COMPETITION EARLY IN THE LIFE CYCLE OF INFRASTRUCTURE PROJECTS
Introducing competition in the
provision of onshore electricity
transmission networks
Since the privatisation of the electricity sector in 1990, the transmission
of electricity, mainly through a network of pylons and high voltage
cables, has been the preserve of three monopoly businesses that are
regulated by the energy markets regulator, Ofgem. Recently, however,
Ofgem has suggested that it might be better for British consumers if
competition were to be introduced into the sector. This briefing explores
how, in practice, this might be done.
Competition in transmission
Jason Mann
Senior Managing Director at
FTI, discusses the potential
for the introduction of
competition in electricity
transmission
Britain’shighvoltageelectricitytransmissionnetwork,thatconveyselectricity
fromthecountry’spowerstationstothelocalnetworksforonwarddistribution
tohomes,factoriesandoffices,iscurrentlyownedandoperatedbythree
regionalmonopolies.NationalGridisresponsibleforthenetworkinEngland
&WalesandSSEandScottishPowerundertakethesameroleinregionally
distinctpartsofScotland.Monopoliessincetheircreationatprivatisationin
1990,therevenuethethreecompaniesareallowedtoearnfromchargingfor
theuseoftheirnetworksissetbyOfgem–theenergymarketregulator.
Theelectricitytransmissionnetworkhas,sincethemid2000s,expanded
significantlytoconnectwindfarmssitedoffshoretotheexistingonshore
transmissionnetwork.Incontrasttotheonshoreregime,Ofgemhas
chosentoadoptaformofcompetitionfortheprovisionoftheseoffshore
transmissionnetworks–onthegroundsthatthiswilldeliverlowercoststhan
asystemofregulationandthereforeultimatelybebeneficialtoconsumers.
Todate12differentoffshoretransmissionowners(OFTOs)havebeencreated,
whichownandoperateoffshoretransmissionnetworksworth£2.2bn.
FTIConsulting,Inc.1
COMPETITIONEARLYINTHELIFECYCLEOFINFRASTRUCTUREPROJECTS.INTRODUCINGCOMPETITIONINTHEPROVISIONOFONSHOREELECTRICITYTRANSMISSIONNETWORKS
Followingtheperceivedsuccessoftheoffshoreregime,
Ofgemisnowkeentoextendasimilarcompetitiveapproach
totheprovisionofnewtransmissionassetsfortheonshore
electricitynetwork.Underthisregime,newtransmission
assetsthatmeetcertainpredefinedcriteriawouldbethe
subjectofcompetitiveprovisionbyso-calledOnshore
TransmissionOperators(ONTOs)ratherthanbeingprovided
bythethreeincumbentmonopolists.However,incontrastto
theoffshoreassetswhereonlythefinancingoftheassetwas
subjecttocompetition,theonshoreONTOresponsibilities
wouldincludeconstructionandoperationoftheassetandmay
alsoincludepartsofthedevelopmentworkssuchasasset
designandconsenting.
Akeyissueinthedevelopmentofaprocesstointroduce
competitionistodecidewhere,inthetypicallifecycleofan
onshoretransmissionproject,thecompetitiveprocessshould
beinitiated.Therearetwobroadoptions:aso-called“late
model”underwhichbidderscompetetoprovidetransmission
assetstomeetrelativelydetailedtechnicalspecificationsthat
have,crucially,receivedthenecessaryplanningconsents;the
alternative,the“earlymodel”introducescompetitionearlier
inthelifecycleofaninvestmentprojectwhenonlyahighlevel
outlineoftherequirementshasbeenspecified.
Figure 1: Understanding when an CATO would take responsibility
during the project life cycle under the Early or Late model
1
2
3
Project
Development
Framework
Identify
Need
Identify
Options
(desktop)
Responsibilities:
Late Model
SO
TO / SO
Responsibilities:
Early Model
SO
TO / SO
4
Identify
Preferred
Solution
5
Initial
Solution
Design
6
Undertake
Surveys /
Studies
7
Obtain
Consents
8
Detailed
Design of
Assets
SO
However,theearlymodelholdstheprospectofotherbenefits
ofconsumers.Mostnotably,becauseonlythehighlevel
requirementsarespecified,itoffersthepotentialofgreater
scopeforbidderstodevelopinnovativesolutionstomeetthe
specifiedrequirements–which,inturn,mayoffertheprospect
oflowerconsumerbillsandamoresecuretransmission
system.Asignificantdownsideofthisapproach,however,is
thatitisnecessarilymorecomplexthanthelatemodel.Hence,
theregulatorhasbeenwrestlingwithhowsuchanearlymodel
ofcompetitionmight,inpracticebeintroduced.
Construction
Late CATO
SO
Todate,Ofgemandtheindustryhaveconcentratedonthe
detaileddevelopmentofthelatemodelonthegroundsthatitis
lesscomplexandhasreducedrisksforbidders.Assuch,itcan
beimplemented,andthereforedeliverbenefitstoconsumers,
morequickly.Therelativesimplicityandlowerrisksofthe
latemodelalsoofferstheprospectofagreaternumberof
tenderersandmoreintensecompetitionwhich,inturn,would
bebeneficialtoconsumers.
9
Main
Contracts
Procurement
Early CATO
The Early and Late models
of competition
Insolvingtheproblemofhowtointroducecompetitionearlyinthe
lifecycleofaproject,twokeyuncertaintiesneedtobemanaged:
•
first,leadtimesfortransmissioninvestmentmeanthatthe
actualneedfortransmissionprojectsishighlyuncertain.
Currently,investmentintransmissionassetsoccursagainsta
backgroundofahighlyuncertainoutlookfortheevolutionof
GBgenerationandGBdemandrequirements.Thatistosay,
adecisiontoinvestintransmissionneedstobeundertaken
recognisingthat,becauseofchangesinexpectedgeneration
anddemandoutturn,itmightnotberequired.Thisriskwill
continuetoexistwereanearlymodeltobeadopted.
•
second,thecostoftransmissionprojectsisalsohighly
uncertain.Notably,planningconsentsthatarerequiredfor
aprojecttoproceedtotheconstructionphaseofaproject
arecostlyinthemselvesand,dependingonthespecific
circumstances,canhavehighlyuncertainoutcomes.
Anydesignchangesthatarerequiredtomeetplanning
requirementsmaysignificantlyincreasetheoutturncost
relativetoinitialexpectations.
FTIConsultingwasappointedbyNationalGridtoworkwith
theelectricityindustryandpotentialinvestorstodevelopa
solutionthat,despitethesesignificantuncertainties,would
allowtheintroductionofcompetitionatanearlystageina
transmissionproject.
2FTIConsulting,Inc.
COMPETITIONEARLYINTHELIFECYCLEOFINFRASTRUCTUREPROJECTS.INTRODUCINGCOMPETITIONINTHEPROVISIONOFONSHOREELECTRICITYTRANSMISSIONNETWORKS
Figure 2: Summary of the Early CATO model design
Key Challenges
Cost
Uncertainty
Asset need
uncertainty
Precedents
Early Model proposition
OFTO
Late ONTO
Model
Fixed price bidding difficult
Multi-part bidding (Dev / Construction)
Complex risk allocation
Risk-sharing factors (with consumers)
Bid evaluation complexity
Statistical analysis (but need transparency
Risk of asset stranding
Compensation for project cancellation
Ourfirstconclusionwasthatthecompetitiveregimethat
hasbeensuccessfullyintroducedforoffshoretransmission
networksandavariantthatisintendedtobeimplementedfor
thelatemodel–inwhichbidderseffectivelybidafixedpricefor
therightstotheproject–wouldnotworkfortheEarlymodel
duetotheinherentuncertaintiesthatneedtobemanaged.
Therefore,significantlymorecomplexbiddingarrangements
willbeneeded.Whilemanyvariantsareconceivable,akey
featureoftheearlymodelwouldbetheuseofmulti-partbids.
Forexample,bidderscouldsubmitatwo(ormore)partbid–a
certainamounttoundertake,say,thepreliminarypartsofthe
project(notablythedetailedplanningandtheconsenting)as
wellasabidforthecostoftheprojectitself.
Tomanagethecostuncertainty,anotherimportantpartofthe
biddingprocesswouldberisksharing:aswellassubmitting
abidtorecoverthecostsofdeliveringtheproject,bidders
wouldalsosubmitsharingfactorsinthetender.Costoverruns
orunderrunsonaprojectrelativetothebidamountwouldbe
sharedwithconsumersatthespecifiedsharingfactors.
Thesemight,potentially,differthroughdifferentstages
oftheprojectorfordifferentcategoriesofcosts.
Evaluationofcompetingbidswithdifferentbidstructuresand
risksharingbecomesincreasinglycomplexasthecomplexityof
thebidincreases.Atthelimit,asthenumberofbidparameters
increases,relativelycomplicatedstatisticalapproacheswould
beneededtojudgebetweencompetingbids.Hence,the
regulatorwillneedtodecidehowtobalancethecompeting
desiresforacomplexbiddingstructurestomanagerisksyeta
simpleandtransparenttheevaluationprocess.
Finally,tomanagetheprojectuncertaintyriskhighlighted
previously–namelythattheprojectisnolongerrequired
becauseofeventsoutsideofthecontrolofthedeveloper–a
furtherkeyfeatureoftheregimeisthattheregulatormust
committokeepthedeveloperwholeforfinancialexpenditure
incurredtodate.Henceshouldaprojectbecancelledbecause
thegenerationexpectedtolocateatapointonthenetwork
doesnotactuallychoosetoproceedwiththeproject,the
transmissiondevelopershouldstillreceivethefundsinvested
today.Thatistosay,theriskofassetstrandingshouldremain
withtheconsumer–asitdoes,forthemainpart,today.
Next steps for competition
InOfgem’sview,theintroductionofmorecompetitioninthe
transmissionsectorcouldbenefitGBconsumers.Forthistobe
thecase,thecompetitivemodelneedstobeappropriateforthe
situation.TheEarlymodelandtheLatemodelbothhavetheir
advantagesanddisadvantagesfromtheconsumerperspective.
WhilethisbriefingnoteshowshowtheEarlymodelcould
workinpracticeandcouldunlockincrementalvaluethrough
innovation,itwillnotalwaysbethepreferredmodel.Insome
cases(forexamplewheretheprojectneeduncertaintyis
larger-than-usual),theLatemodelmaybemorebeneficialto
consumers.Inothercases,anon-competitiveapproachmay
infacttrumpboththeEarlyandtheLatemodel.Wehopethat
thisBriefingnoteandthe[attached]reportwillcontribute
tothewiderindustrydebateaboutthepotentialforonshore
competitioninthetransmissionsector,includingtheinvestor
community,developersandotherinterestedstakeholders.
FTIConsulting,Inc.3
Jason Mann
Senior Managing Director
+44 (0)20 3727 1338
[email protected]
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