12 November 2015

Transmission Operators Look Out: CATO is coming! - 12 November 2015

Ofgem are consulting on the arrangements for introducing competitive tendering to onshore electricity transmission projects.

Mention Cato and, depending on your age, you might think of Cato (the elder or the younger) the Roman Emperor, Cato the Hunger Games competitor from District 2, or Cato the character played by Burt Kwouk in the Pink Panther films. But now there is a new CATO in town: the acronym for the less catchy Competitively Appointed Transmission Operator, which is set to shake up the onshore electricity transmission market.

A reminder of the context

The electricity network in Great Britain is planned, constructed, owned and operated by three monopoly Transmission Owners (TOs): National Grid Electricity Transmission (NGET) in England and Wales, SP Transmission in the south of Scotland and Scottish Hydro Electric Transmission in the north of Scotland. NGET is also the System Operator (SO) for the whole of the transmission network.

As the TOs are monopolies, to ensure that their pricing is fair they are regulated by price controls that are set by Ofgem. There is a (fairly) new price framework (it was set up in 2012) called RIIO (Revenue=Incentives + Innovation + Outputs) which sets the prices in 8 year periods. The first one (RIIO-T1) was decided in 2012 to apply from April 2013 to March 2021. See Ofgem's Price controls factsheet for more detail.

RIIO-T1 prices take account of projects such as infrastructure upgrades that the TOs were planning and could already set a cost for. For future projects that were not yet at a stage to be factored in to RIIO-T1, there is the Strategic Wider Works (SWW) programme. This allows TOs to bring forward projects for consideration when more information is available. This Ofgem factsheet gives more details, including a list of likely projects and three of these have already been submitted for assessment.

Ofgem recently carried out an Integrated Transmission Planning and Regulation (ITPR) project which reviewed the arrangements for planning and delivering the onshore, offshore and cross-border electricity transmission networks in Great Britain. It concluded that onshore transmission should be subject to competitive tendering in the same way that offshore transmission is.

For more details on offshore transmission and OFTOs see our article, The State of the OFTO Market

Bidders will be able to bid to become a CATO for a discrete onshore transmission infrastructure project. A CATO will have a transmission licence from Ofgem and be a party to the System Operator-Transmission Owner Code (STC).

Which projects will be subject to competition?

Onshore transmission projects that are 'new, separable and high value' will have to be tendered. The consultation sets out what this might mean and invites comments.

New – a brand new overhead line, cable or substation, or a complete replacement of these; and
Separable – it needs to be possible to delineate ownership boundaries, but electrical separability is not required, nor do assets need to be electrically contiguous (i.e. directly and physically connected to one another) as long as the works form part of a coherent package; and
High value – only projects with an expected capital expenditure of £100 million or above, but this will be kept under review

After the RIIO-T1 price period ends, the System Operator will recommend whether a project meets the criteria for tendering and whether there is a technical and economic need for it. Ofgem will make the final decision on whether to put a project out to tender.

What about current SWW projects in RIIO-T1?

Projects currently going through the SWW process have to submit a needs case or (for more recent projects) an initial project report. Ofgem will examine the needs case/initial project report (applying the "new, separable and high value" test) and the effect of tendering a project where the incumbent TO has already undertaken pre-construction work. That means that any of the current potential SWW projects could be tendered. See the Ofgem factsheet for the full list.

Where SWW projects are tendered, the TO would be expected to transfer to the CATO all necessary preliminary works undertaken on the project, such as surveys, assessments, designs, studies, site investigations and consents, but TOs should be no worse off as a result than they would be under RIIO-T1.

SWW projects that are tendered would use the 'late CATO build' model (see below) as the TO would have already carried out the preliminary works.

Future projects

For projects that would begin construction after RIIO-T1 (i.e. after 31 March 2021), the SO will be responsible (through the new Network Options Assessment (NOA) process) for identifying potential projects for tendering and doing the early development works, recommending whether a project meets the criteria for tendering, and whether there is a technical or economic need for the project. The projects could be put forward by a TO or suggested by the SO itself, to meet a transmission system need. Ofgem would scrutinise the SO's recommendations and make the final decision on whether a project should be tendered, plus which tender model to use and the timings.

Late CATO build and early CATO build

There are two tender models: 'early CATO build' and 'late CATO build'. The late CATO build model is likely to be the one most used, at least initially, as it most closely resembles other competitive procurement models such as OFTOs.

Under late CATO build, the SO would prepare a specification based on system performance requirements and preliminary works, including the parameters of any planning consent. Bidders would then be able to submit fixed-price bids for construction, operation and maintenance. A late CATO build tender would typically start around four to five years before the assets are needed.

Under early CATO build, the SO would prepare a tender specification setting out the system performance requirements and bidders would set out their high level asset design (e.g. voltage type, alternate or direct current) and consenting (e.g. detailed route planning). The CATO would therefore carry out the preliminary works as well as the construction, operation and maintenance. It is anticipated that early CATO build tenders would start around seven to nine years before the transmission assets were needed.

What's in it for a CATO?

This is the question that will be of most interest, as this consultation is the first time that Ofgem have provided a view on this. Ofgem propose:

A fixed 25-year revenue stream (linked to inflation but with no periodic reviews)
A refinancing gain share mechanism to ensure consumers gain the benefit from a CATO getting a lower cost of debt financing during its revenue term (but note its currently unclear as to whether this works the other way if the cost of financing goes up)
A mechanism for CATOs to make additional investment in upgrades or extensions to their assets during the revenue term to respond to new network needs
An availability-based incentive on the CATO to keep the asset running and possibly a reduction (perhaps 10% of annual revenue) for underperformance
Payment on completion (i.e. a CATO only starts getting its revenue stream once the assets are available for use)

Effect on existing TOs and NGET as SO

There is nothing to stop a TO bidding to become a CATO for a project, but there is a risk that they could have a competitive advantage, particularly if they are bidding for a project on which they have already done the preliminary works. NGET, as SO and responsible for putting forward future projects, is at particular risk of a conflict of interest.

The consultation proposes various measures to address this and create a level playing field for all participants which include: prohibitions on sharing certain information between parties; separate offices and IT systems; separate management of the bidding company from the parent TO; legal measures such as different functions being regulated under different licences and/or being carried out by separate companies; no cross-subsidies. See Appendix 6 of the consultation for full details.

Similar prohibitions are already being added to NGET's licence to reflect its 'enhanced' SO role and so it looks likely that these will be extended to cover bidding to become, and being, a CATO as well as an OFTO.

Next steps

The consultation is open until 11 January 2016 and in the meantime Ofgem plan to hold a number of stakeholder workshops. If you are interested in attending one of these, email Ofgem.

Ofgem expect work on licence changes to support competitive tendering to start next year and are working with Government to draft legislation. DECC will publish draft legislation and a regulatory impact assessment but no time frame is given for this. However, Ofgem expect to be able to run the first competitive tender for onshore transmission in 2017.