Early Competition: opportunities and challenges for all, but we cannot forget the Net Zero context
Ofgem’s ambition of being able to compete onshore transmission projects within the wider market, to companies other than the incumbent transmission owners (TOs), has taken a step closer to fruition. It has done so by incorporating “late competition” models (competition focused on construction delivery and operation of an already designed and consented solution) within the RIIO-T2 price control licences using a Large Onshore Transmission Investments (LOTI) Re-opener condition together with issuing associated LOTI Guidance and Submissions Requirements Document. This form of late competition has already begun to have a potential impact on projects in development, with the publication of the recent consultation on the Eastern HVDC Initial Needs Case[1].
Ofgem is now taking this to the next level by looking to bring “early competition” models (competition before a detailed solution design is produced and consented) to the market. In 2019 the National Grid Electricity System Operator (ESO) was tasked with developing a model for early competition. This culminated in the submission by the ESO to Ofgem of its Early Competition Plan (ECP) in late April 2021[2]. Shortly thereafter, Ofgem published an open letter[3] making clear that soon early competition would also likely to have a role to play in the onshore transmission market.
Key features of the Early Competition model
The Early Competition model has not been fully settled, with the ECP being part of its development. Ofgem is still to consult and make a decision on the final model. Based on the ECP, it is expected that for a project to be considered for Early Competiton:
- it will be an onshore transmission project that is new and separable (consistent with Ofgem’s existing Guidance on the Criteria for Competition published February 2019[4]);
- it will have no minimum value threshold (unlike LOTI which must have a value above £100m capex); and
- there must be “certainty of need” (there being enough confidence the network need will not disappear and having been required in more than one of the ESO’s Future Energy Scenario documents).
It is expected that Early Competition projects will be tendered after an indicative solution has been identified but before the initial design has been done and preliminary works have been undertaken.
Said to be inspired both by the Offshore Transmission Owner (OFTO) model and the Public Private Partnership (PPP) model, the preferred bidder will receive a fixed (indexed) tender revenue stream (TRS) subject to an availability incentive, which will be payable from successful commissioning of the assets. Adjustments to the TRS would be limited in terms comparable to those used in the OFTO regime (e.g. Income Adjusting Events and certain pass-through costs). The term of a project could be up to 45 years, depending on need.
The ESO has also proposed a procurement model with invitation to tender stages and appointment of preferred bidder. Cost of equity, overheads and margins are to be fixed at tender award. The cost and size of debt (and gearing ratio) and underlying costs will remain adjustable via a pre-defined mechanism (e.g. Post-Preliminary Works Cost Assessment (PPWCA)) with an overall cap on upward adjustments. The preferred bidder will also be required to provide security by way of letter of credit or performance bond.
Solutions tendered could be either network solutions (i.e. those needing a transmission licence) or non-network solutions (no transmission licence needed, with a commercial contract being entered into).
Key Challenges of Early Competition
Uncertainty, risk impacts and costs
Other “late” competition models (e.g PPPs and OFTOs) as well as Ofgem’s own “late competition” model typically award their contracts to the preferred bidder following initial design and consents having been granted or post-completion. However, Early Competition introduces competition at a much more embryonic stage. This creates a far higher risk profile and potentially cost uncertainty for bidders. This risk and uncertainty will come at a costin terms of development risk premium which may also be compounded by the need for security, depending on the value and duration for which it is required.
Further, as described above, in order to maintain competitive pressure it is proposed that certain costs will be fixed at tender award. Adjustments would then be allowable only for certain elements within the PPWCA (subject to a cap). Understanding the level of this cap as well as the nature, extent and accessibility of the PPWCA mechanism will be crucial for bidders since the scope and costs of projects could materially change during the preliminary works stage.
Any potential for increased costs will create a natural tension for Ofgem between its principal objective of protecting the interests of exisiting and future consumers (by keeping costs down) with its duties to promote efficiency and economy and to promote competition.
Regulatory impact
If the solution to be tendered is a network solution, the ECP states that the preferred bidder would be a competitively appointed transmission owner (CATO). The CATO model is not new, with draft CATO legislation having been tabled as far back as December 2016. However, that legislation was not enacted. If the Early Competition model is to be implemented in full as set out in the ECP, this will be contingent on CATO legislation being brought before the UK Parliament. The Energy White Paper in December 2020 refers to such legislation being introduced, but only “when Parliamentary time allows”.
In addition, as created for the OFTO regime, tender regulations for early competition are likely to be required.
Granting a CATO licence will also have an impact on an incumbent TO’s transmission licence (given its prescribed “Transmission Area”), meaning that licence modifications are likely also to be needed for incumbent TOs. There will also be impacts for the industry codes, compliance with the Electricity Act 1989 as well as uncertainty as to what the regulatory impact will be in terms of level-playing field and unbundling requirements.
Interface with the network
Unlike the clear ownership boundary demarcations for OFTOs, Early Competition would involve a third party building and operating an onshore transmission project within and forming part of the existing onshore transmission system. This will therefore create a more extensive technical and operational interface between the CATOs’ and the incumbent TOs’ assets. The ECP envisages this will be governed by an interface agreement, which the ECP notes will look to deal with access rights as well as technical, design and operational criteria. However, the necessary scope of this agreement is still unclear and will likely be the subject of extensive and detailed debate around how the interface(s) could be managed and risks allocated.
This interface risk is likely to also attract additional costs for both the CATO’s and the incumbent TO. This will risk increasing the values bid by market participants and is a cost currently not catered for within incumbent TOs’ price control allowances.
Incumbent TOs
For incumbent TOs, the ECP proposes that they should compete for Early Competition models in the same manner as market participants. This would mean that if an Early Competition project were to be awarded to an incumbent TO, it would not form part of the TO’s usual regulated asset value, nor be subject to their price control allowances and/or cost of equity.
Potential conflicts of interest would also need to be addressed by the incumbent TOs, for example, ringfencing bid teams from those supporting connection feasibility assessments or providing initial solutions for Network Options Appraisal. Ringfencing teams might on the face of it be a simple solution, but may be difficult to implement in reality.
Timings
In the ECP, the ESO has mapped out a detailed implementation plan and timeline. This timeline however is contingent upon an estimated view of when legislation might be enacted (by quarter 3 of 2022 for primary legislation) and the necessary activities by Ofgem (including impact assessment, consultation and development of the necessary regulatory principles to govern both network and non-network solutions). Assuming this timeline is maintained, the ECP indicates the earliest tender launch taking place during quarter 1 of 2024.
Next Steps
Ofgem intends to formally consult on Early Competition in July 2021, with a view to making a decision by early 2022. In the meantime, the ESO and Ofgem have agreed that there are various "low regret" activities the ESO can start work on now, including:
- finalising the process for identifying possible projects for early competition;
- exploring the potential for expanding pathfinders as a pre-legislative form of early competition;
- scoping out potential industry code changes; and
- developing a detailed programme plan with Ofgem.
Ofgem also considers there to be further low regrets work that the ESO could do in order to consider the applicability of the early competition model to electricity distribution. This is notwithstanding the ESO’s Thought Piece[5] (also published at the end of April 2021) concluding that there is not a role for the ESO in early competition in the distribution sector.
With the extent and nature of the activities referred to in the ECP, quarter 1 of 2024 for the first tender launch is ambitious. As part of the journey to reaching that stage, there will be many interesting policy and regulatory issues to be resolved. It will also create an opportunity for market participants to engage in the onshore electricity transmission system, and potentially the distribution system, in a way that has never before been possible. However, in developing the Early Competition model, and making it a reality, it will be important to keep in mind the ultimate target of seeking to reduce net zero emissions of all greenhouse gases by 2050 in the UK and by 2045 in Scotland and the energy-related infrastructure that will need to be in place in time to facilitate this.
[2] https://www.nationalgrideso.com/future-energy/projects/early-competition-plan/project-documents-early-competition and https://www.nationalgrideso.com/document/191251/download
[4] https://www.ofgem.gov.uk/system/files/docs/2019/02/criteria_guidance.pdf
[5] https://www.nationalgrideso.com/document/191246/download
