Last month Ofgem again confirmed its position in relation to the introduction of the Competitively Appointed Transmission Owner (CATO) regime, put simply: "don't hold your breath". This aligns with previous Ofgem updates published throughout the course of 2017 which suggested the legislative pipeline for Brexit was likely to overshadow any parliamentary appetite for energy regulatory reform.
Whilst the infrastructure market waits patiently, in this update we take a look at the wider CATO regime, its progress and Ofgem's plans for delivery of the most pressing transmission infrastructure works – the Hinkley Seabank project.
What is CATO?
Put simply, CATO is a competitive procurement process for the delivery of new, separable, and high value onshore electricity transmission projects. The regime was born out of Ofgem's Integrated Transmission Planning and Regulation project, which concluded (amongst other things) that there should be more competition in the procurement of electricity transmission assets. CATO seeks to provide cost benefits to consumers by reducing the costs of delivering large (£100m+) transmission infrastructure that otherwise would have been procured directly by the Transmission Operator (TO) and flowed-down to consumers via grid charges.
However, the CATO regime differs from some other commonly used competitive procurement models in that the procuring party under CATO will not own the asset. Rather, the CATO regime will adopt a design, construction, ownership and operation model. This means that the CATO not only receives revenue for constructing the asset, but also receives payment for managing and maintaining the asset over its life. Payments to the CATO for delivering the asset and providing the ongoing service will commence upon completion of the construction and will not be subject to ongoing review under Ofgem's regulated asset price control mechanisms. Instead, Ofgem proposes that a CATO’s annual revenue stream should be bid through the tender process and then fixed (but indexed) for 25 years, without periodic reviews. The CATO regime is therefore more akin to a PPP project than traditional regulated infrastructure or indeed direct procurement contracting.
Although Ofgem expects the CATO regime to provide significant savings for consumers, the requirement for external sources of funding and the prospect of fixed indexed revenues for 25 years obviously creates a broad market for potential suppliers. Reports indicate interest from a range of entities in various sectors of the infrastructure market, including some of the country's biggest construction contractors, asset operators and investors. We would expect those entities involved in the Offshore Transmission Owner (OFTO) regime – a similar system already in place for the procurement of offshore transmission assets – are likely to be interested in considering onshore opportunities. The prospect of bespoke supply chains being established for each project will no doubt catch the attention of downstream contractors in the locality of future assets – see list here.
When will it be introduced?
Ofgem's official line in its most recent update is that "the opportunity to introduce the required legislation looks unlikely in the immediate future and we have paused our work on the CATO regime". This is unfortunate for those parties who have been looking at progress on the scheme with interest over the last couple of years. Yet Ofgem's tone remains positive, indicating it remains committed to working with the Government to seek an appropriate opportunity to introduce the necessary legislative changes.
However, with the prospect of Brexit legislative reform being required in the short to medium term, it would seem unlikely that the CATO regime will be introduced in full over the next two years.
What happens until then?
The stalling of progress on introduction of the CATO regime has more immediate ramifications for those projects that Ofgem consider to be suitable for procurement under a competitive model. The most urgent of these is the Hinkley Seabank (HSB) project, the electricity transmission project required by National Grid (the TO) to connect the new Hinkley Point C nuclear power station currently being constructed in Somerset. Published estimates of the cost of the HSB project range from £650m to £839m. Ofgem expects this infrastructure will be in service by 2024 at the earliest, meaning procurement cannot wait until the CATO legislative process runs its course.
As an interim measure, Ofgem has decided to use its existing regulatory powers to implement a system for procurement of the HSB project. The project will be delivered through one of the following models depending on the outcome of Ofgem's current consultation:
Competition Proxy Model
Under the Competition Proxy model Ofgem would set the National Grid's allowed revenue for a project in line with the outcome it considers would have resulted from an efficient competition for construction, financing and operation of the project. Ofgem would fix this revenue for a defined period (likely to be 25 years). The revenue would be based on its determination of the project-specific cost of capital for the construction and operational periods of the revenue term and Ofgem's determination of efficient costs for construction and operation of the project.
Under the SPV model, National Grid would run a competition for the construction, financing and operation of the project through a project-specific Special Purpose Vehicle (SPV). The SPV would deliver the project under the terms of a contractual arrangement (the “delivery agreement”) with National Grid. National Grid would retain regulatory responsibility (under the terms of its transmission licence) for, and operational control of, the project. The SPV would finance, construct and operate the project for a fixed period (likely 25 years), in return for a defined revenue under its delivery agreement with National Grid.
Whilst some may question the accuracy of the numbers determined by a "proxy" competition, Ofgem has nonetheless indicated a preference for option 1 above. If this preference is followed through to final decision, Ofgem has explained that the allowed revenue for the project would be based on appropriate benchmarks (e.g. from tenders under the OFTO regime) and a detailed review and determination of costs. Early comments from National Grid on the financial parameters proposed in Ofgem's 'minded to' decision were less than supportive.
It appears the CATO regime will be another casualty of the Government's focus on the legislative reforms required for Brexit. Though this focus is of course understandable, it is unfortunate that a regulator-proposed reform package which has widespread support amongst industry players and cost benefit to consumers has been unable to pierce the Brexit shroud. Industry participants will be forced to deal with the interim measures until more clarity is received from Ofgem and the Government on the timing of the launch of the new CATO regime.
Ofgem's 'minded-to' consultation on the HSB project options is open for submissions until 20 March 2018.