Memorandum from Friends of the Earth
1. We welcome the opportunity to provide
input to this inquiry, particularly given the important role that
the Environmental Audit Committee has played to date in helping
and encouraging the Government to make progress on integrating
considerations of environmental protection and sustainable development
into its policies.
2. Friends of the Earth is keen to see open
and an effective appraisal of the Government's policy on energy
beginning with the part played by the Performance and Innovation
Unit and the recent publication of the Energy Review.
3. The destabilising impact anthropogenic
emissions of green house gases are having on the climate is now
widely accepted. To achieve emission reductions in the energy
sector it is essential that we increase resource efficiency and
move quickly to replace existing fossil based fuels with clean
sources of power from renewable sources.
4. Numerous studies including the Royal
Commission on Environmental Pollution report "Energy the
Changing Climate" have shown that large cuts in emissions
are theoretically possible over relatively short timescales. What
is required is political will to sort out the regulatory and tax
and spend frameworks that set the parameters of the market place
in which commercial energy companies now trade. Liberalisation
and increased competition are welcome, however, if social and
environmental objectives are to be met Government must continue
to play an active role in determining, delivering and monitoring
clear and unequivocal sustainable energy policies.
The impact of recent developments in energy policy
such as the New Electricity Trading Arrangements and the Renewables
5. Electricity generation in the UK accounts
for 32 per cent of our annual CO2 emissions (still
the single biggest category) other emissions also contribute to
acid rain and reduced air quality. Future predictions for transport
indicate that we will become increasingly reliant on electricity
either as a direct source of power or as a means of producing
hydrogen for fuel cells. Successfully arriving at cheap and clean
ways of producing electricity is therefore of primary importance
in energy policy.
6. The electricity industry is being affected
by two major policy developments: market liberalisation, including
the introduction of new electricity trading arrangements (NETA);
and market intervention through the introduction of a Climate
Change Levy and the introduction of a Renewable Energy Obligation
(REO) on suppliers. If it is to meet its targets for green house
gas emission reductions Government must ensure that the combined
effects of these policies is to drive industry towards clean renewables
and away from fossil fuels.
7. The delay in the introduction of the
REO means we cannot yet assess whether this will prove to be the
case. What is known is that since the introduction of NETA in
March 2001, a premium has been placed on flexible plant which
combined with high gas prices has led to an increased proportion
of electricity being generated from coal reversing the downward
trend in emissions from the electricity sector. The Government
should be considering now what corrective actions it will take
if this increase in emissions continues.
Impact of NETA
8. The way in which the NETA operates discriminates
in favour of large flexible generators because they are better
able to avoid and absorb the costs of the penalty system designed
to punish inaccurate supply forecasts. Being in the main both
small in scale and intermittent in nature, renewables and CHP
are being adversely affected. OFGEM in their recent report on
the impact of NETA on small generators acknowledge that there
is a problem but conclude that there is nothing fundamentally
wrong with the NETA mechanism and that it is a matter for Government
to develop measures to support renewable and small scale operators.
Friends of the Earth agrees that NETA has successfully met many
of its objectives two important problems both apply to renewables
but believes there are both changes within NETA and within the
wider market place that will help to correct the distortions currently
9. NETA's balancing mechanism is a way of
quantifying the risk of system failure due to over or under supply
of electricity. Suppliers failing to meet their contracted volume
of output must pay the System Buy Price to make up the difference.
Those overproducing must accept the lower System Sell Price for
The system is designed to incentivise the accurate
forecasting of supply. However because many other factors including
transmission constraints, differing quality of electricity and
unpredictable demand, affect the National Grid's (NGC) ability
to balance the grid, the balancing mechanism unnecessarily singles
out and penalises less predictable sources of power.
10. Indisputably, balancing the system incurs
costs. The question is how should those costs be distributed.
Currently two mechanisms are used: the Balancing Service Use of
System Charge which applies to all parties equally and the Balancing
Mechanism, described above, which penalises all those who inaccurately
forecast their volume of output. The later applies even if the
error is wrong in the right direction eg if the supplier overproduces
when there is a shortage of power or the supplier underproduces
when there is a surplus. NGC are required to balance the net physical
imbalance and do not correct each contractual inaccuracy. Therefore
many errors which can be netted off against each other are penalised
unnecessarily as costs are not always incurred.
11. Friends of the Earth believes that smaller
generators are being disproportionately disadvantaged. Neither
electricity demand nor supply are entirely predictable and yet
NETA penalises unrealised supply contracts even where the "error"
may be as insignificant as a very slight surge in demand. Pre
NETA small differences in predicted output would have been lost
in the "noise" of the system.
12. Finally, NETA is having a perverse effect
on the market making electricity generation less efficient
the system buy price is usually considerably higher than the system
sell price and so to minimise their exposure to risk suppliers
are over contracting (and offering lower wholesale prices to compensate).
This means that more electricity is being generated than is actually
needed, making the whole system less efficient.
13. Numerous suggestions have been put forward
as to how NETA might be improved to make it more cost reflective
for all generators and less penal for smaller scale intermittent
generators. In the longer term after an appropriate period during
which the impact of NETA can be fully assessed it may be necessary
to consider fundamental changes to NETA, however, in the meantime
there are a number of immediate adjustments that can be made to
increase the degree of certainty in the market place.
Suggested NETA reforms
14. These measures would help to further
reduce the uncertainty inherent in the balancing mechanism providing
benefits for all generators:
Reducing gate closure period from
three and a half hours to one hour
This would enable more accurate forecasting
of output and help to reduce uncertainty particularly for intermittent
Reducing the balancing reserve from
150 MW to 0
Removing the balancing reserve would not
affect the way in which NGC operates but would alter the way in
which system buy and sell prices are derived, reducing the difference
between the two prices and blunting the risk. It would not remove
the incentive to accurately forecast as penalties would still
be levied but would reduce the range of the prices and distribute
costs more evenly between system balancing payments which are
universally applied and predictable and variable energy balancing
payments which apply individually and can be volatile.
Encouraging within day trading;
Although trading in futures has taken off
there is currently little within day trading. This has the effect
of extending the gate closure period making it harder for suppliers
to fine tune the balance between supply and demand in advance
of gate closure.
Barriers to market entry and market failure
15. It is very difficult for smaller players
to gain entry to the electricity supply marketthe cost
of the necessary software systems alone is beyond the reach of
all but the largest companies. This was predicted from the outset
and the Government has always held that "consolidation"
was the answer eg the creation of an aggregated generational portfolio
by a third party. There are signs that as experience of NETA grows
third party consolidators are emerging, and actions by the Government
to hasten this would be welcome. However, there will remain the
question of whether independent and small generators should be
required to absorb the cost of deadening the risk in this way
if the risk is fundamentally unfairly apportioned.
16. In addition third party consolidation
is currently being held back by issues surrounding access to embedded
benefits. At the moment the embedded benefits of a particular
generator can only be collected by the regional supplier in which
that generator is located. So consolidators wishing to create
a portfolio of output from embedded generators have to negotiate
with the regional suppliers to receive the associated financial
17. A separate aspect that further complicates
the issue is the question of how independent generators are able
to negotiate with suppliers. The barriers to market entry mean
that there are still only a relatively small number of suppliers,
many of which are highly vertically integrated. The imbalance
of power between large supplier and independent generator is considerable
and there is a real threat that insufficient competition and lack
of objective market information is leading to renewable generators
being offered, and accepting, reduced wholesale prices when they
need not. The lack of any information about the prices being paid
to independent generators means that the extent of this problem
is hard to assess. Guidance for generators to help strengthen
their negotiating position is almost certainly needed particularly
to explain how the workings of the REO and CCL should affect the
wholesale price they are offeredin addition information
about how to trade into Europe would increase competition and
drive wholesale prices for green power up.
18. If problems persist it could be worth
considering calling for the Office of Fair Trading/OFGEM to investigate
with a view to justifying a statutory code of guidance for suppliers
(as has happened recently with supermarkets).
The Renewable Energy Obligation
19. The impact of the Renewable Energy Obligation
(REO) on demand for renewables in this country will largely depend
on how suppliers react to its introduction on 1 April 2002. All
suppliers face a choice of buying the requisite three per cent
of green electricity, buying Renewable Obligation Certificates
(ROCs) or paying the buy-out price of three p per KWh. Suppliers
choosing to meet their target by purchasing green electricity
will in effect buy more than simply the electricity itselfthey
also purchase the saleable ROCs and for business supply they can
add the value of a climate levy exemption certificate (LEC) priced
at 0.43 p/KWh. In addition the money raised from the buy-out price
is recycled or "smeared back" to suppliers in proportion
to the amount of ROCs they present.
20. So in effect although the buy out price
is set at 3 p/KWh, generators of renewable energy should be able
to secure contracted prices at a higher rate than this. This combined
with the fact that the REO is set to increase the percentage of
green power to 10 per cent by 2010 should help to stimulate high
levels of investment in the renewables industry.
21. The most competitive sources of renewable
power will come from on-shore wind and biomass. An attractive
option for owners of plant might be the co-firing of biomass in
existing coal fired power stations which is allowable under the
obligation rules until 2006 when the eligible proportion of fossil
fuel drops to 25 per centand 2011 when co-firing will be
exempt from the scheme altogether. If this option is pursued it
could help to stimulate the supply market for biomass fuel in
this country and act as an effective stepping stone towards 100
per cent biomass generation. However, there is nothing to guarantee
that the biomass is sourced from sustainable sources or to prevent
importing from overseas, for example from Canada and Scandinavia,
where existing supply chains and lower land values make commodities
such as wood chip far more economical. Another issue that would
need careful assessment is whether co-firing would lead to older
plant not currently fitted with Flue Gas Desulphurisation equipment
being brought back on stream leading to an increase in harmful
22. Because the value of the LEC makes it
more profitable to sell green electricity to business customers
there is a possibility that domestic tariffs will, as a result,
contain a higher proportion of "brown power" than is
currently the case. There is little in the way of market intervention
to prevent this from happening and without a domestic tax on energy
there is nothing to encourage demand reduction within the domestic
sector. Friends of the Earth therefore believe it is appropriate
to begin consultation on the introduction of a domestic energy
tax to mirror the effect of the climate change levy by encouraging
energy efficiency measures and stimulating demand for green tariffs.
The tax could be designed in such a way as to avoid harming the
fuel poor (by for example introducing a free tranche where consumption
up to a certain level is tax free) and funds from the tax could
be recycled to speed the implementation of the Government's Fuel
23. Domestic customers may be unaware of
the "content" of their electricity tariff and will almost
certainly not appreciate that following the introduction of the
CCL, it has in effect become more "brown". Full disclosure
on customer bills of the fuel sources used to generate the electricity
and the resulting environmental consequences is therefore necessary
and we call on Government to take action to implement the recommendations
contained in the EU Renewables Directive on this issue.
Current policies to support renewables (including
R&D and capital grants) and the likelihood of meeting Government
targets in this area
24. R&D spending on renewable energy
needs to be increased. Friends of the Earth's analysis, of International
Energy Agency data, shows that in 2000, Britain spent less in
total on renewable R&D than Switzerland, Denmark or Spain
and that renewable R&D spend per head is three times greater
in Germany and the USA and over 10 times greater in Denmark and
Switzerland than it is in Britain.
25. Our analysis shows that, over the last
25 years, more than three-quarters of our energy R&D have
gone to researching nuclear power. Even in 2000, almost 60 per
cent of Government energy R&D was spent researching nuclear
26. The UK R&D budget for renewables
for 2001-04 is £18.5 million per year. Additional funding
of between £5-10 million is also available from Research
Councils. However, the total sum is still dwarfed by comparison
with nuclear spend which over the last 25 years has averaged over
£230 million per year.
27. In addition to increasing R&D spend
on renewables Friends of the Earth is calling for the following
fiscal instruments to be introduced in support of renewable technologies.
Commit to introducing a tax incentive to encourage
investment in off-shore wind energy, photovoltaics, off-shore
tidal and wave power.
28. These technologies will be vital to
maintaining security of supply whilst meeting the UK's climate
change commitments and the Government's targets for increasing
the uptake of renewable energy. The present incentives for renewable
energy, such as the obligation on electricity companies to supply
a percentage of power generated from renewable energy sources,
will benefit most those technologies that produce electricity
most cheaply. It is important the Government provide an incentive
to the next generation of renewable energy technologies that are
currently higher up the cost curve. Providing an additional tax
break for these technologies can be persuasively justified on
the following grounds.
29. This is a tax expenditure made to avoid
the external costs of climate change. Expanding renewable energy
generation is recognised by the Government as central to tackling
climate change. But restricting that expansion to technologies
which have lower costs at present would be short-sighted and inefficient.
It will be necessary to exploit the full range of available renewable
technologies, each of which have particular characteristics, in
order to deliver the levels of output required. Thus, for example,
off-shore wind can exploit the substantial resource provided by
constant high winds and shallow seas in many areas around the
UK; and, photovoltaic technologies can by-pass conventional electricity
infrastructure and be installed directly at the customers' point
of use, their buildings.
30. This measure would reduce the price
of renewable technologies. Early investment in these technologies
is undertaken the faster the costs will fall for future investments.
In other words, investments now have a positive external effect
on investment costs in the future.
31. Third, this policy improves the cost-efficiency
of the overall package of policies aimed at increasing renewable
energy output by reducing the costs of investment.
32. Investing in these renewable energy
technologies would become less risky. A declining cost base does
not mean that investing in renewable energy is free of commercial
risk, as the rate of decline, for example, cannot be predicted
with certainty. Tax breaks can help reduce those risks and stimulate
further output of renewable energy. Investment decisions are very
sensitive to expectations about the future, and to the costs of
the initial capital investment rather than to the costs of operation.
Tax breaks on investment in these technologies reduce initial
investment costs and increase confidence.
33. Action is needed to increase the pace
of innovation. The urgency with which these investments need to
be made cannot rely on the market eventually bringing investment
costs down and addressing climate change now has a clear timetable
for action. Tax incentives of this type speed up investment rates,
increase technological innovation and reduce the costs of future
34. These technologies offer clear and specific
opportunities for UK companies in terms of job creation and competitiveness.
The UK has an established marine engineering industry that can
combine with UK firms that have begun to compete successfully
in the market for wind turbine components to exploit increased
demand for off-shore wind generation. Two major UK companies are
significant players in the photovoltaics market and would be well
placed to exploit increased demand for this technology. The UK
has a technological lead in the development of wave and tidal
power that should be built upon immediately and not allowed to
35. What form the tax incentive takes should
be the subject of a consultation announced at this Budget to be
completed in time for the measure to be installed at Budget 2003.
Other countries that have a lead in renewable energy technologies,
and those which aspire to have, use a variety of tax incentives
alongside subsidies. In Denmark individuals, co-operatives and
companies investing in wind energy could claim exemptions from
income tax and company taxes. More recently individuals and companies
no longer have an exemption as the market has become established
but can claim deductions on annual depreciation of the investment
and on operation and maintenance expenditure. In the United States
the Energy Policy Act of 1992 included a 10 per cent investment
tax credit available to any company investing in or purchasing
solar energy property.
36. The effectiveness of these incentives
is dependent upon them being part of a package of measures including
subsidies for capital investment and funding for R&D. The
Chancellor should make clear that developing this tax incentive
would complement spending commitments that will be announced in
Spending Round 2002.
Commit to a tax break for farmers and households
investing in renewable energy
37. The UK's renewable energy obligation
is an important policy for increasing large scale renewable energy
projects. But the old energy supply structure of a small number
of large power stations feeding a grid needs to change rapidly.
Embedded generation which supplies energy more locally and net-metering
which allows farms, businesses and households to be both consumer
and small-scale producers will weaken the dominance of the large-scale
power plants. At present those who can play a role in this reform,
such as farmers, small businesses and home-owners, are concerned
about the risks of investing in this exciting future despite being
squeezed by energy costs. The evidence from countries that have
expanded renewable energy capacity faster than the UK is that
tax incentives can help to overcome this market failure.
38. In Denmark farmers have been central
to the wind-power revolution. As well as receiving subsidies for
capital investment private co-operatives of farmers have enjoyed
a tax exemption on 40 per cent of the income from electricity
sold. This is highly attractive given the 50 per cent tax rate.
The Home and Farm Wind Energy Systems Act in the United States
proposes a 30 per cent investment tax credit for investments in
39. Existing Government support for renewable
energy is heavily focussed on larger units. Smaller units installed
in farms and households have the potential to make a significant
contribution to meeting both the renewable energy and CO2
emissions target set by the Government. Wind, solar and biomass
all offer opportunities. The "Community Renewables"
initiative, developed by the Countryside Agency and DTI, suggests
that small-scale generators could deliver up to 10 per cent of
the UK's renewable energy. Investments by farmers in renewable
energy will also cut their climate change levy bill.
40. Encouraging a far greater level of investment
by farmers and households in renewable energy will help the Government
to both meet its renewable energy target and demonstrate its commitment
to help farmers and rural economies diversify in a sustainable
manner. At this Budget the Chancellor should commit to installing
this incentive in Budget 2003 and should indicate that new money
to support small-scale renewable energy will be forthcoming in
Spending Review 2002.
Include renewable energy technologies within the
Green Technology Challenge.
41. In the Pre-Budget Report the Government
excluded renewable energy technologies from the Green Technology
Challenge, which will grant enhanced capital allowances to listed
technologies. Instead the scheme will be restricted to two types
of technology that already receive or are set to receive tax breaks
(energy saving technologies and cleaner fuels and vehicles) and
only one, water use and treatment technologies, that does not.
42. Friends of the Earth believes it is
short-sighted of the Government not to include renewable energy
technologies. The justification appears to be that the consultation
exercise did not identify a strong enough demand. Companies are
only just waking up to the opportunities of investing in their
own efficient small-scale renewable energy plant presented by
the exemption from the climate change levy. In light of this the
decision to exclude renewable energy from the scheme seems to
have been taken from an extremely static viewpoint. This is not
appropriate for a measure that is aimed at increasing investment
and innovation. The Chancellor should take a more forward-thinking
position at this Budget and announce that renewable energy technologies
will be included in the Green Technology Challenge. Announcing
that the cost and risk of investing in these technologies can
be reduced by claiming an enhanced capital allowance would speed-up
the knowledge and expansion of this market.
The extent to which current developments reflect
"joined-up" working between the parties involved (Government
departments, Ofgem etc)
43. As might be expected in any situation
involving a wholesale shift in priorities there will be competition
between existing objectives and the instruments in place to meet
them and new objectives and their instruments. This is no more
evident that in the policies of the DTI which retain commitments
to fully exploit indigenous fossil fuel reserves and whose energy
policy seeks to achieve low energy costs to secure our competitiveness.
DTI's sustainability strategy sets out clear objectives for achieving
CO2 reductions and increasing resource efficiency,
however, it is not yet clear how the various components of the
department working on energy will contribute to these targets.
44. The PIU report comments on the revised
hierarchy of objectives for energy policy and recommends that,
where there are conflicts, environmental interests should tend
to take precedence. This is a somewhat timid expression of the
fact that increasing climate instability will have a profound
effect on our society, economy and environment urgent action is
necessary to decrease anthropogenic emissions of green house gases.
It is important that this new hierarchy is adopted and that the
appropriate instruments are introduced to enforce it. Key amongst
these will be the restatement of revised energy policy objectives
and the redrawing of the terms of reference for the independent
regulators, OFGEM. Additional work will be needed to assess the
implications of a properly enacted policy shift and to develop
transitional policies including for example re-training programmes
for affected work-forces and regeneration budgets for regions
affected by declining fossil fuel industries.
45. Greater collaboration between DEFRA
and DTI is needed with regard to the role renewables can play
in helping achieve multiple objectives. For example, farmers could
benefit from reduced outgoings and a secondary income through
diversifying into renewable electricity generation. Unfortunately
support is often concentrated on larger scale projects that will
not be appropriate for the vast majority of farmers. For example,
soon to be announced support for biomass is expected only to apply
to plant over 30 MW in capacity. Similarly the "WindWorks"
Initiative focuses on large scale wind turbines, seemingly ignoring
the fact that lower capacity turbines exist and are capable of
wider deployment, particularly in off-grid situations. Either
DTI or DEFRA or a cross departmental agency should conduct an
assessment of the potential contribution from widespread deployment
of small scale technologies. In addition the contribution energy
from farm waste technologies can make towards meeting the demands
of the Nitrates Directive should be explored in more detail.
46. It is also essential that Treasury and
DTI collaborate effectively particularly with regard to the Spending
review 2002. All Government tax and spend decisions should be
accompanied by an assessment of the CO2 impacts that
will result. The Treasury does not have a Public Service Agreement
committing it to sustainable development this would formalise
the need to put the environment at the heart of tax and spend
The outcome of the PIU energy review and the development
of a sustainable energy strategy
47. The Energy Review was commissioned to
consider how Britain will meet its future energy needs, and how
the Government will meet its commitment to tackle climate change
and reduce emissions of greenhouse gases. The PIU's 200 page report
and various supporting working papers talk, rightly in our view,
about setting energy policy within a sustainable development framework
and make sensible recommendations about the need to prioritise
environmental concerns and to shift to a low carbon economy.
48. But Friends of the Earth believes the
report does not deliver on crucial issues: its target for renewables
in inadequate; it brushes aside the possibility of strong domestic
policies on transport and it proposes keeping the nuclear option
open. Moreover, it has failed to deliver a long term vision and
is short on detailed policy proposals for supporting renewables
or for energy conservation and demand reduction.
49. A supplementary briefing outlining our
thoughts on the review in more detail is enclosed, (see Annex