1
Investment in TransmissionEconomics of
Electricity Markets IDEI Toulouse, 2-3 June
2005

• Jon Carlton Director of Network Strategy

2
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

3
Who are National Grid Transco?

• Formed in late 2002 through merger of Lattice
  Group and National Grid Group
• International energy delivery business with
  market capitalisation of 20billion
• 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

4
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

5
Investment challenges for National Grid in the UK
ASSET AGE PROFILE

• DRIVERS OF TRANSMISSION INVESTMENT
• Ageing coal-fired generation
• And tighter emissions limits
• New gas-fired generation
• Renewables
• Especially wind power
• Asset replacement
• Driven by asset age and condition

6
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 companys 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

7
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

8
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)

9
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

10
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

11
Uncertainty in future generation pattern
Generation Demand
1200
2200
2171
Background A
3667
Background B
6719
9815
7716
12027
3611
5941
1196
1988
1988
1483
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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

13
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)

14
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

15
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

16
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