Alex MacKinnon

							Nick Simpson
Director
Modifications
Ofgem                                                                        26 November 2004
9 Millbank
LONDON SW1P 3GE
                                                                             0141 568 3113




Dear Nick,

Recommendations for best practice guidelines for gas and electricity network operator credit
cover
Consultation Document
September 2004

Thank you for the opportunity to respond to this consultation. This response is submitted on behalf
of ScottishPower UK Division, which includes the UK energy businesses of ScottishPower,
namely ScottishPower Energy Management Ltd, ScottishPower Generation Ltd and ScottishPower
Energy Retail Ltd.

I hope that you find these comments useful. Should you have any queries on the points raised,
please feel free to contact us.


Yours sincerely,



Alex MacKinnon
Regulation Manager
ScottishPower Energy Management Limited




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Recommendations for best practice guidelines for gas and electricity network operator credit
cover
Consultation Document
September 2004

Response by ScottishPower UK Division

1      Summary

1.1    ScottishPower UK Division welcomes this third paper setting out Ofgem’s views
       following the work carried out by the Workgroups. As a participant in the Workgroups we
       share Ofgem’s view that implementation of the Workgroups’ proposals would have
       material adverse effects on suppliers and shippers with low investment grade ratings who
       are not at present required to provide collateral. We also consider that Ofgem’s proposals,
       although less stringent, could still also have a material adverse impact on such suppliers
       and shippers.

1.2    Ofgem’s proposals fail to recognise the reality of the market and are based on an
       assumption that suppliers and shippers could have high/top investment grade ratings
       whereas the reality is that the major market participants have low/medium investment
       grade ratings. The proposals would result in suppliers and shippers who at present are not
       required to provide collateral being required to do so and thus incurring additional costs
       which would be passed on to customers. The beneficiaries of the proposals would be the
       financial institutions providing letters of credit and the losers would be suppliers, shippers
       and customers.

1.3    In our view suppliers and shippers with investment grade ratings should not be required to
       provide collateral unless there is evidence of likely default.

2      Identification and assessment of credit exposure

2.1    We do not feel it is appropriate to relate unsecured credit limits for suppliers and shippers
       to the regulatory asset value of the network operator. Unsecured credit limits should be
       related to the likelihood of a supplier/shipper defaulting rather than to the size of loss an
       individual network operator is able to sustain without itself risking default. Under such a
       system a supplier/shipper dealing with a number of separate network operators could
       obtain unsecured credit many times greater than a supplier/shipper of similar size and
       creditworthiness would who was only dealing with a single network operator.

2.2    In our view it is more appropriate to determine the level of unsecured credit based on the
       approved credit rating and payment record of a supplier/shipper. There is no need for
       suppliers/shippers with investment grade credit ratings to provide collateral unless there is
       evidence of likely default. To require suppliers/shippers with low investment grade ratings
       to provide collateral will result in additional costs which will be passed on to customers.

2.3    While we recognise the simplicity of using a framework similar to the ‘Basel II’ rules it is
       not appropriate to classify counterparties with low investment grade ratings alongside
       unrated parties. Unrated counterparties who are sufficiently creditworthy should however
       be able to be afforded a degree of unsecured credit through credit scoring.

2.4    We do not believe it is appropriate to impose a standard external model for credit scoring.
       Network operators should retain the ability to manage their own internal credit scoring
       processes and supporting methodologies within a high level framework agreed with



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      Ofgem. Many network operators are part of a larger group and will be using credit scoring
      tools developed within the group. Enforced standardisation will increase costs for which
      network operators will seek pass through from Ofgem.

2.5   We do not believe it is appropriate to have a prescriptive approach where an unrated
      counterparty would have its unsecured credit limit increased by 2 per cent for each year of
      perfect payment record. The limit should be determined by the network operator using its
      own credit scoring tools with the unrated company able to appeal to Ofgem if it feels it is
      being unduly discriminated against.

2.6   We agree with Ofgem that there is no need for the value at risk to be based on the
      theoretical peak exposure arising during a billing cycle but rather on actual exposures. The
      suggestion that the VAR for use of system charges should be measured as the value of
      billed but unpaid charges augmented by an amount equal to charges for a further fifteen
      days’ usage appears reasonable and has the advantage of simplicity.

3     Protection of credit exposures

3.1   We support the range of tools proposed by the Workgroups, and agreed by Ofgem, that
      should be available to counterparties to allow them to cover their exposure. We agree that
      letters of credit or equivalent bank guarantees should only be acceptable from a bank that
      maintains a credit rating of not less than A by Standard & Poors or Moodys. It is
      important to ensure that each tool is rated appropriately by network operators consistent
      with its effectiveness in guaranteeing recovery money in the event of a supplier/shipper
      default.

3.2   While we support further work being carried out on the viability of mutual insurance as a
      credit cover tool it will undoubtedly present difficulties in administration and may be
      unattractive to parties who would be required to contribute to the fund with little likelihood
      of ever needing to call upon it.

4     Payment and billing terms

4.1   We welcome Ofgem’s agreement with the Workgroups’ recommendation that no changes
      are required to the current arrangements for payment and billing terms.

5     Remedies for payment default

5.1   We agree with Ofgem’s view that remedies for payment default should be transparent and
      should encourage network operators to deal effectively and pragmatically with
      counterparties experiencing difficulties.

5.2   The follow-up guidelines, however, recommended by the Workgroups in section 4.59,
      incorporate unrealistic timescales which in our view fail to recognise the reality of the
      market. Recommending that all registrations should be suspended and the supplier of last
      resort process started 5 days after the invoice due date encourages network operators to
      escalate their debt recovery process prematurely which would increase market volatility
      and result in a deterioration in relationships between network operators and
      suppliers/shippers.

5.3   There are a limited number of suppliers/shippers in the market and since network operators
      do engage counterparties prior to invoices becoming overdue they should be able to
      identify at an early stage genuine instances of a market participant experiencing financial




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      problems. Premature action against a market participant who is not experiencing financial
      problems will discourage existing participants and potential new entrants.

6     Bad debt pass through criteria

6.1   We support Ofgem’s conclusion that network operators complying with the best practice
      guidelines, and those able to satisfactorily explain departure from the guidelines, should be
      able to recover bad debts. Such guidelines should however be a high level framework
      rather than prescriptive detailed rules.

6.2   We also support a sliding scale for recovery of bad debt losses arising in respect of charges
      overdue for payment at the date of a counterparty’s insolvency. However, we consider that
      the scale set out in section 7.4 is over penal on the network operator and fails to recognise
      the timescales involved in a counterparty going into administration. In particular we
      believe that a network operator satisfying all the required criteria should be able to recover
      100% of the bad debt up to 1 month from the insolvency.




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