House of Commons - Trade and Industry

Select Committee on Trade and Industry Fourth Report

III. THE GOVERNMENT'S RESPONSE TO THE CRISIS (CONTINUED)

Moratorium on Section 36 consents

38. Companies intending to build power stations with a capacity over 50MW require Government consent under section 36 of the Electricity Act 1989. Since 1990 section 36 consents have been granted for the construction of 44 gas-fired power stations as well as the conversion of two coal-fired power stations to dual firing with gas.[90] Power station projects involving the construction of, or conversion to, oil or gas fired facilities with a capacity of 10-50MW require Government's consent under section 14 of the Energy Act 1976. Information about section 14 consents are not in the public domain.[91] Projects with a capacity less than 10MW do not require any statutory approval. Since 1 May 1997 the Government has granted five section 36 consents to power stations projects, all of which will use gas to generate electricity, although four are combined heat and power schemes. The Minister explained that these consents were granted because "they were so well advanced that we would be in great legal difficulty if at that stage we were to suggest they could not be accepted".[92]

39. As the coal crisis developed, the Government was urged to introduce a moratorium on new section 36 consents, in order to prevent the construction of large gas-fired power stations, the use of which squeezes the generation market for coal.[93] On 26 November 1997 the Minister resisted these calls, arguing that "these [gas-fired] stations can take three to four years to get fully into commission. A moratorium on new gas-fired stations will not benefit coal until after 2000. It would slow down the move towards Combined Heat and Power. It would suddenly bring down off the shelf all those gas-fired stations which have received section 36 consent but, for one reason or another, have been put on hold...I am not convinced that a moratorium is the right answer. But we have no intention of simply waving through new applications for gas-fired stations. We will look at applications on a case-by-case basis and I will want to see arguments for approval, not simply in terms of local planning concerns, but also in terms of our long-term energy policy objectives".[94] The Minister confirmed this view in his written evidence to us, dated 2 December 1997.[95]

40. On 3 December 1997, the Prime Minister announced at Prime Minister's Question Time the introduction of a moratorium on section 36 consents, while the Government undertook a review of "the long-term energy requirements of the nation". The moratorium apparently resulted from the security of supply concerns raised in late November by the National Grid Company as a result of the increasing employment of gas-fired power stations, as well as advice received by the Minister for Science, Energy and Industry from the Energy Advisory Panel.[96] On 22 December the moratorium was extended to include section 14 consents but it was also announced that exceptions to the moratorium would be considered, particularly for CHP schemes.[97] 28 applications for section 36 consent were awaiting determination when the moratorium was announced, including 22 new gas-fired projects and 5 conversion projects from coal-fired to dual gas with coal power stations. An 80MW windfarm was also affected.[98] Firms may still apply for section 36 consent during the period of the moratorium. Details of projects awaiting section 14 consent have not been made publicly available.

41. Those companies with section 36 applications trapped by the moratorium, or planning imminent applications, were naturally dismayed by the Prime Minister's announcement.[99] Much of the evidence we have received as part of our on-going inquiry into aspects of energy policy has called for the cessation of the moratorium. We were impressed by the Minister's statement of 26 November, that a moratorium could not help the coal industry in the short run, with which other witnesses, including the Confederation of UK Coal Producers, agreed.[100] There are a number of additional reasons why the moratorium will not help the coal industry in the short run and may adversely affect both the coal industry and other energy industries:

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(c) The moratorium has also affected renewables projects, such as the Humble Hill windfarm, and no clear guidance has yet been provided about whether or not renewable generators can expect exemptions from it.

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We do not believe that the moratorium on section 36 and section 14 consents for new power stations will assist the coal industry in the short run; nor is it necessarily to the nation's advantage to resist the development of new power station capacity, especially in anticipation of the liberalisation of the domestic electricity market. While we acknowledge that the Government requires some "breathing space" in which to conduct its review of energy policy, and that it has no criteria for determining whether or not applications for section 36 consents should be granted, we look to the Government to ensure that the review be speedily completed and the moratorium be lifted as soon as practicable.

42. One problem our inquiry has revealed is the difficulty of finding accurate data about the section 36 consents granted by the Government. We are pleased to be able to publish a full list of section 36 consents given up until December 1997 with this Report. Since then, another has been granted to a CHP project and announced in a House of Lords debate.[105] We recommend that all section 36 and section 14 consents be published, with associated details, by Written Answer in the House of Commons Official Report on the day they are granted.

Pool review

43. In October 1997 the Minister announced that he was inviting the Director General of Electricity Supply (DGES) to set up a review of electricity trading arrangements in England and Wales-the so-called Pool. In November 1997 DGES sought the views of those concerned on the objectives, scope and process of the review. On 28 January 1998 he published his proposals for a review, envisaging a report to the Minister in July 1998. The review, which will be assisted by "a panel of independent senior advisers" and by professional consultants, will cover a range of issues, including the needs of customers and the requirement for transparency and flexibility. Perhaps most significantly in the context of coal, it is proposed that the review should consider what changes to trading arrangements will "avoid discrimination against particular energy sources and be compatible with government policies to achieve diverse, sustainable supplies of energy at competitive prices and with wider government policy, including on environmental and social issues".

44. Many agree that the time is right for such a wide-ranging review of the Pool, quite apart from the particular concerns of the coal industry.[106] It has now been running since 1989. Comparable trading arrangements in other countries, in particular the joint Scandinavian pool, now offer a useful means of comparative assessment.[107] The onset of full liberalisation of the market for domestic electricity, albeit unfortunately delayed, with consequent variations in the retail price of electricity paid by consumers, makes it particularly appropriate to re-examine the mechanisms for wholesale price setting.

45. The concerns of the coal industry stem from the realisation that the theory underlying the Pool, that generators would bid their marginal costs, does not work. The nuclear power generators bid in at zero, since they can only with difficulty cease or reduce generation. Many gas-fired plants are similarly bid in, either because the nature of their contracts with gas suppliers obliges them to take the gas in any event, or because they already have a guaranteed price under side contracts with the RECs. The result, put simply, is that nuclear and gas-fired plants are run as baseload, with coal-fired power stations acting as swing producers, with the three coal generators effectively setting the system marginal price for much of the time. This does not reflect the true marginal cost of generation, although it has proved a reasonably resilient method of providing a pricing mechanism for about 30 separate generators. More accurate cost reflectivity could reduce artificial incentives for the construction of new gas-fired plant, and so restore the balance in favour of electricity generated from coal.

46. The Minister told us that he had asked if the structure of the Pool was "stacked against coal".[108] In 1993 the Select Committee similarly suggested that the operation of the Pool appeared to disadvantage coal-fired generation and called for its effect on coal-fired generation to be considered as part of the Pool review. In the event, the outcome of that review did nothing to help coal-fired generation. This review offers grounds for only limited optimism, not least in view of its proposed completion in July 1998, too late to have any effect on any contracts for coal to be agreed by the end of June. As one coal industry witness put it, "it might well be too late for the coal industry".[109] We recommend that the Director General of Electricity Supply be invited to convey to Ministers as soon as practicable any preliminary findings of his review which suggest that the current electricity trading arrangements do indeed discriminate against coal-fired generation, together with proposals for change.

Review of early gas contracts

47. At the time of the privatisation of the electricity industry, the DGES encouraged entry into the generating market by independent power producers (IPPs). Following the relaxation of an EU directive which prevented the use of gas for electricity production in 1990, the IPPs concentrated on gas-fired projects, encouraged by the favourable financial conditions then pertaining.[110] The IPPs were primarily backed by regional electricity companies (RECs), wishing to secure their own supplies of electricity.[111] Two aspects of the deals struck during the first phase of the 'dash for gas' in the early 1990s have now attracted the Government's attention. First, the IPPs signed take-or-pay contracts with their gas suppliers, whereby they promised to pay for a set volume of gas, irrespective of whether or not that gas was supplied for generation purposes. The costs inherent in the IPPs' take-or-pay contracts were easily passed on to electricity consumers, via the RECs' monopoly franchises. The Minister has now asked the DGES to "examine [the] long-term take-or-pay gas contracts...to prevent those high costs being passed on in full to domestic customers". The second controversial aspect of the early 'dash for gas' was that the IPPs were contractually prohibited by British Gas from re-selling the gas they received if and when commercial opportunities arose to do so. Thus, when gas prices are high, the IPPs continue to produce electricity rather than exploring opportunities to sell their gas, which necessitates the RECs buying electricity from the IPPs rather than buying potentially cheaper coal-generated electricity. The Confederation of UK Coal Producers have complained to the European Commission about this practice, claiming that it is anti-competitive. The Government have now requested the Director General of Gas Supply (DGGS) to consider taking action as well.[112]

48. It remains unclear exactly which aspects of the take-or-pay contracts the DGES has been asked to review.[113] He may consider the way in which RECs have been able to pass the costs of the contracts onto consumers, with a view to requiring the RECs to buy electricity generated more cheaply than at present. He reviewed this issue in 1993 and concluded that no change to the present arrangements was desirable. He argues that once the domestic electricity market is liberalised "it would not be possible for an electricity supplier automatically to pass on to customers the costs of high-price contracts, whether for gas or for coal-fired generation".[114] The recently announced delay to electricity liberalisation is therefore a matter of some concern to the coal industry. DGES may also wish to examine the contracts for differences signed by RECs and IPPs for electricity supply. The design of these contracts permits the IPPs to bid into the electricity pool at a low, or even zero, marginal price, ensuring that their electricity is sold, and thus marginalising coal-fired generators. This issue will be considered as part of DGES' review of the pool, an object of which is to "avoid discrimination against particular energy sources and be compatible with Government policies to achieve diverse, sustainable supplies of energy at competitive prices".[115] The Pool review is considered in more detail above.

49. DGGS is currently consulting on the issue of the prohibition of gas re-sale by IPPs. If DGGS considers that the prohibition is anti-competitive and the restriction is lifted then growth in arbitrage in the gas market can be expected. When gas demand is high and prices rise, particularly during the winter, incentives may exist for IPPs to sell their gas into the transmission network rather than to use it for electricity generation. The RECs would then be required to buy electricity from other sources, particularly coal-fired power stations. If the prohibition is lifted then the impact of the change can be expected to be felt during the winter of 1998/99. This change will not, however, allow coal-fired power stations to operate on base load throughout the year; the impact on coalburn, although appreciable at times of peak demand, will therefore be limited. There will also be security of supply concerns relating to both the electricity and gas systems from an increase in gas arbitrage, which must be considered along with any proposals for reform in this area.

50. The prospect of a positive impact on the deep-mined coal industry resulting from these reviews is slight in the short run. The regulators' reviews may highlight the anti-competitive nature of long-standing contractual arrangements between gas suppliers, IPPs and RECs, but reform can be expected to proceed only slowly. While we support any attempt by the regulators to prevent anti-competitive practices in the gas and the electricity supply industries in future, we are disturbed by the suggestion that the regulators may seek to make up for their past inattention to such practices by unpicking established contracts. This course of action would serve only to harm business confidence in the industries' regulatory regimes, adversely affecting the best interests of electricity and gas consumers.[116]

Extension of existing coal contracts

51. Many of the actions taken by the Government to assist the coal industry have been reviews and medium-term measures which could not protect the industry from closures and job losses after 31 March 1998, when the old British Coal contracts between RJB Mining and the three generators were due to expire. On 10 December 1997, however, the Prime Minister announced at Prime Minister's Question Time, that:

"I understand that the three main generators-National Power, PowerGen and Eastern-and RJB Mining have agreed in principal to make supply arrangements covering the period between now and 30 June 1998. That will allow the UK deep-mine coal industry to continue production at present levels without immediate redundancies or pit closures. That is a six-month delay. However, it is important that we use that opportunity to review the long-term energy requirements of the nation and make sure that we have an energy policy consistent with a competitive industry and the long-term energy needs of the country".[

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Both the DTI and the generators were reported to be unaware that any such agreement had been reached at the time of the Prime Minister's announcement.[118] It has subsequently become clear that the Paymaster General acted as a catalyst for an agreement reached on 15 December 1997 between RJB Mining and the generators about an extension, which will maintain RJB Mining's production levels. RJB Mining also agreed to extend until 30 June the redundancy terms for its workers transferred from British Coal.[119] RJB Mining "will use this period to continue to reduce operating costs and to improve their competitiveness".[120]

52. It is important to recognise that, in agreeing to extend their contracts with RJB Mining, the generators have not agreed to buy any more coal than had previously been negotiated. National Power will "accelerate delivery" of 350,000 tonnes of coal from RJB during the second quarter of 1998; Eastern will take "advanced deliveries" of 250,000 tonnes. Both totals represent a bringing forward of tonnage options agreed during 1997.[121] PowerGen has agreed to take 1.1 million tonnes of coal, before signing a new contract with RJB. This figure represents only half of the tonnage PowerGen is expected to contract for from RJB, however, and some is likely to be stocked at, and burnt by, Eastern's Drakelow and High Marnham power stations under the leasing agreement between the two companies.[122] Consequently, the agreement reached between the generators and RJB Mining represents less than the "six months delay"claimed by the Prime Minister to aid the coal industry, but is instead a revision of the generators' existing commitments which will protect RJB Mining for just three months. The Government must also be reminded that RJB is just one of several mining companies involved in the deep-mined coal industry. Other companies, such as Midlands Mining, have not required Government assistance in order to secure orders from the power generators. The deal brokered by the Paymaster General may well harm Midlands Mining and other small coal firms, by encouraging the generators to stockpile RJB coal at the expense of coal produced more competitively elsewhere.[123] Concerns have also been raised that the generators may, in return, seek favourable responses from Government to other commercial issues, such as those involving the vertical integration of the electricity supply industry, as a result of agreeing to extend their current coal contracts.[124] While we recognise the Government's intentions in seeking at least a short-term resolution of the coal crisis in this way, we remain to be convinced that an exception should have been made to the rule that the Government should not intervene in commercial transactions between private enterprises and note that the outcome of the deal between the generators and RJB Mining may well be rather less propitious than was initially indicated.