An overview of the UK electricity offshore transmission regime and recent developments in policy and market actions.

Background: the OFTO regime

Offshore wind is an important source of renewable electricity for the UK and key to achieving the UK's binding target of producing 15% of its energy needs from renewable sources by 2020. Offshore wind farms need to be connected to the onshore electricity grid but a raft of EU directives which came into force in 2009 (known as the Third Package) prevent electricity generation and transmission assets being owned by the same entity. As a result, developers of offshore wind farms need to get another company to operate and maintain the transmission assets.

To ensure that offshore generators were not held to ransom by the operators of the transmission assets, the government put in place a competitive offshore transmission regime, with three aims:

• To deliver transmission infrastructure to connect offshore generation.
• To provide certainty and best value to consumers through the competitive process.
• To attract new entrants to the sector.

Under this regime, which began in July 2009, companies took part in a competitive tender process to bid for offshore transmission licences and so become Offshore Transmission Owners (OFTOs).

OFTO licence

The OFTO takes responsibility for the transmission assets (normally cables, substations and transformers) under a licence from Ofgem. In return for ensuring the assets are available for transmission of electricity, the OFTO is paid a fixed revenue for 20 years. The amount of revenue (Tender Revenue Stream, or TRS) is determined by Ofgem based on the TRS set by the winning OFTO bidder in its tender. OFTO bidders price their TRS taking into account all their anticipated costs. Ofgem selects a successful bidder based on the amount of their TRS and also the deliverability of their tender submission.

Regulatory framework

The power for Ofgem to run a competitive tender process stems from the Energy Act 2004, which inserted a new section 6C into the Electricity Act 1989. So far, there have been three sets of Regulations governing the competitive tender process, the Electricity (Competitive Tender for Offshore Transmission Licences) Regulations 2009, 2010 and 2013 respectively. Ofgem are now consulting on a new draft set of 2015 Regulations; see "OFTO build" below.

Transitional Regime and Enduring Regime

There have so far been three rounds of tenders for offshore transmission licences. The first two rounds were run under the 'transitional' regime, where the offshore developer constructed the transmission assets and they were then transferred to the OFTO via the competitive tender process. The OFTO finances and maintains the assets and receives a 20-year revenue stream under the licence as described above.

Any projects meeting the qualifying requirements after 31 March 2012 are part of the 'enduring' regime. The enduring regime gives offshore developers the choice of whether they or the OFTO design and construct the transmission assets. Where the developer designs and constructs the OFTO assets, this is known as 'generator build'; if the OFTO does so, this is known as 'OFTO build'. Whichever option is chosen, the OFTO still operates, maintains and decommissions the assets. The two projects that are currently being run under Round 3 (which begin in February 2014) are both generator build projects, i.e. the same as in the transitional regime.

OFTO build

The idea of introducing the OFTO build approach was to get a better deal. Under the generator build approach, OFTOs were being paid for simply making assets available and the generator bore the cost and risk of actually constructing them. However, developers have resisted the OFTO build approach and are understandably concerned about losing control over a critical component of their projects. Even though getting the OFTO to build the transmission assets should in theory reduce the developer's capital costs, since the cost of the transmission assets is typically only 10% of the total capital cost this advantage pales in comparison to the developers' concerns about potential revenue loss if the OFT does not build the transmission assets on time.

With this in mind, in December 2014 Ofgem consulted on making the OFTO Build framework more flexible, with four indicative options:

• Generator EPC – the generator carries out all supply chain procurement and manages construction under an EPC contract with the OFTO.
• Generator procurement – the generator carries out elements of supply chain procurement but the OFTO manages construction under an EPC contract with a third party.
• Generator/OFTO management – the generator splits responsibility for managing construction of the offshore transmission assets with the OFTO (e.g. across onshore/offshore elements).
• OFTO procurement and EPC – also known as the 'late OFTO build' option, where the generator undertakes the preliminary work, consenting and high level design and the OFTO procures the transmission assets and construction phases.

The feedback was generally positive and, although stakeholders' views on the attractiveness of some of the options varied, no significant issues were raised. Ofgem therefore issued on 26 March 2015 a set of draft Regulations that will implement these options and replace the 2013 Regulations. These draft Regulations are open for feedback until 12 May 2015, after which Ofgem will review them and issue final Regulations to come into force by Summer 2015.

The 2015 Regulations will apply to projects which have not yet reached the ITT stage of the OFTO tender process. As all the current projects are past the ITT stage, the 2013 Regulations will continue to apply to them. Any new project will come under the 2015 Regulations. It will be interesting to see how widely-used the new OFTO build approaches are going forward.

Market developments

To date, 12 OFTOs have been licensed for assets worth over £2.2 billion. The key players in the OFTO market are currently Transmission Capital Partners (a consortium of Transmission Capital, International Public Partnerships and Amber Infrastructure Group) – 5 OFTOs; Blue Transmission (a consortium of 3i Group plc and Diamond Transmission Corporation, a UK subsidiary of Mitsubishi) – 4 OTFOs; and Balfour Beatty/Equitix – 3 OFTOs.

A further three projects worth £700 million are currently being tendered. Tenders have been issued in three rounds, the first two rounds under the transitional regime and the third under the enduring regime:

• Round 1 – nine projects worth £1.1 billion in total connecting 1.5GW of offshore wind. All have reached financial close.
• Round 2 – four projects worth £1.4 billion in total and connecting 1.8GW, three of which have reached financial close.
• Round 3 – two projects so far, worth £346 million and connecting 425MW in total, both using the generator build approach.

The industry seems to think there is potential for a further £9-£10 billion of investment in OFTOs in the next five years, but firm information is hard to come by. Ofgem asked the market in January for information on their future plans and is currently looking at the responses.