Guidance to potential storage operators on the rental policy in relation to gas storage

Gas storage and rental valuation

The Crown Estate’s position is that undersea gas storage is a commercial activity in a competitive market and that it is fair and reasonable to charge a commercial rent for this activity; and that such a rent may legitimately exceed the cost plus basis without offending the rules around anti-competitive behaviour. It should be borne in mind that The Crown Estate’s surplus goes to HM Treasury for the benefit of UK citizens and it is important that the nation secures the benefit of the UK seabed being utilised for commercial purposes. Nevertheless in order to be certain of our position we have undertaken the following:

   (a) commissioned an independent storage modelling exercise;

   (b) offered to refer the matter of rental valuation for independent determination by the Valuation Office, or the Chairman of RICS or an energy relevant expert;

   (c) when the proposal for a valuation office determination was declined by potential developers, we commissioned a further independent report from highly regarded consultants Oxera;

   (d) we have sought legal advice from energy specialist law firm Hunton & Williams.

This work is further discussed below. The conclusion of this work is that to charge above cost plus is not an abuse of our monopoly position.

Storage modelling, September 2008

In 2008 The Crown Estate commissioned a simplified independent storage modelling exercise based on publicly available information, by which we were able to assess appropriate rental levels that were fair to both The Crown Estate and to developers.

The findings of this exercise formed the basis of the levels of rent proposed by The Crown Estate in all its gas storage negotiations.

Referral to the Valuation Office or relevant independent expert

Given that The Crown Estate must not and does not, take advantage of its monopoly status we have committed to refer disputed levels of rent on our Marine portfolio to the Valuation Office. Valuation Office direction requires the calculation of value to be the “value of the site to the grantee” and in particular that the value, if any, to the grantee as a special purchaser, should be taken into account.

The Valuation Office has been used for Crown Estate valuations on a number of occasions. The determination of the Rough Field gas storage site was an example of such a case in 1983. In this case, the District Valuer carried out the valuation. A rental valuation not based on cost plus therefore dates back to the 1983 Rough storage valuation by the Valuation Office.

The Crown Estate has offered to refer the determination of the level of rents for projects to the Valuation Office or an agreed third party expert to act as an independent valuer and which we would accept as a binding decision.

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Oxera report summary

Since an independent referral was declined by some potential developers we commissioned a further report from Oxera, as an alternative approach to obtaining another independent view.  Oxera was asked the following question:

How should The Crown Estate set the rent on seabed space for offshore gas storage?

The Crown Estate commissioned Oxera to advise on the level of rent that it could charge on seabed leases for certain offshore gas storage facilities.  Oxera interviewed several potential developers in the course of its work. A summary of the work undertaken and the main conclusions reached are presented below.

Oxera followed a valuation methodology which involved the following steps:

Gas market analysis – the value of gas storage is largely driven by expected variability in gas prices (in terms of seasonal trends and daily volatility). In turn, future gas prices depend on a range of structural factors including energy and environmental policies, the pace of economic recovery, the development of alternative sources of flexibility, and the expansion of unconventional gas supplies. The first step in Oxera’s analysis was to review these structural factors to produce reasoned scenarios concerning the evolution of average price levels, seasonal spreads, and daily volatility in the UK gas market.

Gas storage modelling – Oxera used its gas storage model to assess the market value of storage capacity under these different scenarios. This model works in two steps: first, it translates gas market scenarios into a number of price path simulations to reflect market participants’ expectations of future gas prices; and second, it derives a set of optimal storage operating decisions over the course of the year and calculates their financial impact. The resulting estimate of gas storage value is then adjusted to reflect the notion that, in practice, gas storage users may not be able to capture the full value of the capacity they own due to various market ‘frictions’.

Financial modelling – Oxera combined the revenue forecasts produced by its gas storage model with various financial parameters to estimate the present value of the projects and the amount of rent that they could support. The cost assumptions used for this analysis were obtained directly from the operators or were derived from public sources concerning gas storage projects.

Based on this analysis, Oxera has concluded that the level of rent envisaged by The Crown Estate would not affect the internal rate of return of the projects by more than 0.2%. While it might be desirable to adapt leasing policies to the economics of each project, in principle this level of rent should not jeopardise the viability of the projects that have a strong business case.

The Crown Estate is required by its statutes to abstain from incorporating ‘any element of monopoly value’ in the terms and conditions of its transactions with tenants. Oxera has considered the implication of this provision for this exercise, and has concluded that, in and of itself, it does not constitute an obstacle to the imposition of value-based levels of rent on storage facilities. The value of individual storage sites depends on their geological characteristics and locational advantages, and the ability of The Crown Estate to capture some of this value is not contingent on its ownership of available offshore storage sites. As such, as long as The Crown Estate abstains from withholding seabed space from the storage market, it is not in breach of this provision.

Oxera has also considered the potential for different types of leasing arrangements to best meet the requirements of The Crown Estate and project sponsors. This analysis suggests that there may be merit in sharing the investment risk of new projects by indexing rental charges to an indicator of storage value, or by agreeing a suitable profit-sharing mechanism.

February 2010

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Legal advice from Hunton & Williams

We have received legal advice in order to address concerns raised that we might be abusing our position of dominance in making charges at a level above cost plus and by implication that we are charging “excessively”.  We have been advised that in determining whether there might have been an abuse of a dominant position, a reviewing court or enforcement agency will test whether the price charged is disproportionate to the economic value of the product or service. In making such a determination, it will have regard not only to the cost of the product to the grantor but also to the revenue-earning potential of the grantee.  The economic value of gas storage is in the course of being determined in the market in the ongoing negotiations between The Crown Estate and potential purchasers.

Consequently, the legal advice received supports our view charging on a more than cost plus basis is not in contravention of the relevant law.

Independent third party determination

Should we remain unable to settle the level of rents in ongoing negotiations The Crown Estate would wish to jointly agree a reference to an alternative Independent Valuer (whether this is the Valuation Office or an agreed energy expert), whose decision would be binding. Costs for this exercise would be shared.

We believe we have ensured that the rent levels we proposed to operators are based on sound and expert analysis and advice; moreover our willingness to refer rent levels to independent review is a demonstration of our commitment to charging rents at levels which are fair and reasonable. We hope this demonstrates The Crown Estate’s recognition of the strategic importance of gas storage and our commitment to work with the industry to realise the opportunities for gas storage in the UK.

Policy Statement on Natural Gas Storage Projects

The Crown Estate plays an important part in the development of the UK’s renewable energy industry as owner of the UK seabed out to the 12 nautical miles territorial sea limit, with rights under the Energy Act 2004 in the Renewable Energy Zone (REZ) on the UK’s continental shelf out to 200 nautical miles. As from 6 April 2009 we obtained further rights under the Energy Act 2008 to award leases for the use of these offshore areas for natural gas storage and the unloading of liquefied natural gas (LNG). The Act enabled the UK to exercise its rights under UNCLOS beyond the territorial sea and extended up to 200 nautical miles with the creation of a Gas Importation and Storage Zone (GISZ).

The Crown Estate is committed to working with all stakeholders (government departments, developers and utilities) in realising the UK Government’s energy targets including security of supply related drivers. We recognise that successful exploitation of the geological features situated within both the 12 nautical mile limit and the continental shelf will play an important role in diversifying the UK’s energy supply mix.

In order that individual companies in the industry can make their own plans for the commercial development of gas storage, we set out below our proposed (initial) policy for the granting of rights for commercial development at suitable locations. We will operate in a fair and transparent manner at all times.

The Crown Estate has drafted a standard lease for gas storage projects which is available, on request, for developers with potential projects. In the next few months we aim to publish rental ranges that would be applicable to gas storage projects. We anticipate that the size and scope of each project will vary; however, the ranges will provide useful parameters against which individual projects can be assessed.

Any rights from The Crown Estate will be conditional upon the applicant obtaining a suitable gas storage licence from DECC, and a positive outcome from any relevant Strategic Environmental Assessment (SEA). The existing exclusive rights of petroleum licensees will not be affected whilst their petroleum licence remains in existence.

We currently propose to treat new applications for gas storage lease options for projects which will be subject to the Energy Act 2008 in the following way:

1. Non Hydrocarbon Features

Where preparatory work is required before a feature is suitable for gas storage (e.g. salt caverns), an open tender or expression of interest process will be run, the detail of which we intend to announce later in 2009. The grant of leases will be subject to the SEA that is due to be finalised in 2010. Projects of this type within territorial waters, which were brought forward prior to the Energy Act 2008 becoming law, will be progressed separately.

2. An Already Licensed Hydrocarbon Feature

Projects involving storage in currently licensed hydrocarbon features, which are in principle already in a state to be used for gas storage due to their previous use for hydrocarbon production, have already been subject to a tender and licensing process which has resulted in the licence holder being provided with exclusive rights to that site under their petroleum licence.

Therefore it appears to us that these pre-existing rights justify the granting of a lease for sites within the acreage of the petroleum licence without resorting to a tender, although any applicant will nonetheless be expected to satisfy certain minimum criteria and reach agreement on satisfactory commercial terms before a lease is granted. We are happy to receive these projects on a case by case basis, but rights to store natural gas will only be granted to the holder of a current petroleum licence.

3. Unlicensed Hydrocarbon Features

Similarly, we understand that going forward, currently unlicensed hydrocarbon features will be offered via DECC offshore oil and gas licensing rounds, which will involve compliance with detailed objective criteria to gain a combined petroleum production and gas storage licence. Where such a combined licence has been obtained via this DECC tender process, we propose to grant a lease to the licence holder (who will have obtained exclusive rights over the site) without a tender process, but subject to certain minimum criteria and satisfactory commercial terms being agreed.

This information is updated on a regular basis so please visit again to check for updates from time to time.

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