Gas Regional Initiative North-West, Investment workstream WORKING DOCUMENT DRAFT

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Gas Regional Initiative North
-
West, Investment workstream

“VIRTUAL TEST”


WORKING DOCUMENT DRAFT


“Journal of findings”


Author
: core group
(commented by reference group)


Subject to comments
:
stakeholders of Stockholm workshop on 24.09.09
.


DRAFT:

18
Sep
tember 2009


This draft report is for presentation and distribution in workshop on 24 September 2009, Stockholm.

This draft report is to be finalised based on outcomes of the Stockholm workshop (including decision on a
possible Round 3 of the Virtual Test
) and is to serve as basis for tangible policy advise on regional
investment climate to stakeholders of the GRI NW.


READING DISCLAIMER:

This version of Journal is reflection of work in progress and does not constitute a
final report of the VT.



Contents
:


1

Background

................................
................................
................................
................................
.............................

2

2

Objectives of the project

................................
................................
................................
................................
..........

2

3

Approach

................................
................................
................................
................................
................................
.

2

a.

Introduction

................................
................................
................................
................................
........................

2

b.

Main expectations

................................
................................
................................
................................
..............

2

c.

Detailed description of the Virtual Test (VT) case process

................................
................................
...............

3

France
-

investment trigger

................................
................................
................................
................................
......

4

Netherlands
-

investment trigge
r

................................
................................
................................
.............................

5

Germany
-

investment trigger

................................
................................
................................
................................
..

5

Belgium
-

investment trigger

................................
................................
................................
................................
...

5

4

Simplifications and assumptions of the VT

................................
................................
................................
.............

5

a.

General

................................
................................
................................
................................
...............................

5

b.

Pipeline and costs
................................
................................
................................
................................
...............

6

c.

Tariffs

................................
................................
................................
................................
................................

6

d.

Bidding

................................
................................
................................
................................
..............................

6

e.

Investment trigger

................................
................................
................................
................................
..............

7

5

Detailed findings of the VT

................................
................................
................................
................................
.....

7

a.

Pipeline and costs
................................
................................
................................
................................
...............

7

b.

Tariffs and regulatory regimes

................................
................................
................................
...........................

7

c.

Bidding

................................
................................
................................
................................
..............................

7

Outcome Round 1.

................................
................................
................................
................................
...................

7

Outcome Round 2.

................................
................................
................................
................................
...................

8

Outcome Round 3.

................................
................................
................................
................................
...................

9

d.

Reflection on outcome of VT Bidding process and potential Round 3

................................
..............................

9

e.

Investment tr
iggers for a possible Round 3 of the VT.

................................
................................
......................

9

f.


Concept of transparent Investment trigger
................................
................................
................................
.......

10

g.

Risk distribution of an inves
tment

................................
................................
................................
...................

10

6

Results and conclusions

................................
................................
................................
................................
.........

11

a.

Preliminary high
-
level findings VT (for discussion workshop)

................................
................................
.......

11

b.

Lessons learnt from the VT (for discussion workshop)

................................
................................
...................

11

Path to enhancement of regional investment climate

................................
................................
............................

11

7

Ancillary Investment project initiatives (for strengthening the robustness of the VT).

................................
.........

13

a.

Manual

................................
................................
................................
................................
.............................

13

b.

Tilburg test

................................
................................
................................
................................
.......................

13

8

Longer term perspectives

................................
................................
................................
................................
......

13

9

Annex
-

Relevant documents (attached or available on internet)

................................
................................
..........

14


Page
2


1

Background

A sound regional investment cl
imate for gas pipelines is one of the key building blocks for a
successful, competitive, regional gas market as defined in the working plan 2009
-
2011 for market integration
of the North
-
West Europe under the flag of Regional Initiatives of ERGEG (European
Regulators Group for
Electricity and Gas)
1
.


A lack of the necessary infrastructure, notably regional gas pipelines, could hamper effective regional
market integration, security of supply and competition in North
-
West Europe. Therefore, as part of the wor
k
in the Gas Regional Initiative for North
-
West Europe, one of its workstreams focuses on improving the
soundness of Investment climate in the region of North
-
West Europe for gas pipelines
2
.


2

Objectives of the project

The goal of the project is by end of
2009 to achieve
-

in open debate with public and private players
of North
-
West Europe
-

an agreed detailed view (or path) to key elements of the regional investment climate,
which would meet the following high level description:



The investment climate s
hould be such that investments in capacity are sufficient and (efficient and
therefore) timely and persistent physical congestion is avoided. (…) Investments should facilitate gas
supplies from diverse sources to meet the need for secure gas supplies
”.



3

A
pproach


a.

Introduction


New infrastructure development has been studied on many occasions in (North
-
West) Europe based
on factual cases or academic reports. However, in the region we found that in order to come to an agreed
view on a regional investment cli
mate it is necessary to go beyond a simple assessment of issues and
develop a broad vision of a full gas project dynamic

in a realistic simulation
. This is achieved through the
identification of a need for capacity, establishing potential investment costs
, using a market test and
completing the allocation of capacity in a virtual project environment (further referred as Virtual Test
approach), and allowing “Greenfield”
-
thinking on investment context.


Many parameters have to be taken into account when stu
dying the investment context, including
notably the regulatory status of the pipeline, the way the investment is remunerated, the structure of markets
linked, etc. This includes having a clear vision of risks and their allocation as well as the impact of t
he new
pipe on the market.


By developing a Virtual Test case (
with workshops
held during February, May
,

September
and
November
2009) on a North
-
West European investment situation, we created an opportunity to better
understand how all the relevant parame
ters interact in an investment process, and how to address identified
issues to facilitate a common regional approach to capacity development.


b.

Main expectations

We expected that key to developing an agreed regional investment climate in gas transmission
is by
arriving at common findings on acceptable scenarios of risk distribution between Regulators, TSO’s and gas
companies via a Virtual Test process.


By assessing the risk distributions between various stakeholders in the investment chain contained
in bo
th today’s and an alternative framework, we can enhance stakeholders’ understanding and improve the



1


Regional i
nitiatives are a great example of voluntary co
-
operation of public and private players in Europe in the
sphere of gas market development: governments, regulators, gas companies and TSOs work together to foster gas
m
arket development at pragmatic regional level. For more information please consult the link at:
http://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_I
NITIATIVES/GRI


2


See for outline of the whole project original (now evolved) project brief at the link:
http://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Meetings/Other_meetings/Wor
kshop%20Investment/080801_Project_Brief_Investment_I1_GRI%20North%20West%20E
RGEG.pdf


Page
3

quality of discussions on investment frameworks. This may accelerate progress towards infrastructure
development consistent with an efficient regional mark
et.


The current risk framework may need to evolve with market liberalisation, regional integration and
the greater influence of external factors such as the response to climate change and the desire for greater
security of supply. It must be noted
, that
it could be the case
that
some markets have, in the past, focussed
on consumer protection through the avoidance of ‘gold plating’ the system. This focus is understandable in a
world of unchanging gasflows. In the current world of new LNG and pipeline strea
ms the risk of
overinvestment is
asymmetric

versus risk of underinvestment.


As a consequence, the Virtual Test case is defined as sufficiently challenging as well as practical in
terms of the possibility to learn pragmatic lessons which can be used by Reg
ulators, TSOs and gas
companies (shippers) active in North
-
West Europe. It provides an opportunity to apply such lessons and to
question all stakeholder’s positions on the legal and regulatory arrangements required to enhance the
regional investment climat
e needed to support a better regional gas market within an acceptable risk/reward
framework.


If findings in the Virtual Test conducted during 2009 are supported, advice on enhancement shall be
addressed to governments and other relevant parties by end o
f December 2009 by participants to the test
(Regulators, TSOs and gas companies active in North
-
West Europe).



c.

Detailed description of the Virtual Test (VT) case process


During the test we simulated a process to establish investment signals from a suffi
ciently
representative group of gas shippers that could be used for building a stand
-
alone transmission pipeline
across member states. In subsequent discussions, we reflect on all key elements of the regional investment
climate that we encountered (and had

to 'address') during the VT.


Pipeline and costs

In this VT we envisage the construction of a new pipeline (6 to 20 bcm/year) in three parts, linking
the trading hubs of the four countries Germany (G), The Netherlands (NL), Belgium (B) and France (F). In
the VT, the aggregate demand from Users (Shippers) is assessed against the reflection of the regulatory
regime in each state to establish whether the trigger for investment has been met. The TSO’s have
estimated the capital expenditure of building a 400 ki
lometre long 36 inch and 48 inch pipeline and the
corresponding compressors. Further, the operational costs of the pipelines and the compressors and the fuel
costs are estimated.


Tariffs

The involved regulatory regimes incorporate at a very high level the

national obligations and
legislation, costs, depreciation, asset life and allowed cost of capital. These factors are applied to each leg of
the VT by translating them into likely tariffs for the respective legs of the pipeline. The costs used for
calculat
ing the tariffs are generated based on close dialogue and input of the relevant TSOs (transporters).


Bidding

There are currently 10 Shippers participating in this VT (
E.ON; EDF; StatoilHydro; Poweo; BP; ML;
ExxonMobil; RWE;

GMT; Gas Natural)
. In order to

safeguard commercial interests, each
has been
assigned
a profile with a description of the type of operation and an indication of the requirements of
t
his process.
Page
4

There are a number of different shipper types

in order to represent the range of
parties
in
terested in securing
new capacity

(Producer, Large supply portfolio, Supplier to very large industrial consumers, Traders and
Optimisers
3
).
S
hippers
were asked
to apply their own knowledge and interpretat
ion of the profile supplied
,

within the character of

the type of shipper. In this way it is expected to

include as much realism as possible
within the

virtual

exercise
,
to make the

results
more
meaningful.


The process with shippers is conducted by means of using a simple common bidding sheet where
the “req
uirements” for
each shipper in
the VT
are

entered:




There is a sheet for each leg of the virtual pipeline (G
-
NL, NL
-
B, B
-
F).



Each bidding sheet
gives the opportunity to bid forward over

a period of 20 years.



The bidding sheet has a “price stack”. This has

both price and volume components. These
indicate the tariff which would apply were the given amount of capacity (in aggregate) be
triggered
. Shippers are required to enter in the bidding sheet the amount of capacity they would
require at each tariff in ea
ch year.



A “clearing price” is established by aggregation of all bids and the associated tariff to identify at
which level there is sufficient demand to justify investment, determined by the regulatory
parameters.


The process
initially
consist
ed

of two ro
unds
(
although
a 3
rd

round is being considered to be held in
October 2009
, to be discussed at the September workshop
):




In the first round a shipper enter
ed

bids for the capacity required in each leg over a period within
the 20 years. Within each year the
shipper can indicate what volume of capacity is required at
each of the six “P” prices.




After the first round, a feedback report was circulated indicating the aggregate capacity bid on
each leg of the pipeline at all prices and periods. The feedback indic
ated the “clearing price” and
therefore the expected trigger level of virtual investment
.




In round two, shippers
were

allowed to modify their bids in light of the results of the first round
and the indicative clearing price and volumes.

See chapter 5 for
outcome of the rounds.



Investment triggers

The VT will establish a level at which there is sufficient “User Commitment” to justify the investment.
It must be again noted that this level is non
-
binding (e.g. 60 to 80%) and for discussion purposes within V
T
only.


France

-

investment trigger


In France, the investment trigger does not result from an economic test. Since the new infrastructure
will be included within the TSO’s asset base, it will not get a specific charge. The socialisation of cost
translate
s in a reduced level of risk for the investor; the risks of underuse in the long term are borne by the
consumers. This methodology is made possible by the limited impact such an infrastructure has on the RAB
(however, some tariff simulation are necessary t
o study how it will impact the entry charges into the French
system). In addition, the assumptions are the following: France is keen on facilitating infrastructure
developments beneficial to competition and market integration; the approach based on 80% res
erved for 10
years (at least) also assumes that the gas market keeps developing in the future. This investment trigger is a
minimum requirement, which means that 20% of capacity reserved for short term bookings is not mandatory
but can be adapted regarding

the steps of capacity development.







3

Please consult the Bidding profiles via weblink http://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Priorities1/Investment

Page
5

Netherlands

-

investment trigger


The Netherlands has a different approach to France and this is used in the investment trigger for the
Round two bids in the VT. The investment trigger is based on an equivalent of a
10
-
year contract for 100 %
of the capacity that will be built. This reflects the current policies used in open season processes, and needs
to be considered in perspective of other factors of the current framework including the application of a 20
year depr
eciation period and a chance that capacity which is inefficient shall be excluded from Asset Base.


Germany

-

investment trigger


Investments of the TSO in infrastructure will be added to the asset base of the TSO. On the basis of the new
asset base the ne
w tariffs are being calculated according to German law. The TSO will remunerate the entire
investment costs over the depreciation period. The investment costs are socialized and paid by the grid
users; therefore the investment risk is mainly shifted to the

end consumers.


How is ensured that the TSO is investing efficiently? The ordinance incentive regulation of energy supply
grids gives indirectly strong incentives to invest efficiently. Due to the approach of the incentive regulation
the BNetzA has to aut
horize investment budgets for capital costs for single TSOs' extension and
restructuring projects. The investment budget allows passing on the cost of the investment to the users of
the network. These cost may be added to the given revenue cap for the resp
ective regulatory period.


In case of a reduction of the budget applied for or a project's budget rejection in extreme cases, the TSO can
still realize the project but with a reduced return. A part of this budget approval is to also indirectly monitor
the

execution of the individual project.


Disclaimer added to reflect German TSOs comment on German regulatory framework:


German TSOs highlight that the model does not fully reflect the investment conditions (e.g. discussion
s

o
n

interpretation of Gasnetzentg
elteverordnung, Anreizregulierungsverordnung, Investmentleitfaden are still
pending). Without an exact calculation TSOs find it difficult to draw a conclusion what the investment trigger
for Germany exactly is, since they find that not the utilization of t
he pipeline is fundamental for an investment
decision in Germany, but the attractiveness of the investment, i.e. the Internal Rate of Return.


Belgium

-

investment trigger


The trigger for Belgium, for VT purposes, is as follows : after the firm commitment

period the investment
must have been depreciated at least at 80 %

in the statutory accounts. Under VT (after round
2)

Belgium

therefore does not

meet the trigger. This is because, according to the current legislation,

allowed
depreciation rates cannot ach
ieve this result after 10 years and the risk on stranded assets is too high.



4

Simplifications and assumptions of the VT


a.

General


This chapter includes the simplifications and assumptions in comparison to reality of an investment

made in the VT. These si
mplifications and assumptions
can be grouped in 4 major topics
:


A) Adoption of pipeline characteristics



Virtual new 1
-
directional dedicated pipe running from Germany through to France via the
Netherlands and Belgium



Although, a dedicated unilateral direct
ion pipeline is assumed, in reality pipeline is often
incremental to existing pipes



Each leg is 400km and has three compressors



2 main sizes determined by ‘ínch’
-

10 and 20 bcm



Variation based on compression from 6, 8, 12, 16 bcm possible.

Page
6



Cost provided
with 40% accuracy (capex and fuel cost main drivers).


B)
Simplified (to key elements) frameworks, adopted to the “virtual purpose”.




Current regulatory parameters assumed (switch to Excel or online for details
.
Please
consult the documents via weblink htt
p://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Prioriti
es1/Investment
). This results in tariffs for given pipeline.

Bundled products at borders.
100% same bidding process for all 4 “test” countries



With a price sche
dule and flexible contracts durations



Pre
-
defined investment trigger: “when is it economic to invest”



If trigger is met, capacity will be built



Proven congestion, test of societal need out of scope



Trigger is per definition set illustratively as risk dialo
gue is not finalized


C)
Transparency on investment model
for

all.



Open discussion on principles of settling potentially “uncovered” by contracts part of
investment (risk distribution/risk dialogue).


D)
No other constraints like eg NIMBY (permits); finan
ce.


b.

Pipeline and costs




As noted above, the TSO’s have estimated costs with 40% accuracy.



The price of gas used to calculate the fuel costs is 0,28 euro/m3.



The load

factor is assumed to be 7400 hours/year.


c.

Tariffs


The yearly inflation is assumed to be

1,5%.


The tariff calculation assumes that capacity that is initially unsold is eventually bought by new
-
entrants when pipeline goes live. This approach deals with concerns about the post 10 years period, or the
20% unsold capacity in France. Another sol
ution in reality is that any uncovered costs shall be underwritten
by consumers for the purposes of the tariff calculation.


We chose to derive the tariffs based on 1 ‘fixed’ situation. This provides a fixed point that is not
influenced by the bidding beha
viour at each capacity increment. The variable factor is therefore the
aggregate level of capacity bid for. Knowing fees in advance for each level of investment is central to the VT
approach as shippers can provide a capacity demand against a known supply

schedule and can have
confidence that ‘firm’ bids will only attract the published tariff on allocation.


For each hub
-
to
-
hub leg, shippers are given a tariff for each level of capacity. These tariff are
calculated in several steps. First the NPV of the ta
riffs of one country in the first 10 years is determined for a
given level of demand, using cpi as interest rate. The tariff for transporting gas from one hub to another hub
is then the average of the NPV of the two relevant countries.


d.

Bidding



The
Biddi
ng
process
is
described in 3(c) above.


The bidding is now
based on a two round process concluded by a “virtual” investment outcome (eg
“10” bcm ‘shall’ probably be built
;
a 3
rd

round is being considered as
also
mentioned before

in chapter 3
).


The shippe
r bidding process is built up carefully:




Virtual profiles are provided
as a guide
but real know

how
of
EU gas market
s

is assumed



B
ids are anonymous

Page
7



Bids are for each hub to hub leg

of the pipeline, i.e. will include two countries within each



The price sch
edule has an upper or lower band dictated by the investment size limits (6
prices)



Shippers bid o
nly volume
,

within each of the
1


20 years based on given price



All bidders see the aggregate bids

and
indicative

outcome

before round 2



Bidders have knowledg
e of economic test
structure
(i.e the ‘hurdle’ that must be met)



The process was coordinated by the shipper core group representative



e.

Investment trigger


Each country has developed an investment trigger, based on general legislation. The investment
trigg
er for France is based on the percentage of bookings in the first 10 years laid down in specific
legislation
;

the triggers for Belgium, The Netherlands and Germany are based on current industry practices
(see
previous

chapter for elaboration).


The dema
nded capacity for Germany and France is assumed to be equal
to
the demand on the hub.
The demanded
capacities
for The Netherlands and Belgium are assumed to be equal to the average on the
two relevant hubs.


5

Detailed findings of the VT


a.

Pipeline and costs

Seem largely in line. Fuel/compressor costs are an issue in exact studies.

b.

Tariffs and regulatory regimes


Tariffs differ across countries due to the regulatory regime which has evolved to meet the demands
in each particular market. The manual (see Annex
4
)

provides a broad guide for some of these differences, for
example, the depreciation period, WACC, treatment relative to the existing RAB. Eg i
n France, charges are
equal
at all the entry points. This means that any new investment at an entry point will ha
ve an impact on all
the others. The depreciation period is 50 years and the WACCC amounts to 7.25% plus 3% of remuneration
for new entry capacity. In Netherlands, Belgium and Germany and France tariffs reach similar levels, though
via different regulatory
routes. It is found that particular tariff levels are not the bottleneck to investment at
regional level. Having clarity and confidence


like in the VT


how tariffs are derived now and in the future
is sufficient

for good regional investment climate
.

c.

Bi
dding

By organising a transparent process like in the VT, we can create a better signal for investment.
Providing the rules of the process, an understanding of how to trigger investments and an ability to bid for a
volume of capacity in a flexible way, me
ans that shippers can influence likely investments to a higher degree.


In the discussion below, we outline the outcomes from the different rounds of shipper bidding. The
VT does have an element of learning by doing, so some refinement of the rules did oc
cur between rounds
and this is also discussed in Box 1 and Box 2
, further in this Chapter
.

Outcome Round 1.


Based on general analysis, there does appear to be a demand much closer to the 20 bcm/a across
the first two legs and we see that the limitation is

from the relatively low demand on the final leg.

Furthermore
, we

should virtually

consider building 10, 12, 16 or 20 bcm
.
E.g. based on triggers

for French
-
Belgium leg we

will build 10 and 12, but

NOT 16 (very close call)

and 20 bcm.





4

Please consult the document via weblink http://www.energy
-
regulators.eu/portal/
page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Priorities1/Investment

Page
8

However, based on (
1) the investment triggers considerations, (2) technical assumption of
preference for 1 pipe size across borders and (3) conservative approach (most conservative national
outcome counts heavily) we arrived to preliminary indication that
10 BCM pipeline acr
oss our 4 countries
is to be virtually constructed based on Round 1.

Box 1:
Disclaimers/assumptions//mandates for Round 1



It is a virtual test, with pragmatic approach but a degree of realism.




We are reflecting realism by operating in spirit of a real inv
estment case, where we seek balance
between conservativeness (preserving public from gold plating the systems) versus satisfying market
demand to the fullest.



The parameters and calculations are simplified. This especially concerns the investment trigger
a
ssumptions. For the trigger, the NPV is based on revenues (from the shipper capacity bids and the
tariffs from the model) minus the opex, the investment cost and with the real regulatory WACC
applied.



It would have been possible to iterate the tariffs ba
sed on the Round 1 bids but we decided against
this level of complexity, and it would have also undermined the firmness of bids against a known
price.



We worked on mandates provided in i.a. Dublin as concerning investment trigger (numbers could lie
in rang
e of 60 to 80% of certain type of NPV coverage).



We used our common knowledge of the systems, to choose a virtual trigger of "70%" for German,
Dutch
and
Belgian part of the legs. For France we based the signal on a reservation rate. For that
we assumed a
very conservative 80%

reservation rate for first 10 years.



If

we use this trigger French 'part'

will

virtually build 10

or 12 bcm, but not 16 and 20. 16 bcm leads to
79% rate, however

its is very close to

chosen trigger! 20 bcm is only 61%.




If we would h
ave used high degree of socialisation, then the investment hurdle in France versus
other 3 countries would been much lower, potentially leading to different pipe size outcome.



For pragmatis
m we used also 50% sales of the ‘to be

pipeline’ for years "11 to
20"

where no bids
were entered.




We should also note that investment trigger formula in the sheet had to be pragmatically adopted.
The investment trigger as it was

in the spreadsheet cannot calculate the trigger for differing biddings
over the years.



For
preventing complex cross
-
border cost
-
allocations we tended to come to 1 pipe size across
the
countries.

Outcome Round 2.


Shippers responded to the information contained in the Round 1 outcomes by altering bids.
The
main conclusion

of Round 2

is that no p
ipeline will virtually be built
, as in the “transiting” [Belgium,
Netherlands] countries
the investment trigger is not met. This occurs because the investment trigger is not
met in all legs and the single pipe size criterion means that failure in any l
eg results in no investment. The
outcomes from the bidding indicated however that the investment trigger for France supports building a 16
bcm or smaller pipeline, and the trigger for Germany supported building a 20bcm or smaller pipeline.


Box 2: Change
s to Disclaimers/assumptions/mandates behind the conclusions for Round 2


The investment trigger
s

used are based in the input provided by regulators and TSO’s. The trigger
for eg Netherlands is strict in comparison to France on preventing stranded asset risk and based on
current open season practices. Eg for France trigger is
based on a legal provision.

See further the disclaimers in Box 1.

Page
9


Outcome Round 3.


PM, based on Stockholm outcomes
, if a GO to round 3 is given
....



d.

Reflection on outcome of VT Bidding process

and potential Round 3


In assessing the Round 2 outcomes we
need to be careful to distinguish whether the failure to invest
is a function of the regulatory frameworks or the simplifications to the model (such as the 1 size pipeline). Or
indeed, some may conclude that the no investment outcome is the right economic

answer.


A further point to note is that the regulatory frameworks are to some extent built around current open
season processes rather than designed for the VT which is supposed to be a regular process. For example,
if bidding shippers were told during t
he VT that this might be their only chance to secure capacity for the
foreseeable future, they may have bid more or even bid for periods they didn

t need the capacity just to
ensure something was delivered.


As it was, we presented the VT as an annual proc
ess which is a
completely different risk scenario where shippers can demonstrate demand as their own business risks
become clearer.


Where we believe that the outcome is framework driven, and for the benefit of the VT, it may be
worth testing changes that
shift some of the risk and in effect lower the investment hurdle trigger required by
firm commitments.

For this reason, the core group proposes another round after the Stockholm workshop


(Round

3)


with the trigger

allowing for more

riskier


approach.

In deciding to undertake this approach
arguments should be considered to express why this is an appropriate appro
a
ch (
e.g.

shorter depreciation
period in Belgium or a certain degree of socialisation in NL because of roundabout ambitions, security of
suppl
y reasons etc).


We might also want to consider in Round 3, if shippers are prepared to

fund


money to TSOs in
country/ies for taking the risk of

stranded asset

. This would at least illustrate the value of pipeline being
built, versus risk of stranded a
sset and give a more regional dimension to capacity bidding. It also allows, for
good discussion outside the test, on how to mitigate that

risk

.


Next to the 2 discussed above points, it is crucial for Round 3 to have full transparency on the
investment
triggers used for the VT purpose at the start of Round 3. It is also potentially interesting to
consider in Round 3 what consequences has the choice of dedicated tariffs (as a dedicated
pipe
line is
assumed) versus rolled
-
in tariffs. For expected under VT i
nvestment level in Round 3 it is currently assumed
to work further with assumption that the same
(only
acceptable

under all 4 investment triggers
)
“size” will
eventually be built

(if triggers are met)

for all hubs in the VT.

e.

Investment triggers for a possi
ble Round 3 of the VT.


Looking forward beyond the currently applied in the VT investment triggers (as described above), we
want under VT continu
e

to explore if it is possible to build more capacity than contracted by users in the first
10 years. However
we cannot on our own (without comment of all stakeholders involved) just lower the
investment barrier. The main question here is who is going to pay for the additional capacity that is not
initially contracted in the first year of the process and how the r
isk is distributed if the asset is not ever
booked.


Therefore we propose to have as one of the outcomes of workshop in Stockholm

acquiring
stakeholder support for a trigger for Round 3, which is below a 10
-
year contract for 100 % of the capacity
that wil
l be built. It would also be helpful if guidance for arguments for certain trigger numbers
and approach
5

could be gained.





5

Reference group comment: It is crucial that no market (commitment) signal is ignored just because of bidding process
design and/or format chosen for investment triggers.

Page
10

This support is to be built based on arguments as how to address the stranded asset risk and
disallowance from the asset base, assum
ptions on sales after 10 years. Also the subsequent risk of raised
tariffs and less gas streams because of that should be taken into account.


Then
-

if support is gathered
-

we shall test a trigger for Round 3 which is below a 10
-
year contract
for 100 %
of the capacity that will be built (e.g.
more
in line with current trigger approach in France). If no
support


based on arguments
-

is gathered in the workshop for adopting VT triggers in Netherlands,
Belgium and Germany
(
to be able to adopt to carry more

stranded asset risk
)
, then we
can only
repeat the
Round 3 with present triggers.


f.

Concept of transparent Investment trigger


A transparent investment trigger is important when shippers have flexibility in how they bid for
capacity. [We saw that shippers

responded to information between rounds of the VT.]


In Round 2 we saw that in the Netherlands the capacity demand was just short of the 100 per cent
for a number of pipe sizes yet produced no investment. If shippers had clarity and information about thi
s
likely outcome they may have responded to trigger the investment, particularly if it supported desired
capacity outcomes in other networks.



Although we are running a virtual test, we have made a decision to use (close to) real world
economic tests for
the investment.


What we haven’t done, for simplicity, is to consider the case of the
ambiguous outcome. For example, could we be sure that if faced with the VT outcome from Round 2, the
real world decision on investment in the Netherlands would be to do
nothing?


The outcomes underline that the investment triggers from shipper bidding are a strong indicator of
demand, but they are not the only one, and that pragmatic assessments (including for example 10 year
plans) will continue to play a role in investm
ent decisions.



g.

Risk distribution of an investment



Risk distribution between various stakeholders is a crucial underlying part of the discussion on “build
up” of the investment triggers. During the VT the following quantitative investment trigger aspect
s


used to
spread the risk
-

were modelled:



Years of depreciation



Length of contracts



% of capacity
covered

by contracts



Real WACC pre tax



Next to the above mentioned considered risk distribution tools, following tools could be discussed
and are someti
mes used for risk decrease of stranded assets (and thus influencing the preset investment
triggers level):



Shorter or non linear depreciation within the legal prescribed period



Put aside delta revenue from higher ROI compared to “normal” ROI as security
for stranded
assets



Consider higher tariffs for short term capacity products
6



Stimulate longer commitments from shippers



Consider to roll
-
in part or entire investment in existing infrastructure
7










6

Referen
ce group comment: or e.g. consider higher (stabilized) tariffs for first years of investment.

7

Reference group comment: pay attention to stranded asset risk and consider
-

educated by relevant reports
-

view on
future flows and policy goals.

Page
11

BOX 3. EXAMPLE Risk Distribution and investment trigger
.




In France, socialisation leads to a clear distribution of risks. New infrastructures are
included within the regulated asset base and, hence, are repaid and remunerated through the
tariff. In case of under
-
use, there is no stranded risk cost for th
e TSO.




How is such risk mitigated for stranded assets in France? Investment is rolled into the
current asset base and there is a higher Real WACC for these kinds of investment (e.g. up to
+3%).




In France it is therefore possible to build mor
e capacity than is underpinned by shipper
commitments. The objective is to provide some short term capacity products to the market
(up to 20% of the total capacity). We saw in the virtual test also that it is possible to build
capacity in France of which 8
0% is underpinned by contracts. In other words, the trigger for
investment adopted for France consists in having (at least) 80% of the capacity booked for
10 years or more.


6

Results and conclusions


It is yet difficult to define the
definitive
key element
s of the regional investment climate, which seem
to be relevant for incentivising investment. However, some elements do stand out and will be for discussion
in September 2009 workshop in Stockholm.


a.

Preliminary high
-
level findings VT (for discussion worksh
op)




Detailed regulatory regimes can differ


and if carefully explained


still bring a common
result on tariffs required to construct a regional pipeline. It seems so far possible to work with


at detail
-

different approaches to calculating tariffs for

pipelines. We therefore specifically
decided to keep national regulatory issues reflection out of the VT as much as possible (e.g.
differing regulatory periods length or regulatory risk like ex
-
post assessment of TSO costs of
construction).




Concept of tr
ansparent Investment trigger (process) as means to enable regional investment
certainly seems a very interesting option to explore further on more binding 'foot' within the
region. VT bidding process design could be a way to economically test the demand.




Finally, risk distribution of an investment is already happening in each country of the VT.
Quite differing but developed risk mitigation tools are available (such as 20 years
depreciation period, special new investment budgets, socialisation in a (large)
TSO asset
base, 'bonus' revenues for new investment). However the combined (positive) effect of these
tools on investment at regional level needs to be ensured by continuous dialogue between
shippers, TSOs and regulators. Without that dialogue the 'risk di
stribution' effect could be
that some parties 'win' too much (e.g. a proper investment climate should ensure that it has
incentives for TSO to keep CAPEX and OPEX of an investment low; addressing who is to
carry 'stranded assets' risk etc.). In adequate ri
sk distribution dialogue everyone loses a bit.


b.

Lessons learnt from the VT
(for discussion workshop)

P
ath to enhancement of regional investment climate


The VT has provided a significant opportunity for stakeholders to provide input into w
ays in which a
common problem can be examined, tested and to some degree resolved. We believe that the VT provides
valuable lessons for policy makers to consider, particularly as the third package provides additional impetus
from regional markets and allo
ws greater cross border consideration of investment policy.


Page
12

As with any complex problem, the solutions are not necessarily simple, discreet or easy to deliver
over a short time frame. We have therefore broken our advice into two broad categories, quick w
ins and
longer wins. We have also identified other lessons that may impact on general policy development and
thinking.


We consider that
the quick wins

are changes that can be achievable over a maximum three year
horizon and require little in the way of l
egislative change. That is, they may be deliverable under existing
investment processes. Improvements to these processes could be made by:




Increased transparency of the regulatory frameworks and in particular the investment
decision process. Such transp
arency of frameworks as in VT brings understanding and thus
quicker co
-
operation, thus quicker investment where needed;




Greater clarity on the formation (and confidence) in the tariff derivation; and




Better processes to allow shipper demand to be signal
led through methods such as bidding
rounds indicating the cost of different investment levels, aggregate demand transparency and
investment decisions based on aggregate demand rather than individual shipper demand
8
.


Longer terms wins
9

are also available b
ut these may require legislative change or further
discussion to move investment processes toward a more regional basis
10
. Such measures could include:




Regular coordinated bidding processes based around a regional view of investment;




Ensure that investme
nt triggers in different markets are not harmful to the regional
investment framework, perhaps by setting common minimum criteria on risk distribution
(approaches
11
); whilst ensuring:



More transparency on the regional level of commitment needed to trigger i
nvestment;
and



Methods to better share risks on a regional basis so that investment is undertaken
efficiently.


The VT has also produced
other lessons

that may be worthy of further consideration, or at the least
may help inform policy makers as they seek
to improve the inv
estment framework
12
:




There seems to be asymmetric risk of too little capacity versus gold

plating, however present
systems have not yet found a solution. Governmental support driven by other policy
considerations such as enhanced flexibil
ity and security of supply might help to rebalance the
risks of underinvestment;




It is found that particular tariff levels are not the bottleneck to investment at regional level.
Having clarity and confidence


like in the VT


how tariffs are derived now

and in the future is
sufficient

for good investment climate
.





8

Reference g
roup comment: the current (bidding, open season) processes
s
hould
be (re)designed in such a flexible way
that they
do not
a
llow for
ex
clusion of
any

market commitment

just because it does not ‘fit the format’; specific
examples concern e.g.
commitment in t
he years beyond 10 years or only in the first few years of investment
.

9

Reference group comment: this could take between 3 and 10 years due t
o
now
assumed difficulty of such changes
.

10

Reference group comment: to make the final advise to policy makers mor
e concrete one might cons
i
der

to link
recommendations to the “umbrella” of 3
rd

package implementation, specifically
addressing
stranded asset risk

distribution

on regional level.

11

Reference group comment: e.g.
it should be ensured that
the national system
s react in a unified way to same
market
signals of investment

need
.

12

In this respect, we
also
note the work of the SEE CAO approach for electricity capacity allocation
:
the introduction of
a regional social welfare function in the investment process could

aid discussion and decision making.

For further

details please consider

the ECRB website, via
http://www.energy
-
comm
unity.org

.


Page
13


7

Ancillary Investment project initiatives (for strengthening the robustness of the VT).


a.

Manual


The Manual, provide
s

a reference of the investment regulation approaches across 9 different
Member States of the region Nort
h
-
West of GRI. It is in itself a static “photograph” (anno September 2009)
of 9 regulatory investment frameworks across the region, together constituting the regional investment
climate.


Based on the Manual we explored if it is possible to use the outco
mes of the Virtual Test, conducted
in frameworks of Germany, Netherlands, Belgium and France to draw wider lessons for enhancing the
regional investment climate for the whole region. Based on the performed analysis, we find that it is possible
to roll out

lessons learned in the Virtual Test to


at least


the regional level. There are sufficient
commonalities in structure of all the national investment frameworks in the region. These national
investment frameworks

together constitute a regional invest
ment climate tested (for 4 frameworks more
specifically) under Virtual Test regulatory framework. We welcome the discussion of these findings at
Stockholm workshop on 24.09.2009.


In itself Manual already provides a starting point to learn from each other
s regulatory approaches
and, where possible, apply best practices. The variation in the Manual responses shows that at the very
least more th
a
n 1 solution to regulatory challenges is possible.
As t
h
e

Manual describes the frameworks

in
GRI NW countries
, w
e
see that at detail they can
differ.

We note therefore that
-

as part of GRI work
-

d
eveloping a common understanding of where national frameworks fit into a regional environment
continues
to be
important.


We note that in
GRI NW countries, appropriate ince
ntives and risk mitigation tools

for good
investment climate
are often in place, including:




Appropriate rate of return and incentives



Specific rules for new investment



Specific mitigation tools: investment budget, regulatory account, etc.


The development

of the manual provides a solid foundation for understanding the regulatory
frameworks of different countries and may become a useful tool for policy makers to use when considering
regional investment solutions. The VT
implicitly discussed issues related t
o the regulatory frameworks and
raised question how this could hamper

sufficient and timely investments to reduce persistent physical
congestion. For further conclusions please consult the
MANUAL SUMMARY
and the Manual
14

(Annex).


b.

Tilburg test


This study h
as been ordered by NMa in order to support the robustness of work on the main test of
the GRI NW Investment project, the Virtual Test Simulation. Any findings from this study at this stage, which
the stakeholders support during the Stockholm workshop on 24
.09.2009, will be incorporated in the Journal
of Findings of the Virtual Test Simulation.

For further
description
please consult the

attached paper

of

Bastian Henze
15
.



8

Longer term perspectives

The Virtual Test and
ancillary
GRI NW Investment project initi
atives (such as Manual, Tilburg Test)
will (potentially) show under which framework and risk distribution scenario(s) the TSOs shall have the



14

Please consult the document
s

via weblink http://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Priorities1/Investment

15

Plea
se consult the document via weblink http://www.energy
-
regulators.eu/portal/page/portal/EER_HOME/EER_INITIATIVES/GRI/North_West/Priorities1/Investment


Page
14

confidence to build the capacity (which the gas companies have signalled they need). The answer shall be
derived b
y testing various scenarios in risk distribution under current and potentially enhanced regulatory
frameworks of the region.


We should be aware of the fact that the current regimes are quite different and sometimes rather
complex. Therefore, any comparis
on would need an in
-
depth analysis of the differences and a common
understanding of important elements before coming to a final conclusion. The Virtual Test process during
2009 provides for that in
-
depth analysis.


A finding of that analysis could be that
with certain simple adjustments in key (risk distribution)
elements of different regulatory frameworks of the region, a common view on regional sound investment
climate shall be reached leading to timely (efficient) investment in the region, where required
. Currently
investments in the region seem to typically take long times due to lengthy discussions on regulatory
frameworks.


Once an agreed common view on (path to) investment climate is established, TSOs should be able
to ensure that timely, efficient a
nd sufficient investments in pipelines take place, so that gas supplies are
secured at all times within the region.
Virtual Test Case

will contribute to define an
agreed regional
framework for new cross border investments by assessing
interaction

of
existi
ng regulatory frameworks

and
developing common thinking on
alternative approaches (while ensuring sufficient realism

in comparing the
national frameworks)
,

a
nd

continuing on the path set out by the 3
rd

package.




9

Annex
-

Relevant documents

(attached or a
vailable on internet)




Summary and Manual (with 9 frameworks)



Advise (report) on bidding process test from “Tilburg” experiment



Roadmap, ToR

VT
, VT kick
-
off document for Brussels

workshop
, conclusions Brussels and Dublin
workshops



Developed Excel model VT



Developed bidding profiles