Financing system operator preferred connection method in contestable builds

Introduction

On October 26 2011 the Commission for Electricity Regulation (CER) issued a important decision paper(1) that should be reviewed by anyone that is considering a contestable build of connection works(2) to connect its generation assets to the distribution or transmission system.(3)

Sections 34(1)(A) and 34(1)(B) of the Electricity Regulation Act 1999 (as amended) confer on generators the right to construct all or part of their connection to the transmission system and the distribution system. A party typically opts for a contestable build in order to ensure that the connection works are carried out more quickly than would typically be the case if constructed by ESB Networks Limited or EirGrid plc.

The purpose of Consultation Paper CER/11/027, which is entitled "Consultation on Financing of the System Operator Preferred Connection Method in Contestable Builds", is to set out proposals by EirGrid plc and ESB Networks Limited to overcome issues faced by independent power producers(4) when choosing the contestable build option (ie, where they carry out the connection works themselves, rather than the relevant asset owner (ie, EirGrid plc or ESB Networks) doing so, which is the default 'non-contestable' scenario), and when the connection method specified by the system operator results in costs greater than the 'least cost chargeable' or 'least cost technically acceptable' connection method, thus imposing an additional financing burden on the independent power producers.

Position prior to decision

Contestable builds
For a contestable connection built by the independent power producer where the system operator specified a connection method greater than least cost chargeable/least cost technically acceptable, the approach prior to the new CER decision paper was that the transmission asset owner or distribution asset owner, on behalf of the use-of-system customer, would be responsible for paying these extra costs to the independent power producer.

Previously, those extra costs would be paid following the satisfactory completion of the connection in line with the system operator's specification, and after the asset had been transferred to the asset owner (ie, the distribution asset owner or the transmission asset owner) and the extra costs added to the regulated asset base.(5)

Prior to the decision, no advance payments or stage payments were made by the relevant asset owner to the independent power producer.

Where a connection method greater than least cost chargeable/least cost technically acceptable had been specified by the system operator, independent power producers(6) had two concerns with respect to those extra costs. They were concerned that:

• a higher amount of borrowing for the additional Capex would be required; and
• a financing cost would be incurred in relation to the extra capital raised.

The paper set out the options with regard to how the independent power producer could be assisted in relation to those concerns, without any adverse impact on the use-of-system customer.

Non-contestable builds

A 'non-contestable build' is one which is carried out by the relevant asset owner itself. The independent power producer always retains the right to opt for a non-contested connection (in which case only the regulatory approved rates for the least cost chargeable/least cost technically acceptable will be payable). However, the independent power producer may opt for a contestable build to ensure that the connection works are carried out more quickly than would typically be the case if constructed by the relevant asset owner.

The position with respect to non-contestable builds (which remains unchanged following the decision) is as follows:

• Assets are added to the regulated asset base as they are built. The use-of-system customer incurs tariffs that reflect the return and deprecation of the extra costs of the connection which are added to the regulated asset base on an as-incurred basis. In practice, this will typically mean additions to the regulated asset base over a number of years until project completion.
• The independent power producer is not required to obtain finance or incur any financing cost for the incremental cost of the connection over and above the least cost chargeable/least cost technically acceptable requirements.

Decision

In making its decision, the CER sought to balance the interests of system operators and independent power producers, while leaving the use-of-system customer in a position of neutrality as to whether works are completed contestabily or non-contestabily.

The CER made decisions in relation to the following areas:

• stage payments;
• standard or vouched costs for transmission build;
• financing costs; and
• threshold of the scheme.

Stage payments
Staged payments at certain intervals will be provided to independent power producers where system operator specified 'overbuild' is required in a contestable project (ie, where the costs are greater than the least cost chargeable or least cost technically acceptable connection method). System operator or asset owner engineer sign-off will be required before payment is made to the independent power producer to ensure that the work carried out is in line with system operator specifications and standards.

The format of the staged-payment structure is outlined in the table below. The relevant asset owner will provide payments for works in excess of the least cost technically acceptable or the least cost chargeable at particular stages, which will be passed to the relevant system operator, which will then disburse this to the independent power producer.

At the start of a project, the relevant asset owner will also provide to the independent power producer a clear written undertaking demonstrating its obligation to pay moneys for the satisfactory completion of certain stages of the build. It is intended that this should afford comfort to financiers providing the additional capital funding to the independent power producers.

If required, provisions will be drafted in to the relevant connection agreement to facilitate sign-off by the system operator and asset owner at each milestone.

Financing costs
Payment in respect of the financing costs will be made at the regulated CER-approved cost of capital(8) (in nominal terms) and at the same intervals (as shown in the table) when the principal payments for the overbuild elements of the connection works are being made.(9)

However, as the cost of capital provided for by the CER is measured in real (ie, non-indexed) terms, the interest payable would be adjusted for the rate of general price inflation (ie, according to the harmonised index of consumer prices) pertaining at that time. Under this methodology, inflation is applied to the interest rate and interest is compounded with interest applied to the interest accrued to date.

The amount payable to the independent power producer in respect of the interest will be calculated in accordance with the following formula:

Interest payable = [(1+ regulated approved cost of capital) x (1+ applicable harmonised index of consumer prices)] x assumed amount of principal overbuild expended

Financing costs, like staged payment, will not be paid until sign-off is received by the system operators and asset owners.

As noted above, at the start of a project the system operators will also provide the independent power producers with a clear written undertaking demonstrating the asset owner's obligation to pay moneys (including financing costs) for the satisfactory completion of certain stages of build. This should provide comfort to financiers that are providing the additional capital funding to independent power producers.

Scheme threshold
The threshold payments for overbuild will be made available to independent power producers where additional capital costs exceed €250,000 or 5% of capital outlay.

 

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.

Endnotes

(1) CER decision paper "Financing of the System Operator Preferred Connection Method in Contestable Builds" (CER/11/188), October 26 2011.

(2) "Contestability" is the right of applicants to construct, or arrange to have constructed, a generator connection to the distribution or transmission system.

(3) This decision paper should be read in conjunction with, among other publications:

• "Contestability on the Distribution System – ESB Networks Key Principles and Processes Paper", issued by ESB Networks Limited in January 2011;
• EirGrid plc's paper "Contestability of Connection Assets", October 16 2007 (these papers set out the principles under which contestability will operate at the distribution and transmission levels respectively); and
• CER's decision paper "Contestability for Distribution & Transmission Level Connections to the Electricity System" (CER/10/056), April 15 2010.

(4) The consultation paper provides that the consultation also applied to any party who may contest a connection including demand customers where such customers are entitled by legislation to do so (eg, transmission connections) in addition to independent power producers.

(5) The value to be added to the regulated asset base only includes the amount over and above that which would have been recovered from the independent power producer for the building of their connection.

(6) Being independent power producers who were borrowing for the costs of the contestable build.

(7) See CER/10/235 and CER/10/224 for the most recent charges published by the CER.

(8) See Section 5 of CER/10/206, which can be accssed at www.cer.ie/en/electricity-transmission-network-decision-documents.aspx?article=163210c1-f11f-4713-bfc9-d3b1c2fb4df3.

(9) In some cases it may well be that the cost of finance for an independent power producer exceeds that of the regulated CER-approved cost of capital (but this will be one of the considerations for independent power producers in deciding to proceed to contest the works or not). Contestable connection is worthwhile to them.