Offshore electricity transmission: another piece of the jigsaw

Overview

Much of what is contained in the Joint Policy Update has been outlined in previous papers issued by the Office of Gas and Electricity Markets (Ofgem) and the Department for Business, Enterprise & Regulatory Reform (BERR). Nevertheless, the document provides a useful summary of the broad policy position, bringing together a number of work streams which have until now progressed separately.

The Joint Policy Update also provides a first opportunity to consider the proposed changes to the transmission licences and industry codes by which the new regime will be given effect, and the technical standards that will govern offshore transmission.

The document covers the following broad topics:

• the Regulatory Regime to apply to offshore transmission network owners (OFTOs);
• the Transitional Arrangements to apply to projects that are already in operation or that have reached a certain point of development;
• the Tender Process by which OFTOs will be appointed;
• the Licence Conditions to apply to OFTO licences;
• the changes that are proposed to the relevant Industry Codes;
• the applicable Charging/Compensation Methodology; and
• the process for Connection Applications.

Timetable

The consultation/implementation timetable has been revised slightly as follows:

• 7 July 2008: BERR/Ofgem External Communication Session at the BERR Conference Centre;
• July 2008: consultation on Tender Regulations;
• September 2008: publication of draft tender documentation and second consultation on Licence/Industry Code/Technical Standards modifications;
• October 2008: second consultation on Tender Regulations;
• December 2008: final consultation on full regime;
• December 2008: adoption of powers under Energy Bill;
• April 2009: 'Go-Active' - commencement of sections 90, 91 and 92 of the Energy Act 2004; modification of Licences, Codes and Technical Standards; and commencement of first Tender Process; and
• April 2010: 'Go-Live' - commencement of sections 89 and 180 of the Energy Act 2004.

If you wish to attend the 'External Communications Session' on 7 July, you should contact BERR by email at offshore.transmission@berr.gsi.gov.uk.

Regulatory Regime (Chapter 2)

The basics of the proposed regulatory regime are set out in the Energy Act 2004, and the key policy decisions were taken in 2006/7. Hence:

• it will be an offence to own or operate offshore electricity networks of 132kV or above without a licence;
• National Grid Electricity Transmission (NGET) will be the only person licensed to operate these networks;
• ring-fenced businesses (OFTOs) - which may be affiliates of the relevant generator - will be entitled to own these networks, and to earn a regulated rate of return on the costs of building and operating these networks; and
• such costs (and rate of return) will be recovered through NGET's charging methodology.

The Joint Policy Update provides further details of, and seeks comments on, the proposed regulatory regime.

OFTO licences will generally be subject to revocation on 18 months' notice, such notice not to be served prior to the commencement of the 19th year. However, Ofgem will have the ability to shorten the minimum period below 20 years where the tender has been "less than optimal".

Where there is an ongoing need for the asset beyond this 20-year period, Ofgem may either choose to allow the OFTO licence to continue, or may choose to re-tender.

The OFTO price control will allow adjustments to the revenue stream in the case of unexpected events, which Ofgem will consult on in coming months.

The regulated revenue will be subject to penalties (of up to 10% of annual revenue), which will apply to missed delivery dates and availability/reliability requirements.

An OFTO will be able to undertake "incremental" extensions to its network without the need to re-tender. It is likely that a threshold of 20% of the initial capital expenditure will apply, though comments are sought.

Transitional Arrangements (Chapter 3)

In order to be eligible for the transitional arrangements, a project must have reached a particular stage of development by the Go-Active date (or by the Go-Live date to participate in the second transitional tender round). Developers are invited to approach BERR with detailed proposals of their expected status for qualifying as a transitional project by the end of July 2008.

The necessary stage of development (intended to reflect financial close) is that the developer has:

• secured an onshore connection offer from NGET;
• obtained all necessary property rights (e.g. consents and leases) and all environmental and planning consents for the offshore transmission assets to be constructed and maintained;
• completed construction of, or entered into, all necessary construction contracts for the construction of the offshore transmission assets;
• reached full financial close (or there is evidence of an equivalent financial commitment, such as demonstrable parent company commitment) for the construction of the offshore transmission assets;
• provided its financial model for the offshore transmission infrastructure and all other necessary financial and other data to Ofgem to enable the assessment of the efficient and economic cost of constructing the offshore transmission assets;
• agreed to populate a data room with all the relevant data necessary for a prospective OFTO to be able to bid effectively;
• committed to transfer the offshore transmission assets to the selected OFTO under the terms set out in its request for the appointment of an OFTO;
• provided the appropriate fee to cover some of the costs of initiating the tender process; and
• where the transitional project has been constructed ahead of Go Active, the developer has provided an independent engineering audit report on functioning and performance to Ofgem.

The tender process for projects that satisfy these requirements will commence at Go-Active, so that an OFTO can be appointed by Go-Live.

Where a tender does not result in an OFTO being appointed, it is possible for the relevant developer to become the OFTO (the OFTO of last resort). However, Ofgem retains the right not to issue a licence if it considers it would not be in the best interests of consumers to do so.

For transitional projects that have not yet been constructed, it has again been confirmed that the developers will receive the greater of: (1) 75% of Ofgem's ex-ante regulated asset value (RAV) estimate; and (2) 100% of the efficient economic cost incurred on an ex-post basis.

Tender Process (Chapters 3 & 4)

Save in the case of the projects that are subject to the transitional arrangements, OFTOs will be appointed by way of annual tender processes commencing on a fixed date. Ofgem will run the tender process, recovering costs from participants.

Further details of the tender process will be established by way of secondary legislation, on which Ofgem will consult shortly.

The tender process will involve four stages:

• expressions of interest;
• invitations to tender;
• best and final offers; and
• preferred bidder.

Each stage will be supported by standard form documentation on which Ofgem intends to consult shortly. Assurances are given that the offshore developer and NGET would have key roles in the tender process.

Save in the case of the transitional arrangements, the successful OFTO would be responsible for constructing the offshore transmission infrastructure, and would be required to provide security cover to be drawn down in the event that construction could not be completed by the OFTO.

The offshore developer will remain responsible for obtaining the consents and leases necessary for the construction of the transmission infrastructure. Comments are sought on who is best placed to bear the cost of seabed surveys.

Licence Conditions (Chapter 5)

A successful OFTO will be granted a transmission licence. The transmission licence will define the geographical scope of the licence, and will be subject to standard and special conditions.

The special conditions will be unique to each OFTO and will largely be concerned with the regulated revenue applicable to the particular infrastructure.

However, the standard conditions will (subject to any amendments made by the special conditions) apply equally to each OFTO. As Ofgem indicated in February, the standard conditions applicable to electricity transmission licences will be amended to include a new section E.

OFTO licences would only be subject to the conditions contained in sections A and E. NGET's licence would remain subject to the conditions contained in sections A, B and C. The Scottish licensees would remain subject to those in sections A, B and D.

The intention is that the section E conditions should be similar to comparable conditions of existing transmission and distribution licences.

The proposed drafting for the standard conditions applicable to transmission licences is contained in Annex 1 to the Joint Policy Update, and also includes amendments to certain conditions in sections A, B and C.

Industry Codes (Chapter 6)

In addition to legislative and licence changes, it will also be necessary to make certain changes to industry codes and the applicable technical standards.

The Government is largely proposing an extension of existing onshore arrangements so that they apply offshore. However, there are obviously a number of ways in which such provisions can be extended, and the changes will not necessarily be uncontroversial.

The detailed changes to each of the following documents are set out in Annexes 2 to 8 of the Joint Policy Update: the Balancing and Settlement Code (BSC), the Connection and Use of System Code (CUSC), the Distribution Connection and Use of System Agreement (DCUSA), the Distribution Code, the Grid Code, the System Operator-Transmission Owner Code (STC); and the Security and Quality of Supply Standard.

The primary relationship between NGET and the OFTOs will be documented in the STC. The STC and CUSC will also provide for limitations of liability between the offshore generator and the OFTO.

NGET is running a Codes workshop on 19 June. For more details, contact: GBSO.Offshore@uk.ngrid.com.

Charging/Compensation Methodology (Chapter 7)

Again, the intention is to mirror the onshore methodology to the extent possible. However, the Joint Policy Update highlights certain areas where a different approach may be necessary. It is apparent that Ofgem and NGET continue to debate some aspects of the proposed regime.

In brief, the charging regime will provide for:

• the costs of the offshore transmission infrastructure to be recovered by NGET, and passed-through to the OFTO;
• NGET to recover these costs through both 'locational' and 'non-locational' transmission network use of system charges;
• the 'locational' charge to be met by the offshore generator, and the 'non-locational' charges to be smeared across users.

While, the compensation methodology will be based on:

• firm access at the onshore connection point, but non-firm access at the offshore connection point;
• compensation for the offshore generator linked to the performance requirements of the OFTO's licence (though recovery would be against NGET under the CUSC);
• the option (under the CUSC) for the offshore generator to choose (and pay for) greater offshore redundancy than is required by the technical standards, and thereby become entitled to revised compensation arrangements.

Connection Applications (Appendix 6)

Although it is relegated to an appendix, and does not receive its own chapter, the process to apply to connection applications will be an important one.

The difficulty for offshore developers of co-ordinating the connection applications process with the OFTO tender process will be a difficult one.

A prospective offshore generator will not be entitled to have its project considered in an OFT tender until the prospective generator has entered into a bilateral connection agreement with NGET under the CUSC.

The prospective developer must therefore apply to NGET for an offshore connection under the CUSC before an OFTO tender can commence. However, at the time of such application, NGET will not know any details of the design or cost of the necessary transmission infrastructure, or whether it would be appropriate to connect the infrastructure to an onshore distribution system. Such details will be established only as part of the OFTO tender.

It will therefore be necessary for NGET to vary the generator's bilateral connection agreement once the OFTO tender has been completed.

The prospective generator will be able to refer disputes to Ofgem regarding either the initial connection offer or the proposed variations, but this 'two-stage process' is bound to include an element of duplication. And as is recognised in the Joint Policy Update itself, referrals to Ofgem are likely to involve a delay which might prevent participation in a tender, or resolution of an OFTO price control.

Wragge & Co's legal experts have provided some action points on this issue.