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Policy Review

Alternatives to UK’s CATO: Competition for onshore projects still Ofgem's agenda [free access]

December 8, 2017

Electricity transmission, in general, remains a monopoly business. While governments world over have successfully introduced competition in generation, only a few countries have succeeded in bringing competition in tranmsission. Britain’s Offshore Transmission System Owner (OFTO) model, which was launched in 2009 by British energy market regulator, the Office of Gas and Electricity Markets (Ofgem), is among the few case sudies of successful regimes for competitive transmission. The OFTO model has delivered an economic and efficient development of the UK’s offshore grid.

 

To replicate the success of the OFTO regime, Ofgem in 2015 decided to extend the use of competitive bidding to a set of onshore electricity transmission assets that are new, separable and of high value. These assets are part of the Strategic Wider Works (SWW) regime encompassing large and uncertain projects identified by the incumbent transmission operators. Ofgem identified a few onshore projects to be bid out under what it called the Competitively Appointed Transmission Owner (CATO) regime. For two years, Ofgem worked on developing the legislation, policy and supporting documents that would enable it to tender onshore electricity transmission assets.

 

However, in June 2017, Ofgem notified that it will further develop CATO only when there is greater clarity on the timing of the enabling legislation, which is facing major delays due to Brexit taking up the Parliamentary timetable for the next two years. Nonetheless, a recent consultation related to the Hinkley–Seabank transmission project, which will link the new Hinkley Point C nuclear power station to Britain’s electricity transmission network, shows that competition in the onshore grid is still under Ofgem’s precedence. With CATO not an option for the time being, the regulator has put forward two alternative models, namely, the Special Purpose Vehicle (SPV) model and the Competition Proxy model. According to Ofgem, both these models are expected to deliver potential savings of around GBP30-GBP120 million as compared to the SWW status quo.

 

Suggested models for competition in onshore grid

 

SPV model: Under this, the national transmission system operator National Grid Electricity Transmission (NGET) instead of Ofgem would run a competition for the construction, financing and operation of the Hinkley–Seabank project through a project-specific SPV. The SPV would deliver the project under the terms of a contract or delivery agreement with NGET, which would retain responsibility for operational control of the project. The SPV would finance, construct and operate the project for a fixed period, potentially 25 years, in return for a defined revenue under its contract with NGET.

 

Competition Proxy model: NGET would deliver the project, but Ofgem would set for NGET an ‘allowed revenue’ in line with the revenue Ofgem considers would have resulted from an efficient competition for construction, financing and operation of the project. The revenue would be fixed for potentially 25 years and Ofgem would base it on its determination of a weighted average cost of capital for the revenue term and efficient costs for construction and operations. Ofgem would use appropriate benchmarks (e.g. from OFTO tenders) to determine these costs.

 

Alternative models versus CATO

These new models are comparable to CATO but not reasonably the same. Both the SPV and Competition Proxy models, like CATO, foresee a 25-year revenue stream, either set by competition under the SPV model, or by Ofgem using their experience of running tenders under the OFTO regime. However, under these new models, unlike under CATO, the assets would be governed by NGET's transmission licence as the SPV would finance, build and operate them on behalf of NGET under a contract in the SPV model or NGET itself would build and operate them under the Competition Proxy model.

 

Under the SPV model, the terms of contract between the SPV and NGET would indicate the required construction and operational works and take account of the requirement for the SPV to comply with relevant licence obligations of NGET, which would also retain overall regulatory responsibility. Additionally, NGET having first approved the principles with Ofgem, would take the lead in drafting the delivery agreement.

 

According to Ofgem, the SPV model in particular is expected to present a significant level of price discovery on how the market values the risks faced by incumbent transmission owners. It is also expected to offer some useful benchmarks for Ofgem that can later be considered in establishing future price controls.

 

As of now, NGET has been favouring the Competition Proxy model, under which it constructs and owns the assets. The Competition Proxy model allows NGET to retain ownership and control of the project and assures lower risk for NGET than the SPV model but still gives a guaranteed 25-year revenue stream.

 

Way forward

After the consultation that closed in October 2017, Ofgem is expected to decide on the final needs case for the Hinkley–Seabank project in December 2017. There is still the option of not using either of these models and simply continuing the SWW process.

 

If chosen as the preferred route, competition under the SPV model may begin by the first quarter of 2018. In early 2018, Ofgem will publish further details on approaches for introducing competition and will conduct a project assessment for the Hinkley–Seabank transmission project.

 

However, there are still some details to be ironed out for building confidence in investors or new entrants. In particular, matters such as whether and how any subsidiary of NGET could bid in an SPV tender; the extent to which the revenue stream is completely fixed, or whether there may be review points for operational expenditure; and last resort arrangements such as transmission owner termination and step-in rights, require more clarity from Ofgem’s side.