180374.3

Gas Industry Co feedback on advice from the Panel of

Expert Advisers on gas transmission access and

pricing

Date issued: August 2012

180374.3

About Gas Industry Co.

Gas Industry Co is the gas industry

body and co-regulator under the Gas

Act. Its role is to:

develop arrangements, including

regulations where appropriate,

which improve:

○ the operation of gas markets;

○ access to infrastructure; and

○ consumer outcomes;

develop these arrangements with

the principal objective to ensure

that gas is delivered to existing and

new customers in a safe, efficient,

reliable, fair and environmentally

sustainable manner; and

oversee compliance with, and

review such arrangements.

Gas Industry Co is required to have

regard to the Government’s policy

objectives for the gas sector, and to

report on the achievement of those

objectives and on the state of the

New Zealand gas industry.

Gas Industry Co’s corporate strategy is

to ‘optimise the contribution of gas to

New Zealand’.

Executive summary

Under the Gas Transmission Investment Programme (GTIP), in July 2012, the Panel of Expert Advisers

(PEA) provided preliminary advice to Gas Industry Co on gas transmission access and pricing. The GTIP

Programme Sponsor congratulates the PEA on its work in describing and tackling the difficult issues

related to gas transmission access and pricing, and in recommending a set of possible improvements

on current arrangements (the ‘straw man’).

To assist the PEA’s further consideration of these matters, Gas Industry Co identifies some areas where

we believe that further clarification and development of suggested improvements would be helpful.

In particular, we request further clarification of:

the process that would lead to a capacity auction being initiated. We believe that this will shed light

on:

○ what conditions would trigger an auction;

○ how much transparency there can be around the process;

○ whether a point-to-zone capacity product might be more compatible with the auction proposal;

how the nominations arrangements should work;

what questions in relation to scarcity pricing should be asked of the Commerce Commission and

MoBIE, and who should ask those questions; and

what specific information the PEA considers should be transparent.

We also request that that additional consideration be given to:

the recommended form of interruptible agreements;

whether the Maui pipeline access principle – that all users are interruptible, but can buy rights to

priority service – could or should be considered for Vector pipelines; and

the PEA’s preliminary thoughts on the preferred method(s) of implementation.

In addition, we encourage the PEA to consider the next steps, in light of submissions, and discuss

these with the Program Sponsor.

We look forward to further engagement with the PEA on these matters.

Steve Bielby

GTIP Program Sponsor

180374.3

Contents

1 Introduction 6

2 Clarification 8

2.1 Initiation of auctions of scarce capacity 8

2.2 Design of the nominations regime 10

2.3 Investment uncertainty and scarcity pricing 11

2.4 Transparency 12

3 Development 15

3.1 Interruptibility 15

3.2 Maui pipeline approach to efficient use of system 18

3.3 Implementation 19

4 Work Plan 21

6

1 Introduction In July 2012 Gas Industry Co received preliminary advice from the Panel of Expert Advisers (PEA) on

gas transmission access and pricing. As envisaged by the Gas Transmission Investment Programme

(GTIP) communications protocol (Figure 1), this preliminary advice has now been issued by Gas

Industry Co for stakeholder input.

Projects

Stakeholders

Panel of

Strategic Advisers

OversightGIC Board

Project

Manager

Information Projects

Objective: minimise

information

asymmetries

Project

Manager

Market Projects

Objective: efficient

market design

Project

Manager

Regulatory Projects

Objective: appropriate

regulatory

arrangements

Panel of

Expert Advisers

Gas retailers

Pipeline

companies

Commerce

Commission

End users

Ministry of

Economic

Development

Minister

Programme

SponsorOthers

Figure 1 - Structure and communication channels of the GTIP

The Programme Sponsor considers that the PEA has delivered a substantial piece of work that clearly

describes current access arrangements, how these compare with those in other jurisdictions, and

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where they can be improved. The PEA’s preliminary advice also sketches out a ‘straw man’ set of

incremental improvements that have the potential to enhance efficiency. This is a significant co-

operative effort that is a credit to all members of the PEA.

As intended, the PEA’s straw man has drawn substantial submissions from a broad range of interested

parties, and the PEA will shortly begin its analysis of those submissions and re-assess its proposal in

light of them. As the recipient of the PEA’s preliminary advice, the Programme Sponsor also thought it

would help the PEA if Gas Industry Co provided some initial feedback.

This report suggests where the PEA could:

provide further clarification of some of its recommendations (Section 2);

consider some matters not covered in the draft, but which we consider are important to the further

development of industry arrangements (Section 3); and

once the PEA has fully considered the submissions, discuss with Gas Industry Co how best to

proceed (Section 4).

8

2 Clarification Gas Industry Co understands that the straw man sets out a number of incremental improvements to

current arrangements rather than being a panacea for all issues. However, even with such an

evolutionary approach it is important that the first step is described with enough clarity to confirm that

it is realistic and likely to bring results. There are a few aspects of the proposed improvements that we

think would benefit from further clarification.

2.1 Initiation of auctions of scarce capacity

A key element of the straw man is that capacity will be auctioned when it is scarce. It is proposed that

the trigger for an auction will be the TSO deciding that the demand for (commercial) capacity exceeds

the supply. We think that the proposal would benefit greatly from some illustrations of how this

might work in practice. To explain why, in Table 1 we set out a possible process for allocating

capacity, and identify a number of questions that arise.

Table 1 - Possible Capacity Allocation Process

Possible process for issuing capacity Matters requiring clarification

1. TSO confirms availability of point-to-

point grandfathered entitlements

(say, 80% of the reserved capacity

then on issue), and invites

provisional reservations.

Since the PEA’s preliminary advice (p44 under the heading

‘Geographical dimension’) is not recommending any further

movement towards wider zones on the Vector network at this

stage, we assume that these entitlements will be mostly for

point-to-point capacity, as at present.

2. On receiving provisional reservations

TSO makes an assessment of

whether demand for capacity

exceeds supply.

Would this assessment based of a simple comparison of

numbers (a ‘bright-line’ assessment), or on some kind of system

modelling (a ‘black box’ assessment)?

Bright-line assessment

If the assessment is to be bright-line, would the assessment be

done at a point-to-point level or a system level? Eg:

for point A to point B: available capacity = 100, provisional

reservations = 120, therefore supply exceeds demand; or

for, say, the North pipeline: available capacity = 1000,

provisional reservations = 950, therefore supply does not

exceed demand.

9

Possible process for issuing capacity Matters requiring clarification

Also, how would the bright line numbers be established? For

example, would they be based on reservations in the (then)

current year?

Black box assessment

If the assessment is to be based on engineering judgments that

are difficult to articulate, or modelling that is difficult to

replicate, will the resulting lack of transparency be a problem?

3. Where demand for capacity does

not exceed the available supply, TSO

will confirm the provisional

reservations.

4. Where demand for capacity exceeds

the available supply, TSO will

confirm only the grandfathered

quantities, and initiate an auction

for the remainder of the available

capacity.

Issues may arise if there is some inter-dependency between

point-to-point deliverability, as illustrated in the example below.

Assume:

current year reservations of A to B capacity and A to C

capacity are both 100 units;

the declared capacities available for the next year are 100

units of A to B capacity, and 100 units of A to C capacity;

provisional reservations for A to B capacity are for 110 units,

and for A to C capacity 90 units.

In this example, only 80 units of A to B capacity would be

allocated (80% of current reservations), and an auction would

be called for the remaining 20 units of A to B capacity

(available capacity of 100 units less grandfathered capacity of

80 units). All 90 units of A to C capacity would be allocated,

and no auction would be necessary (requested capacity of 90

units is less than available capacity of 100 units).

If A to B and A to C capacity are independent then:

Capacity at the margin will have gone to its highest value

use (assuming the auction for A to B capacity received

competitive bids).

However, if A to B and A to C capacity are inter-dependent (ie

the TSO could transport any amount from A to B or A to C as

long as the total does not exceed 200), then:

10 units of requested shipper capacity will have been

declined, although it could have been provided.

Shippers will have paid a premium for the 20 units of A to B

capacity sold at auction, although capacity in aggregate is

not scarce.

10

We are not suggesting that the PEA should consider the design of the auction at this stage. We accept

the PEA’s view that this is a matter that requires considerable thought and attention, and can be

deferred. However we think that it is important that the capacity product definition is compatible with

the auction proposal. It appears from the example given in Table 1 that there might be a problem if

point-to-point capacities are inter-dependent. If this is the case, perhaps the PEA should reconsider its

recommendation that there is no need to move to a point-to-zone1 definition of capacity.

If a point-to-zone definition were considered to be more appropriate, an added benefit could be

greater liquidity in each capacity auction. This might be a significant benefit given the small size of the

New Zealand market.

2.2 Design of the nominations regime

Section 5.6 of the PEA’s preliminary advice explains that the introduction of a nominations regime

would help manage situations of short-term capacity constraint by:

incentivising short-term trading at times of constraint;

facilitating the forecasting of peaks; and

providing valuable information for the market.

However, we think that the effectiveness of a nominations regime in achieving these outcomes will

depend on its design. We encourage the PEA to consider whether more design details could be

provided. In particular, consideration could be given to:

how and when nominations are made available to the market;

what incentives are appropriate to ensure nominations are reasonable;

whether nominations should be required for all transport contracts or only for reserved capacity

contracts; and

whether the TSO should publish its forecasts.

1 Note that Vector’s current ‘zones’ are price zones. Each zone comprises a set of delivery points within a region that all have the same

Capacity Reservation Fee. For such a zone, the VTC allows that overrun fees for deliveries within the zone will be based on aggregate numbers. For example, if Shipper A has 100 units reserved from A to B, and 200 units from A to C, and delivers 120 units at B and 190 units at C, then the overrun will be 10 units (120+190-100-200) if B and C are in the same the zone. However, if a shipper wishes to transfer some of it’s A to B capacity to use as A to C capacity, In contrast, the kind of zone that we assume in this paper is a trading zone, where capacity can be transferred within the zone without Vector’s prior approval.

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2.3 Investment uncertainty and scarcity pricing

In the concluding paragraph of Section 5.7 Reducing Investment Uncertainty, the PEA proposes that:

The investment uncertainty and scarcity pricing issues cannot be addressed though the

access arrangements alone. The issues relate to the design of the regulatory arrangements

and its interface with the access arrangements. Given this observation, the next step would

be to discuss the investment uncertainty issues and scarcity pricing with the Commission,

which is responsible for economic regulation, and (possibly) the Economic Development

Group of the Ministry of Business, Innovation & Employment.

We suggest that it might be helpful to consider investment uncertainty and the treatment of scarcity

rents as two separate matters.

In relation to investment uncertainty, the original GTIP scoping paper (‘Gas Transmission Investment

Programme - Structure and Scope’), described a Regulatory Project called ‘Testing Investment

Options’. It is this project that will test whether current regulatory arrangements are appropriate to

support efficient investment in transmission infrastructure. The issue of investment uncertainty belongs

with that project rather than the Transmission Access and Pricing project.

If the PEA does wish to provide advice in relation to investment incentives, we suggest that more work

would be required to give a full description of how the Part 4 regulation for gas transmission

businesses works. (Although we note that the regime is somewhat unsettled while the merits review

litigation is going through the Courts, and until the default price-quality path is set in 2013.) In

particular, we think that the operation of the customised price-quality path, including the scope of the

input methodologies for the customised price-quality path proposals, would need to be described

(these input methodologies are not subject to merits reviews and are therefore settled.). It may also be

necessary to consider the rules applying to the information a supplier of transmission services must

provide, the verification and audit that information must be subject to, the role of consumer

consultation, and the evaluation criteria the Commerce Commission will use in assessing proposed

investments. The additional mechanisms (for contingent and unforeseen projects) that the Commerce

Commission has put in place may also need to be described.

However, we think that scarcity pricing is a matter squarely within the scope of the Transmission

Access and Pricing project. On that matter it would be helpful if the PEA described in more detail what

questions need to be addressed to the Commerce Commission and MoBIE, who should make those

enquiries, and how the outcome may influence the recommendations of the PEA.

12

2.4 Transparency

Section 1.1 also notes that one of the PEA principles is:

3. Improve transparency of market information;

Asymmetric information is often cited as a barrier to competitive market outcomes. Market

arrangements should enable participants to make informed decisions.

In keeping with this, the PEA’s advice emphasises the importance of transparency. In section 4.2,

under Primary Allocation, Incentives to Issue Capacity, it is noted that:

Finally, criticism has been made that there is a lack of transparency around Vector’s capacity

decisions – shippers and end consumers do not feel they have enough information about

physical capacity, how Vector sets commercial capacity, and spare capacity. Transparency is

particularly important given Vector’s vertical integration across pipeline ownership, system

operation and gas trading. Vector itself has acknowledged these issues and is working on

ways to address them.

In the same section under Primary Allocation, Interruptibility, it is also noted that:

Interruptible contracts on Vector’s transmission pipeline are ad hoc and confidential, and

they appear to be rare. More transparency, including information on the risk of interruption

(e.g., the maximum number of interrupted days), might assist allocative efficiency…

In Section 5.3, Capacity Product Definition, Other Issues, it is suggested that:

To the extent possible, the terms of such bespoke contracts should be transparent and non-

discriminatory.

In Section 5.8, TSO Governance, it is noted that:

Particularly if it is a vertically integrated entity, the TSO would need to be subject to explicit

governance requirements (eg, in the VTC) to ensure independence, competitive neutrality

and transparency.

…

There is also a need for improved transparency around decisions about allocable capacity,

the make-up of that capacity and the ongoing use of that capacity.

…

What is clear to the PEA is that there needs to be a significant increase in the transparency of

Vector’s decision-making regarding its pipelines.

In Section 5.9, Matrix Summarising the Issues and Proposed Solutions, the importance of clarity of the

TSO’s disclosure obligation is emphasised:

It is important that the TSO has clarity (and indeed prescription) on the information that is

required by market participants for the development of an efficient market, and the

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requirements to provide information need to take account of the costs – to the TSO and the

market – of doing so. Ambiguity in the TSO’s obligations to provide information to market

participants should be avoided. The PEA therefore welcomes Vector’s current initiatives to

improve transparency and further enhancements in this area are desirable.

And in Section 4.4, Concluding Comments, it is said that:

The most fundamental problems with the existing governance arrangements as they apply to

capacity allocation and investment are:

o a lack of transparency of the state of the transmission system, which inhibits market

information on the value of capacity and the potential value of interruptible capacity;

…

o the effectiveness of the secondary market is still unclear but it is thinly traded and

non-transparent;

…

o a lack of transparency regarding the determination of the amount of commercial

capacity and the terms of non-standard contracts;

Also, in Table 6, where the PEA’s proposals are summarised, the recommendations in relation to

transparency are:

in relation to ‘Lack of price signal for capacity’, one of the straw man proposals is listed as:

Introduce nominations regime, increased transparency around capacity and utilisation, and

more generally facilitate secondary trading.

in relation to ‘Lack of transparency around Vector’s capacity-setting decisions and capacity

utilisation’, the straw man proposal is listed as:

Vector is already addressing transparency around capacity-setting, but more transparency

is also needed around capacity utilisation.

in relation to ‘Being vertically integrated’, one of the straw man proposals is listed as:

Ensure transparency of decision-making and appropriate governance arrangements in

VTC.

These conclusions are summarised in the Executive Summary:

Transparency is addressed in relation to the primary allocation of capacity, but it also has a

more overarching role in terms of promoting the efficient use of transmission capacity. In

particular, transparency addresses the information asymmetries that are an inherent feature

of natural monopolies such as transmission pipelines. It is important that the TSO has clarity

(and indeed prescription) on the information that is required by market participants for the

development of an efficient market, and requirements to provide information need to take

account of the costs – to the TSO and the market – of doing so. Ambiguity in the TSO’s

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obligations to provide information to market participants should be avoided. The PEA

welcomes Vector’s current initiatives to improve transparency and further enhancements in

this area are desirable.

However, given the importance placed on improving transparency, and the PEA’s view that

‘[a]mbiguity in the TSO’s obligations to provide information to market participants should be avoided’,

we believe that its recommendations should be more specific. In Table 2 we suggest how the PEA

could achieve this.

Table 2 - Suggestions for more specific recommendations in relation to Transparency

Current recommendation Suggestion for more specifics

Introduce nominations regime,

increased transparency around

capacity and utilisation, and more

generally facilitate secondary trading.

Vector is already addressing

transparency around capacity-setting,

but more transparency is also

needed around capacity utilisation.

All Shipper nominations at each delivery point to be in the

public domain.

All Shipper deliveries at each delivery point to be in the public

domain.

Ensure transparency of decision-

making and appropriate governance

arrangements in VTC.

Once the means of assessing if demand for capacity exceeds

supply, more specifics could be considered.

To the extent possible, the terms of

such bespoke contracts should be

transparent and non-discriminatory.2

All contracts for transport services to be in the public domain.

No confidentiality clauses to be included in future contracts for

transmission services. (Or, if the PEA wishes to specify what

matters could be confidential, any confidentiality clauses should

relate only to those matters.)

2 This recommendation appears in Section 5.3, Capacity Product Definition, Other Issues, but was not picked up in the Table 6 summary. We

assume this was an oversight.

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3 Development 3.1 Interruptibility

The only definite recommendations that the PEA made in relation to interruptible agreements (IAs) are

to:

review the value proposition (IAs provide TSO with more flexibility to manage pipeline at peak times,

but users need to be able to assess the risk of interruption); and

price interruptible capacity lower than reserved capacity.

(Table 6, p52)

It appears to us that IAs serve two critical functions and therefore warrant more attention. In

particular, IAs serve to:

on every day, ensure that capacity that is not available as ‘firm’ capacity, but nonetheless is

physically available, can be accessed by the market; and

on days when the pipeline becomes physically constrained, provide a ‘soft landing’, avoiding the

need to invoke critical contingency arrangements.

It may help to illustrate the first of these functions by example.

Suppose there is a simple pipeline supplied with gas at Receipt Point A and delivering gas at two

offtake points, Delivery Point B half way along its length, and Delivery Point C at its extreme end.

There will be a range of possible capacity combinations that can be fully provided for without

breaching pipeline constraints. The pipeline could deliver, say, 400 units from A to B, but that would

leave no capacity available to supply any demand at C. Alternatively, the pipeline could deliver 100

units from A to C, but there would be no capacity to supply any demand at B. There will be a range of

other possible combinations between these two extremes that will allow some demand at each

location to be met. Table 3 sets out a number of possible combinations.

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Table 3 - Possible capacity combinations in pipeline with two delivery points

A to B 400 300 200 100 0

A to C 0 25 50 75 100

For this simple pipeline we can plot the set of possible capacity combinations on a graph to map a

‘frontier of possible capacity combinations’. The pipeline is capable of delivering any combination of A

to B and B to C deliveries below this frontier. We could also imagine a sample of actual peak demands

for, say, the last 5 years, and plot these on the graph.

Assuming that the TSO defines the available reserved capacity on this pipeline on a point-to-point

basis, it will need to assess how much ‘firm’ capacity it can sell for each point-to-point combination.

For example, it might decide that 80 units could be available from A to B and 30 units from B to C.

This would be a ‘safe’ level of capacity to offer since, even if the full quantity was subscribed to and

used, the outcome would not cross the frontier. The situation is illustrated in Figure 2.

Frontier of possible capacity combinations

A to C Capacity

A to B Capacity20080

50

30

Available

A to C

Reserved

Capacity

Available

A to B

Reserved

Capacity

Actual peak capacity requirements in Year 1

Figure 2 - Capacity availability and use on a one Receipt Point two Delivery Point pipeline

Note that the selection of 80 and 30 is essentially an administrative decision; one that appears

reasonable in light of past demand requirements at B and C. There are many other possible

combinations of ‘firm’ capacity that could have been defined by the TSO. If trading of firm capacity is

possible (and liquid) it may not be important if the TSO’s selection is not optimal. For example, if

shippers anticipated an outcome similar to the actual peak in Year 1, they could trade capacity so that

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this is achievable under a ‘firm’ capacity reservation (assuming the trades were approved by the TSO).

A possible outcome of shippers trading their firm capacity entitlements is illustrated in Figure 3.3

A to C Capacity

A to B Capacity20080

50

30

Trade of capacity

Figure 3 - Capacity availability altered through trading

Whatever the final result of trading, on the actual day of gas flow the firm capacity entitlements will

be fixed at those certain values (on-the-day or post-facto trading is not envisaged by the VTC).

However, there are other possible combinations of physical deliveries that are possible (ie within the

frontier) but not within the area of firm reservations (represented by the white area on the diagram).

The domain of these outcomes is illustrated by the shaded areas of the diagrams. IAs allow outcomes

in the shaded areas to be achieved via a mix of firm and interruptible capacity, allowing the full

physical capacity of the pipeline to be used.

Of course the illustration is a gross simplification of the real situation. In practice there are dozens of

delivery points on each of Vector’s pipelines. So it is a daunting task for Vector to define the available

capacity at each one in a way that results in optimal capacity availability. It would certainly require

some complex system modelling, making it very difficult to achieve transparency. Also, as noted by the

PEA, Vector has an incentive to be conservative in its assessment of how much capacity can be made

available. For these reasons we consider that IAs have an important role in ensuring that all capacity is

available for use and not ‘sterilised’ due to conservative calculations, underutilised reserved capacity,

lack of trading, uncertainty over whether Vector will approve trades, or any other administrative

restrictions.

The second benefit of IAs is easier to explain. On days when the pipeline becomes physically

constrained, they offer a means of providing a ‘soft landing’ to avoid critical contingency

3 The example assumes that A to C capacity can be traded for A to B capacity in such proportions as to allow the frontier to still be

achievable. In practice it is more likely that they would trade on a unit for unit basis or, as at present, on an equal value basis.

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arrangements being invoked. This is done by calling on the holders of the IAs to interrupt. Of course

this should still be done in an efficient manner, if that is possible.

From the above we believe it is clear that IAs can (and should) have a vital role in preserving the

efficiency of the access regime, and maximum utilisation of the pipeline. While the PEA’s advice

addresses the efficient allocation of the firm capacity the TSO declares to be available, we consider

that it also needs to consider whether the arrangements allow for maximum utilisation of the pipeline,

and that must involve further definition of IAs.

Some questions the PEA could consider are:

Should IAs always be available, or only available in certain circumstances (such as when all firm

capacity is allocated)?

If IAs are only available in certain circumstances, what are those circumstances, how will the

availability of IAs be notified, and will the uncertainty of availability inhibit the development of

interruptible demand?

If IAs are always available, will the total amount of interruptible capacity offered be limited?

Should all IAs be standard?

How should IAs be priced? For example, could the price of IAs be different depending on the

probability of interruptions, ie close to the firm price when the likelihood of interruption is low, but

increasingly cheaper as the likelihood of interruption increases?

Can interruptible capacity be used by shippers as a substitute to overrun capacity? If so, what are

the consequences (for example, is there a danger of a ‘flight from firm’?). If not, how will

substitution be prevented?

We think that some degree of prescription around IAs is necessary for the PEA to be confident that its

proposal will allow for the efficient utilisation of the pipeline. If it is not possible to describe how IAs

will function, we think it will undermine the claim that the PEA’s proposals will lead to efficient use of

the pipeline.

3.2 Maui pipeline approach to efficient use of system

Considering the PEA’s view that a common access regime across the Vector and Maui pipelines is

desirable, we wonder if the PEA should comment on the practicality of extending the Vector regime

across the Maui pipeline, or vice versa.

Since the PEA’s recommendations substantially relate to the Vector pipeline, it may be sufficient to

note whether extending the Maui access arrangement over the Vector pipeline is a practical option. If

it is an option, the PEA could also explain why it is not a better option than the one it is currently

proposing. (At face value, it appears that extending the arrangement across both pipelines would

19

achieve a common access regime, whereas the PEA’s current recommendations may further entrench

differences.)

Essentially the MPOC offers users access to all capacity in the Maui pipeline. If a user anticipates

capacity constraints, it can buy Annual Quantity (AQ) to give it a priority right to service. The means of

allocating AQ have yet to be established.

A possible development of the Maui regime to suit the Vector pipeline (that predominantly delivers

gas to distribution networks) could work as follows:

each shipper would nominate its receipt and delivery quantities;

shippers would receive a common carriage service (ie no reservations of capacity);

shippers wishing to obtain a priority position during periods of congestion could purchase an

optional AQ service;

the TSO would determine the amount of AQ available for each capacity zone, and would sell the AQ

at auction;

in the event of anticipated congestion within a capacity zone, non-AQ shipper nominations would

be first scaled back;

shippers would be deemed to have received their nominated quantities of gas;

following month end reconciliations, any shipper who has an imbalance at a delivery point:

○ may receive balancing charges (where the shipper’s imbalance has contributed to a balancing

action being taken); and

○ would receive penalty imbalance charges if its nomination had been scaled back in anticipation of

congestion.

3.3 Implementation

In Section 6.2 of its advice, the PEA proposes that ‘[o]nce the PEA has provided its final advice on

transmission access and pricing options, it will turn its attention to options for implementing its

recommendation.’

We accept that implementation can only be fully considered once the proposals are clarified. However,

it would be helpful for planning purposes if the PEA could at least indicate its preferred method(s) for

implementing the recommendations. Perhaps something like the Table 4 layout could be incorporated

into the PEA’s advice.

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Table 4 - Preferred means of implementation

Current recommendation Suggestion for more specifics

Water down grandfather right (s5.3) TSO to initiate VTC Change Request.

If demand > supply, auction un-grandfathered capacity. (s5.3)

TSO to specify auction design and develop auction

platform.

Make interruptible arrangements

more transparent. (s5.3)

TSO to voluntarily stop including confidentiality provisions

in transmission services contract, and allow all future

contracts to be viewed in the public domain.

Rebalance tariffs: CRF ↑ TPF ↓ (s5.4) TSO to include in its pricing methodology the principle

that variable charges should reflect variable costs.

Confirm bulletin board and

tradability of power station capacity.

(s5.5)

Already achieved?

Introduce a nominations regime.

(s5.6)

TSO to specify nominations regime and propose VTC

Change Request if necessary.

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4 Next steps The PEA’s preliminary advice to Gas Industry Co proposed a straw man package of proposed

improvements to pipeline access arrangements. The PEA’s paper addressed many of the elements of

Key Deliverable 1 of the PEA Work Plan (Table 5). Given submissions on the PEA’s preliminary advice

we consider that it is timely for the PEA to consider how best to proceed.

Table 5 - Extract from PEA Work Plan

Key deliverable 1: Assessment of current arrangements and identification of options

The PEA should:

a. Identify whether there are market failure(s) which cause it to believe that:

i. The current regime requires reform, and

ii. Reform is unlikely to be achieved through the negotiation of contracting parties.

b. Review previous work completed by Gas Industry Co on access arrangements including the papers (available on the Gas Industry Co website):

i. Review of Vector Capacity Arrangements - A Research Paper, January 2009

ii. Options for Vector Transmission Capacity, May 2010, and submissions on that paper.

c. Develop a set of evaluation criteria for assessing the merits of alternative options.

d. Identify and assess reasonably practicable access regime options and prepare an initial shortlist of preferred access regime options (including service definition and pricing methodologies). The supporting analysis should contain:

i. Descriptions of the options that could alter/replace the existing regime so as to enhance efficiency, including a description of how the option would allocate capacity efficiently and effectively signal the need for investment in additional capacity;

ii. An assessment of how well the alternative options would meet the objectives of the Gas Act, GPS and GTIP;

iii. An evaluation of the options against the evaluation criteria; and

iv. Justification for the rejection of any options;

e. The PEA will submit its analysis of options to Gas Industry Co, which will compile the work into an Access and Pricing Options consultation paper and seek submissions from stakeholders.

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In our view, submissions on the straw man expressed a strong preference for defining a ‘target model’

(to borrow the term used by the Council of European Energy Regulators4) by evaluating a range of

options. We believe that the PEA does have the necessary industry knowledge, and access to all

necessary resources, to develop and evaluate such options.

Submissions also asked that the PEA not lose sight of the need to address current issues in a timely

manner. If the target model looks significantly different from current arrangements – for example, if it

proposed a single carriage regime across both pipelines, or integrated gas and transport markets –

then an implementation timetable of 5 to 10 years would be expected. We think that for the GTIP

maintain credibility it needs to deliver more immediate improvements.

The challenge for the PEA is to deal with these requirements in a coherent and timely way. Once the

PEA has considered its preferred approach we believe that it should be discussed with the Programme

Sponsor. The Work Plan can then be modified accordingly. To get the discussion underway, we

illustrate a possible re-orientation of the work in Figure 4.

Figure 4 depicts a three step process involving defining a target model, taking some immediate steps

towards the model, and describing the options to achieve the model. Of course there would be

further steps after this, such as assessing the options, selecting a preferred option and deciding

whether or not to pursue that option. Figure 4 only addresses what the PEA might expect to achieve

in the next, say, 6 months.

4 It’s interesting to recall that discussion on the need for a unifying vision of the structure of European gas network access only started at the

18th Madrid Forum in 2010, after the three ‘gas directives’ reforming the market had been issued (in 1998, 2003 and 2009). The idea was that a vision was needed to ensure a more consistent implementation of the 3rd directive by the member states. As the PEA noted in Appendix A of its preliminary advice to Gas Industry Co, the Council of European Energy Regulators (CEER) presented the final version of the Gas Target Model to the Madrid Forum in December 2011. The forum, a semi-official body comprising all gas market participants, endorsed the model. The unifying vision presented in the Gas Target Model was of various hubs across the EU, each large enough to allow for competitive spot gas trading, and located in ‘entry-exit zones’ where parties only pay for entering the zone and delivering the gas at an exit point, but not for the distance the gas travels. The interconnection of these ‘virtual gas hubs’ is intended to create a single integrated market. The Gas Target Model also proposes auctions for cross-border pipeline capacity. During the consultative process leading to the adoption of the Gas Target Model, the Florence School of Regulation FSR proposed two possible models: MECOS and EURAM. MECOS was a “Market Enabling, COnnecting and Securing” model aimed primarily at providing every European end user easy access to a wholesale gas market. In contrast, EURAM (EURopean American Model) emphasised the importance of transport investment and long term contracts. We think the PEA may find it helpful to explore the development of the Gas Target Model in more detail, and we will prepare a separate note on the matter.

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Figure 4 – From where we are to where we want to be – a possible re-orientation of PEA work

Define the target model

Specify Immediate Improvements

1

2

3Options could include:

Contract carriage

Common carriage

Hybrid

Market carriage (Victorian regime)

For example this might comprise:

Seamless transport

Market price signals when capacity is scarce

Maximum efficient use of physical capacity

Encourage competition in associated markets

Etc.

These might include changes to:

Water down grandfathering rights

Formalise use of interruptible contracts

Auction scarce capacity

Etc.

Describe options to get to target

1. Define target model

2. Specify Immediate Improvements

3. Describe options to get to target