1

Project NexusApproach to modelling costs and benefits

Cesar Coelho

Ofgem

Project Nexus UNC Workgroup15 May 2012

2

Agenda

• Overall approach to analysis and modelling

• Steps for conducting analysis

• Take-up scenarios

• Costs and benefits

• Competition and distributional impacts

3

Where we are

• Project Nexus (PN) has the potential to deliver significant benefits for consumers

• At PNAG in March, Ofgem offered to help support the workgroup’s analysis

• We have developed an approach for modelling the costs and benefits of PN for discussion today

• We also intend to facilitate discussion on consumer issues

Ofgem’s role

4

Overall approach• Standard approach to cost benefit

• NPV modelling costs and benefits

– Decision on time horizon

– Discounting

• Uncertainty

– Scenario-specific uncertainty (e.g. specific to PN implementation)

– Universal uncertainty (e.g. Magnitude of energy prices)

• Approach to questions: simplify so these do not need to reflect the detail of the modelling

High-level principles

TIME

NP

V

5

Steps for conducting the analysis

Establish potential take-up scenarios

Estimate benefits, quantify where possible

Compare Nexus implementation with counterfactual scenarios

Assess any impacts on competition, distribution of costs & benefits

High-level principles

Establish how industry costs would change according to the level of take up

6

Step 1 – Take-up scenarios

• Take-up scenarios drive:

– Costs

– Benefits

– Impacts on competition

• Define:

– Implementation scenario

– Range of counterfactual scenarios

7

Step 1 – Take-up scenarios – Settlements

TIME

Counterfactual: Maximum plausible take-up of DM settlement without Nexus implementation (LSP) 3

Counterfactual: Minimum plausible take-up of DM settlement without Nexus implementation (LSP)

SETT

LEM

ENT

PRO

DU

CTS

– TA

KE U

P

100%

0%

3 1

2

4

3

33

Settlements implemented: Maximum plausible take-up of daily settlement products

Settlements implemented: Minimum plausible take-up of daily settlement products

8

Step 1 – Take-up scenarios – Settlements time reference

TIMEMilestone for framing stakeholder questions – Post-implementation

SETT

LEM

ENT

PRO

DU

CTS

– TA

KE U

P

100%

0%

3

Time to be used as reference to frame questions:

•Need to understand current take-up (DM/NDM)•Post implementation assumption: Daily meter data is available•Post-2020

3

33

Milestone for framing stakeholder questions – Pre-implementation (central agent)

9

TIME

3

Milestone for framing stakeholder questions – Post-implementation

SETT

LEM

ENT

PRO

DU

CTS

– TA

KE U

P

100%

0%

3 1

2

4

3

33

Milestone for framing stakeholder questions – Pre-implementation

Step 1 – Take-up scenarios – Settlements questions

Question:

•Assuming that it is possible to access daily meter reads, what are minimum and maximum likely take-up scenarios for each settlements product (at milestone XX)?

Bottom up + top down approach:

•Ask the group for a common view•Ask individual stakeholders for view across their portfolio, weight by portfolio size

10

Step 1 – Take-up scenarios – AQ, MPR frequency

TIME

2

Milestone for framing stakeholder questions – Post-implementation

Rolli

ng A

Q –

TAK

E U

P

100%

0%

3 1

3

Rolling AQ/MPR implemented: Maximum plausible take-up

Rolling AQ/MPR implemented: Minimum plausible take-up

Time to be used as reference to frame questions:

•Post implementation assumption: Daily meter data is available•Post-2020

11

Step 1 – Take-up scenarios – AQ, MPR frequency questions

TIME

2

Rolli

ng A

Q –

TAK

E U

P

100%

0%

3 1

3

Question:

•Assuming that it is possible to access daily meter reads, what percentage of your portfolio would update the AQ/be reconciled on a monthly, quarterly, six monthly, annual basis (at milestone XX)?Bottom up + top down approach:

•Ask the group for a common view•Ask individual stakeholders for view across their portfolio, weight by portfolio size

For discussion:

•Frequency intervals•Counterfactual

12

Step 2 – A framework for costs – Applying a cost curve

Take-up100%

AG

GR

EG

AT

E C

OS

T

t Today’s level of DM-settlement take-up

Increased take-up of DM settlement over time

TIME

NP

V

13

Step 2 – A framework for costs – Question on costs (1)

13

1

Take-up100%

AG

GR

EG

AT

E C

OS

T

2

Cost at maximum plausible take-up, post-implementation

3

Cost at maximum plausible take-up, counterfactual

x x

Question:

•What would your costs be to meet the take-up of DM settlement at (1), (2), (3) and at (4)?

Cost at minimum plausible take-up, post-implementation

4

Cost at minimum plausible take-up, counterfactual

xx

14

Step 2 – A framework for costs – Question on costs (2)

14

1

Take-up100%

AG

GR

EG

AT

E C

OS

T

2

3

x x

Question:

•Are there levels of take-up that would require you to make capital investment? If so, at what level of take up do these bite?•How much additional capital investment is required?

4

xx

5

Additional detail on upgrade points and costs

15

Step 2 – A framework for costs – Sensitivity analysis

15

1

Take-up100%

AG

GR

EG

AT

E C

OS

T

2

3

x x

4

xx

5

Sensitivities

16

Potential benefits• Accurate allocation of energy costs:

– Lower balancing/settlements costs

– Suppliers’ costs more accurately reflect customer usage

• Other benefits

– Long term gas purchasing gains

– Identify and reduce unallocated units

– Efficiencies/cost savings

• Network benefits from Nexus

– More accurate allocation of network costs

– Better network planning

– More accurate reporting of losses

Step 3 – Assessing benefits

17

Step 4 – Comparing costs and benefits (1)

TIME

TIME

TIME

TIME

• Compare implementation costs and benefits...

... with counterfactual scenarios and sensitivity testing.

18

TIME

PN Implemented

NPV

Net cost

Net benefit

Hurdle test

Sensitivity testing

High-level approach

•Quantitative modelling gets you so far•Test is what then has to be delivered by non-quantified benefits to go ahead•Apply this methodology to each counterfactual scenario / sensitivity

Could derive from qualitative benefits

Step 4 – Comparing costs and benefits (2)

19

Competitive and distributional impacts

• Need to assess impacts on competitive position of market participants

• Quantify distributional effects / improvements in allocation

– Allocation of charges

– Charges effectively paid – reconciliation

– Effects of meter reads submission on allocation and reconciliation

Step 5 – Distributional effects

20

Different rules for different segments

• NDM SSP– Allocation based on annual AQ– No reconciliation– Meter reads do not affect reconciliation; only affect AQ on an

annual basis

• NDM LSP– Allocation based on annual AQ– Reconciliation once a meter read is submitted– Meter reads used for reconciliation; only affect AQ on an annual

basis

Step 5 – Distributional effects – Market segments

21

Approach

• 2 sources for inaccuracy if daily meter reads are not used– allocation– reconciliation

• Bottom-up approach (zero-sum game between providers, but possibly not between segments of customers)– Assume error for allocation– Assume error for reconciliation– Possibility for using different profiles for errors

Step 5 – Distributional effects – Approach

22