Anticipatory Investment: Ofgem's minded-to decision

To encourage developers (the initial users) to assume the AI risk on behalf of later projects, Ofgem is proposing that such risk should be shared between consumers and developers of the projects which will benefit from the shared offshore transmission infrastructure: 

• consumers will bear the risk of AI (via TNUoS residual charges): 
  • until such time as the later project has been constructed and connected to the shared offshore transmission infrastructure and the developer of that project (the later user) starts paying TNUoS charges, designed to recover the cost of building and maintaining the transmission system; and 
  • if the potential later user fails to connect the later project; 
• the later user will be liable for: 
  • the AI Cost Gap, comprised of the TNUoS tariff in respect of the AI element, for the period between the transfer of the shared asset to the OFTO and the point when the later user connects and starts paying TNUoS charges for the use of the shared asset. In a scenario where the AI Cost Gap cannot be recovered because the potential later user fails to connect, the cost is borne by consumers, who are effectively underwriting that risk; and
  • TNUoS charges in respect of the AI element from the date it starts paying such charges for the duration of the relevant OFTO licence period. If the later user never connects, consumers will assume the costs of the unused AI element of the asset; and
• the initial user will be liable for TNUoS charges associated with the non-AI element. 

The extent of the AI element and the non-AI element will be determined on a case-by-case basis depending on the proportional usage of the shared infrastructure.

The way this would work in practice is that the final transfer value of the transmission assets transferred to the OFTO will include, where eligible, any economic and efficient AI for the connection of the identifiable later user, so that the OFTO revenue for those assets, funded through TNUoS charges, will reflect both the AI and the non-AI elements. 

This is different from the current regime which allocates the TNUoS charges for both these elements to the initial user, without any route to reclaim the AI, with an added complexity that the size of the AI Cost Gap is unknown until the date the later user connects.

These proposals are a shift from Ofgem's earlier position, published in July 2013, that the generator for whom the assets were being constructed is the party best able to manage generator focused anticipatory investment stranding risk, and that such risk should not be shared with consumers.

The rationale behind the shift is to unlock investment in coordinated offshore transmission infrastructure.

The initial users and the later users will benefit from the shared infrastructure and lower total TNUoS charges relative to the cost of separate connections. 

The initial user, by taking on construction risk and making AI on behalf of the later user, will likely shorten timelines for the later user to connect. Allocating the AI Cost Gap to the later user should incentivise the later user to connect as quickly as possible. This achieves a fair balance of risk and reward.

It is thought that consumers will benefit from assuming AI risk because of lower total capital costs, which would translate into lower socialised TNUoS charges and a reduced level of subsidy through the CfD scheme, reduced environmental impacts, accelerated connection of offshore wind power generation and reduced impact on communities of transmission infrastructure.

Ofgem is proposing a combination of measures to reduce the AI risk of non-connection and to mitigate its effects should it materialise.

• Early stage assessment

One of them is a mandatory early stage assessment. This process would be initiated by a developer applying to develop coordinated infrastructure which would require any AI relating to an eligible project within the Early Opportunities workstream. 

Its aim is to reduce the risk of developers including AI costs that would not be recoverable at a later stage. The assessment would provide an indication of whether the proposed AI would in principle be an allowable cost in any future cost assessment process. This would inform developers' decisions relating to design, planning and procurement.

Ofgem will conduct a high level review of each submission to assess whether the proposal meets the objectives of the OTNR and decide whether the AI should be recovered through the OFTO transfer process. 

It will then publish a draft decision which will be followed by a 4 – 6 weeks' consultation after which a final decision letter will be published.

To put this into practice, Ofgem will: 

a) issue guidance ahead of the early stage assessment process coming into effect, specifying the details to be included in the application; and

b) review ancillary documents and guidance (including cost assessment guidance) to make any necessary modifications for the AI to be treated in accordance with this policy.

• Section 15 of the Connection and User of System Code (CUSC): extending user commitment provisions

Section 15 of the CUSC deals with liability of prospective users of the onshore transmission system in respect of the investment that the transmission owner (TO) must undertake to connect them to the system: 

a) local assets necessary to achieve connection; and 

b) possibly, wider system reinforcement to take account of the changed power capacity requirements on the system. 

If a user cancels their project or reduces capacity after works have begun, they are liable for any unnecessary costs incurred on their behalf. When applying for a connection, a prospective user is required to place credit support in respect of these liabilities.

The offshore transmission projects constructed to date have been developer-led, with radial connections, where the developer was responsible for building the offshore transmission works associated with its own project. Since the developer has borne the risk of termination or reduction of capacity, it has not been considered necessary to require any user commitment under Section 15 of the CUSC in respect of the offshore element of such connections.

However, if Ofgem's proposals to encourage AI are implemented, initial users will be developing more shared offshore infrastructure on behalf of potential later users. Consumers will bear the risk of the later users never connecting and using the AI assets. With this in mind, Ofgem believes it appropriate to apply the user commitment provisions under Section 15 of the CUSC to the later users of offshore transmission assets funded by AI.

To put this into practice, Ofgem will work with the Electricity System Operator (ESO) to bring forward code modifications to extend the provision of user commitment to new offshore transmission assets which provide offshore transmission works for more than a single user. These modifications will be subject to a further consultation in due course.