The economic regulation of gas processing services

Key issues and initial thoughts

Ofgem presentation18 June 2007

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Ofgem consultation document

Consultation document on gas quality to be published soon• Presents five key issues and our initial views• Consultation window of 6 weeks

Purpose of this meeting• Outline of consultation document • Present and discuss key issues

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Why this step?

Initial schedule of monthly workstream meetings, April – Aug 2007• Dedicated to issues in NGG offering gas quality services

Industry response has indicated further consultation is required• Via submissions to Ofgem and workstream meeting of 23 April• More comprehensive assessment of key issues before further

progressing policy development

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Key issue: risk-sharing with consumers

Market failure must be demonstrated to justify sharing service risks with consumers. Ofgem is aware of 3 main arguments for market failure:

(1) High level of uncertainty• Future supply sources• Compatibility of upstream arrangements• Future gas specifications in GB & across the EU

(2) Cost targeting• Difficulty of developing user-pays systems

(3) Monopoly advantage• NGG may have a technical cost advantage in providing on-shore gas

processing services

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Key issue: risk-sharing with consumers (cont)

Ofgem view

There is considerable uncertainty but we do not consider this to be sufficient evidence of market failure

• Commercial opportunities of users the key driver of investment• Identification of investment opportunities a core business of shippers

We recognise the difficulties in targeting service costs to users but consider that there may be more efficient alternatives than socialising costs

• Alternative solutions may be for increased monitoring of flows across the supply chain, or the relocation of gas processing facility upstream

We agree that NGG may have a monopoly advantage in providing onshore processing services

• Does not necessarily warrant sharing of service risks with consumers• The current regulatory regime may not ensure NGG provides gas quality

services if they are demanded.

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Key issue: competition impacts

The market determines the most efficient sources of gas, the way in which it is brought to GB and the price GB consumers pay for it

Onshore gas processing services represent one potential link in the supply chain delivering gas to GB customers

• Link would only be applicable for off-spec gas imported to GB

Upstream (production and

transport to beach)Processing Transportation Distribution Supply

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Key issue: competition impacts (cont)

Locating the risk of a gas processing facility with consumers may distort commercial incentives across the gas supply chain

• Service users would receive a commercial advantage as they would not bear the full cost

• Potential to cause distortions across the gas supply industry• Extreme effect may be to ‘crowd out’ private investment in

processing services

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Key issue: competition impacts (cont)

Ofgem view

Potential for a regulated approach to create distortions across the gas supply industry is a key concern

• Ultimate impact may be to increase gas prices for GB customers

Allocating services costs/risks to those users that directly benefit commercially from their provision mitigates this risk

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Key issue: upstream issues

Upstream arrangements currently prevent off-spec gas from being imported to GB

• Gas quality specifications on interconnector & import pipelines and on ‘feeder’ networks are tailored to current GB specifications

Amending these arrangements may be a complex and challenging exercise • For example Bacton – spec amendments required for IUK & BBL,

Fluxys network, several parties involved, contractual issues, etc.• Potentially less complicated at other terminals

The CEN mandate may facilitate the necessary amendments• However, earliest date this may occur under current schedule is

2012-13

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Key issue: upstream issues (cont)

Ofgem view

Extent of required amendments may be significant however the barriers to agreement between commercial parties may not be insurmountable

If the commercial opportunity is sufficient then parties may be able to agree to substantial amendments

• The commercial opportunity may be significant (as implied by new investment in gas processing services)

Ofgem is prepared to help resolve relevant issues• In support shipper effort & where need for our involvement is clear

Upstream considerations may be a key factor favouring a processing solution (if required) upstream of the NTS

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Key issue: level of user commitment

ER workstream model requires investment in gas processing services to be fully underpinned by user commitment

• Protects GB consumers from the risk that this investment becomes a stranded asset

• Potential users are allocated this risk as they are considered to be best placed to signal demand for processing services

This approach provides flexibility to share residual service risks with consumers…

• Commitment may only need to cover an ex ante cost estimate or may need to cover the full service costs (measured ex post)

…although the overall difference between this approach and a pure commercial approach may be limited

• A key difference would remain the obligation on NGG to assess and develop processing services if requested by a third party

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Key issue: level of user commitment (cont)

Ofgem view

Important to protect consumers from situations where there is a significant risk of asset stranding

• Level of uncertainty expressed to date implies potentially high risk of asset stranding for this investment

• Not yet a clear case for sharing services risks with consumers

Also important to ensure that NGG responds to market interest in gas processing services

• There is no obligation for independent investment in processing services by third parties to include NGG

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Key issue: investment by NGG not backed by user commitment

The ER workstream approach allows for two different regulatory regimes to apply to a single processing facility

• One for capacity underpinned by user commitment• Another for additional capacity in which NGG may invest

Key benefit was seen as potential for NGG to drive investment• May have additional information as NTS system operator

This presents several issues in effectively regulating such as asset• Regulatory complexity – in design and monitoring• Impact on user incentives

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Key issue: investment by NGG not backed by user commitment (cont)

Ofgem view

While there may be benefit from allowing NGG to make investment not backed by user commitment…

…it would introduce some potentially significant problems

We would only consider such a feature in any regulatory regime if the benefits outweighed these potential problems

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Summary

• Publication of consultation document discussing key issues and our initial views

• Consultation window of 6 weeks

• Detailed written submissions sought

• Next step by Ofgem will be to develop Initial Proposals

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