of Onshore assets (which are typically depreciated over a 45 year period) against the expectation that debt financing for periods greater than 30 years would have more limited availability, bearing in mind that the debt would also need to cover the construction period.

10 This would therefore accommodate construction periods of up to 5 years. A proportion of the revenue stream (a proportion to be proposed by the bidder in the Competitive tender process). would be subject to indexation. Indexation may be by reference to the consumer price index (CPI) rather than the retail price index (RPI) depending on the outcome of the views expressed in response to Ofgem's open letter of 14. October 2015, which is considering moving from RPI to CPI also for future OFTO and interconnector licences.