Examination of witnesses (Questions 20
- 33)
THURSDAY 23 JULY 1998
PROFESSOR JOHN
H CHESSHIRE and MR
NICK HARTLEY
Dr Iddon
20. Can we have a look now at another review
that is taking place and that is the review on the utility regulators.
Of course there is a suggestion that OFFER and OFGAS merge. Perhaps
you would like to comment on whether this review is in your opinion
radical enough and whether the economic factors are weighing more
heavily in that review than the environmental factors, and perhaps
say what in your opinion the Environmental Agency's role in all
this is. Is it clearer, is it spelt out enough? What about the
consumers? Are their economic interests also outweighing the environmental
interests that many consumers have and expect Government to have?
(Mr Hartley) The thing I would say first is that
in my view the Government's Green Paper has got one thing absolutely
right, which is that it should be for the Government to direct
the regulators to take account of environmental and social concerns
in ways in which the Government specifies. There has been a longstanding
debate in this country about the environmental obligations of
the regulators, and some people would like the regulators to be
solely responsible for making the trade offs between environmental,
social and economic concerns. My own predilection is to seek some
sort of separation so that you have a set of regulators who are
primarily economic regulators, a set of regulators who are primarily
environmental regulators, and also to have the Government taking
key social decisions on behalf of the nation. I think that sort
of clarity is better than what I would see as a muddle when you
actually have one individual to make all the trade offs in a not
necessarily very transparent way. That is why I would say that
the Green Paper got it absolutely right, that it is trying to
achieve some greater transparency of decision making. Of course
it will be very interesting to see exactly how the Government
goes about setting directions to the economic regulators, exactly
how it specifies its social concerns. One can see some of that
in the Green Paper already. Some of the social concerns are spelt
out there. Perhaps the environmental concerns and the way in which
they will be pursued are not spelt out nearly so clearly. I will
be interested to see how that works through. I imagine that one
of the key elements is going to be that the Government is going
to take a rather more considered view on what the regulators should
do to encourage energy efficiency, and again in those circumstances
it does seem to me right that it is the Government who gives that
direction rather than expecting the regulator, as it were, to
come up with his or her own policy.
(Professor Chesshire) Like Mr Hartley I welcome
the Green Paper for its attempt to clarify the framework. I think
there is an advantage in having some creative tension in the system
between maybe the environmental regulators and the economic regulators.
My concern has been over the kind of fudge as I have seen it in
the past of utility regulation, the idea that the economic regulators
should be operating at arm's length from Government, but that
the Secretary of State and the economic regulator share the primary
and the secondary duties. I could never understand how, if the
Secretary of State and the regulator share the primary duties,
secondary duties, that was consistent with the idea of arm's length
economic regulation and it still causes me concern. I think that
has been fudged again this time round. Nevertheless there is an
effort to clarify the framework as Mr Hartley said. However, it
seems to me that the devil is in the detail. Going back to the
debate we had earlier, Chairman, if I may, is there a hierarchy
of concerns? Is there a hierarchy of regulation? I do not know.
It needs to be made more explicit. Certainly when the Trade and
Industry Select Committee had hearings on energy regulation in
the early part of last year it was quite clear that the economic
regulators and the environmental regulators hardly ever spoke.
There was hardly a dialogue occurring between them which I found
rather surprising. Therefore, whilst the Green Paper says many
things with which I agree, it does not really go much further
than saying, "and this is the way it will happen". For
example, if one did regard—and I am not necessarily advocating
it—the environment as being the top of the regulatory pyramid
as it were, one of the functions of the economic regulators would
be to seek to secure the least cost routes to meet those environmental
objectives. That might be an appropriate way, but the Green Paper
does not say that. It still leaves a lot to be worked through
and it is a very complicated area. I think Ministers will need
to give direction to the regulators. The regulators have I think
by default rather than by design or desire been forced to take
some policy decisions, particularly in the energy efficiency area
and maybe in the fuel mix area in power generation as well.
21. Can I press you on the role of the Environmental
Agency? Do you think that is clear enough in all this argument?
(Mr Hartley) It certainly is not spelt out at
all, is it, in the Green Paper? I suppose one is seeing something
of the way in which the tension might work in the case of water
where clearly there both the economic regulator, OFWAT, and the
Environment Agency are debating quite openly what should be done
in terms of water quality standards, and ultimately there are
clearly some decisions which are going to come back to Government,
I think quite rightly. So far as energy is concerned you are probably
right that the particular role of the Agency is not very clearly
spelt out, but then of course quite a lot of the major environmental
constraints that are hitting the energy industry either come from
outside, from EU obligations, or else perhaps come from the climate
change obligations which are very much driven by the Government.
(Professor Chesshire) Not only is the Environment
Agency not very significantly discussed here—I think they
are only mentioned once that I can see and that is rather en
passant as it were—"after exchanges of information
between the regulator, the Environment Agency, industry and the
Government, the Secretaries of State give non statutory guidance
to the regulator, which is published".[11]
It is hardly integrated as thoroughly as one would wish.
Mr Grieve
22. Perhaps we can go on to look at another
aspect of the matter and that is the European context. To what
extent do you think the EU is significant in assisting integration
of energy and environmental policies within Member States? What
do you see the prospects for such integration within its own institutions?
(Professor Chesshire) That is my starter for 10,
is it? I think it is important to remember the formal powers which
the Commission has in these areas. There clearly is still no energy
chapter. The major drivers which the Commission has used to influence
the energy sector over the past five to 10 years have either derived
from the competition powers, liberalising markets and so on, DG4,
or from increasing the use of environmental powers given to Directorate-General
11. I would have thought in the first of those areas, competition
and liberalisation, the EU has not been significant in forcing
the pace in the United Kingdom, rather than the other way round.
I cannot think of any area in the interest of the Gas Directive
for example where UK policy will need to change. In fact we are
so far in the van that European gas markets will only be as liberalised
as those already in the UK by about 10 years' time, something
like that. On the environment area, clearly the Commission in
the past exercised some leverage, particularly in the sulphur
dioxide area. There has been concern likewise of course about
oil dumping at sea, nuclear dumping at sea. John Prescott is out
in Lisbon at the present moment of course on that. In terms of
the integration done by the Commission itself in Brussels I have
to express some disappointment, and one of my current research
tasks is to help the Commission on the post-Kyoto energy and environment
strategy. What has struck me over the last six or seven months
that I have been engaged on that work is the fact that these two
institutions within Brussels, DG11 and DG17 for energy, hardly
have any dialogue one with another. It is quite astonishing.
23. That is a feature of the Commission
generally, compartmentalising.
(Professor Chesshire) Yes, it is extremely compartmentalised.
Chairman
24. Even more so than the British Government,
the various Departments of the British Government, in your experience?
You are nodding, Mr Hartley.
(Mr Hartley) Yes.
(Professor Chesshire) He is the insider, Chairman.
One of the difficulties quite clearly for the UK was the separation
and breakup of the Department of Energy. There may have been good
reasons perhaps, but the supply side functions went into the DTI
and the energy efficiency functions went into the Department of
Environment, Transport and the Regions. Whitehall likes to change
name tabs all the time, so the Energy Efficiency Office became
the Energy Efficiency Management Directorate and now the Energy
Efficiency and Waste Directorate, and a lot of change is going
on. Economic regulation of course is led by the DTI so again it
is rather a supply side flavour in my view. One needs to divide
the cake some way in administrations but I think it has been unfortunate
the way in which the demand side of energy has been separated
from the supply side and that has posed some problems, quite serious
problems, in getting an integrated perspective, as is reflected
in many of these documents. Energy efficiency is tagged on as
the last paragraph almost.
25. You do imply very strongly in your comments,
Professor Chesshire, that there is a lack of coherence about the
Government's approach to energy efficiency and indeed you recommend
as something we should consider that we could make a contribution
in this area. Could you elaborate on that a bit?
(Professor Chesshire) What disappoints me so very
much, Chairman, is that I have felt for very many years that UK
energy policy is a supply led policy. What I mean by that is that
decisions are forced by the pace of events on the supply side,
tackling the coal industry, nuclear decision-making, offshore
investment decisions and so on, and the demand side, the energy
efficiency side, has been very much relegated in governmental
thinking. If we are going to take climate change and sustainable
development seriously I would want to reverse that and start with
the demand side: what is the realistic scope for energy efficiency?
We know a lot about the barriers and they are quite profound in
some cases. We have historically relied on the market to bring
about some equilibrium between energy efficiency and the new supply
side investment, but we know that despite the environmental imperatives
we have been discussing that it is likely we face a low energy
price world. Most of the long term forecasts I have examined recently
suggest that oil prices might not rise above $20 a barrel by the
year 2020 in 1998 money. Many forecasts have been proved wrong
in the past but it does suggest a much lower trajectory of price
increases than was assumed five or 10 years ago. That does suggest
the market may provide fewer incentives, fewer inducements as
it were, to take energy efficiency seriously. Therefore it does
suggest to me that there may be a bigger role for Government or
other agencies than one was thinking a few years ago. Clearly
if we internalise external costs and introduce a carbon tax regime,
emissions trading, again market base solutions and the incentives
may drive us further than currently we think possible. It does
seem to me there is a role for Government. I think there is a
fragmentation of responsibility in Government, some of which is
inherent. If you do a bottom up analysis, clearly you have the
Department of Transport there, for example, as a very important
actor, you have the housing stock, a range of consumer interests,
construction industry interests, building societies, and so on,
it is a very atomistic pattern of responsibilities. To conclude,
the recent spate of reviews that we have seen again have all largely
been on the supply side. There are one or two sections like combined
heat and power for example, fuel poverty but I am disappointed
that as part of this wider new Energy Policy Review which the
Prime Minister announced in the House I think on 10 December last
year, there was not a counter-balancing and significant component
for the review of energy efficiency responses and strategy. That
is why I think I recommend to the Committee that this is one of
the biggest black holes I can see in the preparation of this climate
change response strategy.
26. Anything you would like to add?
(Mr Hartley) I agree with much that Professor
Chesshire says there. The split between the supply and demand
sides in Government has been very real, as he said. Of course
I suppose it is the case that in some ways until climate change
came right on top of the agenda, the Government in some ways had
no reason to respond very directly on the energy efficiency side.
The energy ratio in the UK has been falling throughout the period
since the war and clearly the shake out of manufacturing industry
caused quite a considerable reduction in energy demand, and so
to some extent the reasons for the Government having to concern
itself with energy efficiency were perhaps rather limited. Certainly
they should include the social ones and it does seem to me important
that the DTI, for instance, has now fully picked up, I think,
the agenda of fuel poverty which was not the case before. That
has been an interesting development. In so far as the need to
integrate, as it were, environmental concerns and energy policy
are concerned, I suppose really I would say we have to wait until
we see the consultative document on climate change which I understand
is going to be produced from Government one side or other of the
summer break. I am not sure whether it is going to come out immediately
after the summer break. It is clearly coming soon. No doubt that
will deal with energy efficiency and the role which energy efficiency
must play in meeting climate targets. The last Government in drawing
up its plans for how it was going to meet its target of reducing
CO2 emissions by ten million tonnes between 1990 and 2000, included
a quite significant role for energy efficiency, in fact, of course,
that was a role the actors did not have to play because in fact
emissions were reduced dramatically by the Dash for Gas and also
by the outperformance of the nuclear industry, which performed
much more effectively than people had anticipated. So to that
extent, as it were, past policy has been drawn up and put in a
drawer but never really called upon. Now it seems to me, given
the targets which the Government has set, 20 per cent. reduction
in CO2 by 2010 is a very major target indeed, that there is no
hope of achieving that target solely on the supply side nor I
would say is there any hope of achieving it solely by the use
of the price mechanism. Interestingly the kind of simulations
which were done for the Government's Energy Advisory Panel showing
the kind of carbon tax which would be necessary in order to reduce
demand and also to change supply in order to meet the 20 per cent.
target show that the kind of increase in prices required is very,
very large indeed, larger I think than any Government will countenance.
Certainly it is necessary I think for one of the elements of the
climate change programme, an important element, to be energy efficiency.
Chairman: Thank you
very much indeed. We have to draw our proceedings to a close but
I will just ask Mr Grieve to ask a question.
Mr Grieve
27. There is just one question, I hesitate
to ask it because I suspect this may be another starter for ten.
I picked up a number of points about the role of the Environment
Agency during the course of what you had to say. Now the Environment
Agency on matters concerning water seems to have a very well established
and increasingly powerful role, that is our impression, certainly
my impression sitting on the Committee and discussing that. Of
course it is the coming together of a whole different series of
strands and the old Inspector of Pollution certainly was not very
concerned about CO2 emissions, he may have been concerned about
plumes of black smoke, dioxins and other things but CO2 I do not
think, certainly in my experience, was very high on his remit.
Do you see an absence of a suitable agency or at least the expertise
within a suitable agency for implementing reduction and actually
advising on reduction of emissions?
(Mr Hartley) The Environment Agency is of course,
as it were, picking up new responsibilities under the Integrated
Pollution Prevention and Control Directive from the EU. As I understand
it, it is able to treat CO2 as a pollutant. To that extent it
seems to me that the Agency is starting to direct itself towards
the issue of the regulation of energy efficiency in a way certainly
which has not been the case in the past, you are right. In the
past it has dealt primarily with issues of acid rain and VOCs
and other persistent pollutants. Also, you are right I am sure
to say the heart of the Agency is in the water side, it comes
from the old Water Inspectorate rather than from HMIP, but I do
think that actually these new requirements under EU legislation
are forcing the Agency to consider energy efficiency and the regulation
of energy efficiency, and I think that is something to come. I
think there is quite an interesting question about how far CO2
reduction should be achieved by regulation and how far by market
mechanisms, and I would worry that maybe regulation might be rather
an ineffective way of doing it. Nevertheless I think the Agency
is starting to come to grips with that.
(Professor Chesshire) Could I add a brief supplementary
then? It seems to me it is a phenomenal change in the span of
actors it needs to oversee. Very briefly let me put it this way.
If the primary target was the Large Combustion Plant Directive,
the number of target companies, large industrial users, power
generators and so on—probably of the order of 40 or 50,
I cannot remember, I am slightly out there but measured in tens
probably hundreds—as they move to Integrated Pollution Prevention
and Control and so on I think the numbers rise to about 45,000
sites[12]
I think in industry which are likely to fall within its ambit,
something of that order, there would be quite a significant expansion
in the number of techniques it needs to understand, interests
it needs to have a grip on. If you move to carbon dioxide, inevitably
it is systemic. You need to look at the housing sector services,
public sector, transport, power generation, the lot, so they do
not have that range of expertise, they do not have an understanding
of consumer decision making, they might have an understanding
of industrial decision making but not of consumer decision making.
As that range of actors expands so the range of expertise, understanding
and insights and data you need to familiarise yourself with expands
in orders of magnitude.
Mr Blizzard: We did
not have a question on the review of energy sources for generation.
I would like one quickie on that.
Chairman
28. We are really running out of time.
(Professor Chesshire) Shall we answer in writing,
would that help the Committee?
Mr Blizzard
29. My question—and if this was covered
before I arrived I do apologise, I do not want to ask anyone to
repeat themselves—was going to be basically is there any
environmental case for coal at all? How good an answer is flue
gas desulphurisation?
(Professor Chesshire) There is not a strong case
for coal and a less strong case as you approach the Large Combustion
Plant Directive targets in certainly the year 2010. Application
of flue gas desulphurisation of course helps on the SO2 side but
as I am sure the Committee will be aware it lowers the efficiency
of the plants because of the fans and the pumps, self use of power
on site and so on, and that inevitably increases the carbon dioxide
emitted per kilowatt hour produced.
Mr Dafis
30. Extraction.
(Professor Chesshire) It is very difficult to
have a sustainable environmental case for coal.
Dr Iddon
31. I do not think we have dealt with the
nuclear generation side this morning and I would be interested
to know whether they see a genuine role if not an increasing role
for the nuclear power generation industry, especially in terms
of the fact it helps with the CO2 problem.
(Professor Chesshire) Certainly the Trade and
Industry Committee thought that it ought to be kept on the agenda,
as it were, although in my own view the economic case for new
nuclear construction is pretty hopeless at the present time. At
existing pool prices the pressure may well be downwards for pool
prices because of the pool review. At any prospective level of
gas prices for the next 20 years, the economic case for nuclear
power will be impossible. You will need to do very courageous
things indeed I think in terms of internalising external costs
to overcome the capital intensity difficulty of nuclear power
and obviously, the more liberalised the electricity market becomes,
the more risk averse the players in the market become and the
higher the cost of capital. The CEGB used five per cent. cost
of capital for nuclear, occasionally did a valuation on the basis
of eight, on a new nuclear station you would need to use a discount
rate of I should think 12 maybe 15 per cent. which would increase
the costs of generation from nuclear stations by factor two, possibly
factor three. Although some of them might say, on the grounds
that you would, that displacing fossil fuels as quickly as possible
is the only robust way to a more sustainable development path,
I think looking to nuclear power to play that role over the next
ten or 20 years, unaided from the state, or unaided by a review
of tax policies, is almost impossible.
Mr Dafis
32. Can I ask whether emission of carbon
dioxide in the construction process is sufficient to be a consideration
at all? Is there not an issue of the payback period, the energy
payback period from nuclear plant? Large quantities of energy
going into construction in the first place and taking quite a
long time to get it back.
(Professor Chesshire) Nuclear obviously is very
concrete and steel intensive. I am not a great fan actually of
the energy analyses which have been done here. For example if
one was giving evidence to this Committee 150 years ago, at the
time of the great race for the railways, I suppose one would say
what is the energy balance of all these railways lines you are
manufacturing and all these bricks you need for tunnels and the
viaducts and stations and what is the energy payback of this huge
investment in the railway systems, whereas nowadays we would regard
it as very environmentally benign. The energy theory of value
only takes us so far. It is an important insight I think in looking
at this. Those analyses have shown that the payback is comparatively
short.
33. How short?
(Professor Chesshire) Ten years. I would need
to check and let the Clerk know but of the order of ten years
or less I think.
(Mr Hartley) Certainly sums have been done and
I think those initial emissions do pale into insignificance when
you see the final gain. My view of nuclear would be that I have
not yet seen a viable very long term scenario which reduces CO2
emissions which does not have some role for nuclear. It seems
to me that, as it were, it is up to politicians to address the
problem because the political concerns surrounding the use of
nuclear power are so great that it seems to me that it is a matter
of political debate, and not just a debate in the UK. It seems
to me that a policy towards the nuclear industry has to be developed,
certainly within the EU and possibly even wider than that actually,
if we are to put nuclear back in the threshold again.
Chairman: Thank you
both very much indeed. I think we all found it absolutely fascinating
and we are extremely grateful to you for your contribution this
morning.
11 Economic Instruments and the Business Use of
Energy: A Consultation Paper, HM Treasury, 1998. Back
12
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