Offshore Transmission Network Review: Update on Anticipatory Investment Allocation (Early Opportunities Workstream)

Introduction

In support of the UK Government’s offshore wind and net zero ambitions, the Offshore Transmission Network Review (the “OTNR”) aims to deliver improvements in the way that offshore generation is connected to the onshore transmission network and facilitate a more supportive approach for multi-purpose interconnectors (“MPIs”) that combine market-to-market interconnectors with offshore transmission. In April 2022, the Energy Security Strategy increased the ambitious target for offshore wind to 50GW by 2030 (see our commentary on the strategy here), placing a renewed importance on OTNR.

The OTNR contains four workstreams with the following objectives:

1. Early opportunities – to identify and facilitate opportunities for increased coordination in the near term, with a focus on “in-flight” projects.
2. Pathway to 2030 – to drive coordination of offshore projects progressing through current ScotWind and Crown Estate Leasing Round 4, connecting before 2030.
3. Enduring Regime – to develop a new post-2030 framework that drives coordination from the earliest stages of an offshore project, with changes being driven across multiple Government departments.
4. Multi-purpose interconnectors – to make tactical changes to facilitate early opportunity MPIs and to develop an enduring MPI regime for 2030 onwards.

This Law-Now article discusses the minded-to decisions Ofgem is seeking input on as part of its work under the Early Opportunities workstream and allocation of anticipatory investment stranding risk.

Background

Anticipatory Investment (“AI”) in this context relates to investment in offshore transmission infrastructure that goes beyond the immediate needs of a specific offshore wind project. Generators need certainty that AI will be recoverable to mitigate for the inherent risk of ‘stranded assets’.

As it stands, the AI risk is either allocated wholly to the developer or on a case-by-case basis under Ofgem’s Offshore Transmission Owner (“OFTO”) regulatory regime. The current framework for offshore wind development encourages competition between developers, including during seabed leasing rounds and Contracts for Difference (“CfD”) allocation rounds. This structure has been successful in driving down costs and encouraging timely delivery of offshore wind projects. The risk of unrecovered investment has prevented the developers from making AIs in offshore transmission projects that would support the later connection of other offshore developments. AI into shared offshore transmission infrastructure is crucial to deliver the shared assets envisaged by OTNR.

AI was identified in Ofgem’s original Early Opportunity consultation as a barrier to implementation of OTNR. In this most recent minded-to decision, Ofgem sets out its thinking on how AI should be addressed to enable the implementation of shared offshore transmission system infrastructure. It considers that AI stranding risk should be allocated in a way that supports consumer benefits and the objectives of the OTNR. Ofgem’s position is that allocation of AI risk to consumers would best support the wider objectives of the OTNR.

AI Risk

AI risk designates situations where a potential later user (the developer who will use the shared asset in the future) fails to become a later user and does not use the assets constructed on its behalf with AI. Due to the nature of AI, the potential later user is not in a position to take its final investment decision at the time the initial user investment is made. It is not always certain whether a later user will ever use the infrastructure in question, or if it does, when that will be. This risk exists until the later user connects and starts to pay Transmission Network Use of System (“TNUoS”) charges in respect of the infrastructure constructed with AI.

For that reason, Ofgem proposes to allocate the risk of AI to consumers until the earlier to occur of (i) the later user starts paying TNUoS charges or (ii) on an ongoing basis if the potential later user fails to connect.

To protect consumers from increased AI stranding risk, Ofgem is considering extending user commitment provisions under Section 15 of the Connection and Use of System Code (“CUSC”) to the later user of any shared infrastructure which is the subject of AI. This would mean that AI is built into the Cancellation Charge calculations. Cancellation Charges are due from any developer that was due to be connecting to the offshore transmission system but terminates connection agreements or reduces capacity.

Ofgem proposes that AI principles should not apply when projects are expected to participate in the same CfD allocation round, as the initial user will not require the cost recovery mechanism (subject to each developer being successful in the allocation round). Ofgem believes developers should be able to enter into a commercial agreement for the shared investment costs from the certainty of the CfD. Ofgem will permit developers to submit the assessment process to ensure eligibility of coordinated infrastructure when developers are uncertain as to whether the projects will be in the same CfD allocation round with the cost assessment process to be added later if projects are allocated CfDs in different allocation rounds.

(Mind the) AI Cost Gap

Following the shared asset transfer to the OFTO and before the date that a later user connects to the system and starts using the assets funded by the AI, there is a portion of the AI element of the offshore generator TNUoS charges which will not be paid. However, the equivalent amount will be payable to the OFTO because the costs of the infrastructure form part of the asset value to the OFTO. The OFTO revenue will reflect the full asset value fixed at the date of asset transfer. This difference is what is payable to the OFTO but what is not recoverable in the absence of the later user and is referred to as the ‘AI Cost Gap’.

Ofgem considered three policy options in respect of which party should bear the cost of the AI Cost Gap:

1. Paid by consumers

Under this option, there is recognition that ultimately consumers will benefit from shared assets. The AI Cost Gap should be borne by consumers until the later user connects to the offshore transmission system, at which point it starts to bear the AI Cost Gap.

2. Paid by initial user and later user

This allocation would start from the point that the initial user and later user each start paying TNUoS charges, and then continue over the relevant OFTO licence period. This arrangement could provide incentives for both the initial user and the later user to minimise the period that the AI Gap Cost is required to cover, by aligning their respective delivery timelines as far as possible.

3. Paid by later user

The corresponding charges for the later user would reflect the cost of the offshore infrastructure assets that they can or do use, based on the extent to which they can use them. The initial user will have taken on construction risk and may have shortened timelines for the later user as a result of making AI on behalf of the later user. Allocating liability for the AI Cost Gap to the later user should incentivise the later user to connect as quickly as possible. This is because it will have sole liability for the charges in respect of the AI Cost Gap which will accrue from the date of the initial user connecting and which will continue to accrue until the date of connection of the later user.

Ofgem’s minded-to decision is that the AI Cost Gap shall be borne by consumers (policy option 1).

AI – Early Stage Assessment Process

Ofgem proposes that an early stage assessment process would be initiated with an application by any developer who is seeking to develop coordinated offshore transmission infrastructure which would require any AI. This assessment should be mandatory to reduce the risk of developers including AI costs that would not be recoverable at the cost assessment stage.

Eligibility will be met by the projects meeting the following conditions:

• having in place a valid and enforceable Agreement for Lease with The Crown Estate or Crown Estate Scotland; and
• having been assessed through the Connections and Infrastructure Options Note Process.

Comment and Next Steps

AI has been a key road-block to improving coordination in offshore transmission network infrastructure. Allocating a significant portion of AI risk to consumers is intended to incentivise developers to go beyond what is necessary when investing in offshore wind projects. It is hoped that this will benefit consumers in the long run, however there may be push back to allocate further costs to consumers during a time of high energy costs.

The deadline to respond to the consultation on the minded-to decisions on AI was 9 June 2022.

This current Ofgem minded-to consultation has coincided with its other minded-to decision on the approach to multi-purpose interconnectors which we cover here.