CATO regime will drive innovation and improve efficiency

Recent months have seen increased activity in the UK by the department for energy security and net zero (DESNZ), the office of gas and energy markets (Ofgem), and the national energy system operator (NESO) to implement the CATO regime. This regime aims to introduce competitive participation in the development of onshore electricity of onshore transmission assets in GB, which can currently only be carried out by the three incumbent licensed transmission owners.

Providing new investment opportunities in our onshore networks for new participants will be of critical importance if the £58 billion of investment needs set out in NESO’s ‘Beyond 2030’ network design recommendations are to be met. 

CATO commercial model

The CATO regime involves NESO, in conjunction with Ofgem, running a competitive tender process for granting onshore electricity transmission licences. The developer successfully appointed as the CATO will be responsible for designing, constructing, financing, owning, and operating transmission assets. Each CATO will receive a 35-year regulated tender revenue stream (TRS) from the point of asset commissioning, primarily availability-based and payable by NESO.

Ofgem is consulting on the commercial framework that will apply to CATOs, which includes:

• a requirement for financial security to be provided by CATOs in the early stages of construction, for up to 10% of the forecast construction costs, to reduce the risk of non-delivery
• a preliminary works payment to be made by NESO for up to 50% of the anticipated early works costs, where Ofgem determines this will remove barriers to entry for bidders, such as complex consenting requirements
• proposals to allow a CATO to adjust its cost proposal (by up to 40%) and TRS between bid submission and the completion of the preliminary works stage, given it is possible for there to be a four- or five-year gap between bid submission and construction starting
• the operation of performance incentives and penalties within the CATO licence
• additional works obligations - whether CATOs can be required to undertake additional works to their assets to support the development of the wider network – for example, through providing new user connections, modifying assets as a result of user connections elsewhere, or to support changes to another transmission investment plan; and
• revenue period - the proposed revenue period under the licence to be issued to each CATO is 35 years, after which it is proposed a review is carried out to determine asset health, and whether re-tendering the licence is feasible.

CATO tender regime

The proposed early competition model that underpins the CATO regime seeks to identify potential solutions for network needs through competition before the technical aspects of a solution are fully developed. This approach allows bidders to compete on the design, delivery, and operation of the solution, potentially leading to more innovative and cost-effective outcomes.

Ofgem recently issued a consultation on the form of regulations that will govern the regime - the draft Electricity (Early-Model Competitive Tenders for Onshore Transmission Licences) Regulations 2024. The draft regulations show that the CATO regime will be substantially based on the existing Offshore Transmission Owner (OFTO) Build regime, with some elements also reflective of the interconnector cap and floor regime. To begin each tender process, NESO will select qualifying projects that are required to address network needs across GB.

Projects assessed by Ofgem to meet the following criteria may enter the CATO regime:

• Wholly new or an entire replacement of existing assets.
• Separable from the wider transmission system.
• Capable of addressing a network need.
• Likely to deliver consumer benefits.

Participants will bid to be appointed as the CATO for a particular project, with responsibility for the development, financing and operation of that project. The CATO will receive a payment a tender revenue stream (TRS) over a 35-year period based on the availability of certain assets, with payments adjusted according to changes to the consumer prince index (CPI) to account for inflation.

The CATO will be able to earn bonus upside availability adjustments and be subject to limited downside availability adjustments. This provides greater long-term revenue certainty during periods of poor performance, which is attractive to project financing funders. As the payments are availability-based, the CATO will not be exposed to any risk associated with the actual flows of electricity which will continue to be directed by NESO.

Each bidder participating in a CATO tender round will need to set out its proposals for developing and constructing the project in question, along with the total anticipated project costs and the bidder’s proposal for the TRS it would need to receive each year. This should broadly enable the CATO to recoup design and construction costs and cover its long-term operational and financing costs.

The lower the TRS proposed, the more competitive a bid will be. Bidders will not be expected to undertake extensive planning, consenting or ground-risk studies at the bid stage - any changes to the design of the project resulting from reasonably unforeseeable issues resulting from these factors will be recoverable by the CATO as a permissible change to the TRS at financial close, subject to Ofgem assessment.

Ofgem will determine the successful bidder, which will be awarded a CATO licence and be referred to as the CATO. Following licence issue, preliminary works on the relevant project can begin – for instance, planning and consenting works and design development. Prior to financial close, Ofgem will assess actual construction costs incurred to date, and details of costs yet to be incurred. 

The final TRS will be adjusted at financial close to consider those costs submitted which Ofgem agrees are “economic and efficient”.

An early example: WCN2 circuit

A significant milestone was reached in early December with Ofgem's consultation on the needs case for a new onshore transmission link between Kilmarnock South in Scotland and Carlisle in England (the WCN2 circuit).

Ofgem has issued the WCN2 circuit consultation to seek interested parties’ views on whether the WCN2 circuit meets the criteria to enter into the CATO regime, on the basis that this is the first project to be proposed as being subject to the competitive regime, and on the basis that Ofgem has not previously confirmed a needs case in respect of the WCN2 circuit in previous consultations on proposed transmission infrastructure. Ofgem has stressed that it does not anticipate consulting on whether the needs case set out above is made in respect of future projects. However, this consultation is the clearest indicator yet that the CATO regime is finally here - and is likely to generate greater interest from potential bidders

The Ofgem consultation document details the sub-components of the WCN2 project critical for addressing network constraints and supporting the integration of renewable energy sources which NESO has proposed for competitive tendering.

The components that are proposed to be tendered are a new 400 kilovolt (kV) double circuit electric line from the Glenmuckloch substation to a new 400kV substation at Dumfries North and a new 400kV double circuit electric line from the new Dumfries North substation to a new 400kV substation at Carlislie.

The ‘earliest in service date’ for elements the new infrastructure is between the last quarter of 2035 and final quarter of 2036.

Should Ofgem determine that the consulted sub-components of the WCN2 project qualify under the CATO regime, the inaugural CATO tender round is anticipated to commence in late 2025, with the pre-qualification phase expected in the first quarter of 2025.

Both the rules that will apply to a CATO tender process, and the commercial model outlining the proposed revenue streams for participants if they are selected to develop and operate a particular transmission asset, are still under consultation. The outcome of the tender regime consultation and the commercial model consultation should be known early 2025, after which Ofgem will open a consultation on the CATO licence terms.  Stakeholders are also encouraged to respond to the WCN2 project consultation.