Examination of Witnesses (Questions 240-259)|
TUESDAY 13 NOVEMBER 2001
240. Are most of them dependent on gas? What
is the extent to which there are dual fuel capabilities?
(Mr Green) At the end of the day it depends on the
relative price of the fuels, but historically most CHP in the
country was based on coal. There was then, as with much in the
power generation section, quite a move to gas. Initially on the
move to gas it was based on interruptible supplies, so it was
dual fuel with heavy fuel oil. Most CHP schemes in the UK are
now powered by gas although by no means all and there is a surprising
variety of fuels used including geothermal fuels, biomass, energy
from waste, coal. About 60 per cent of the fuel used in the CHP
sector is now gas fired.
241. We are aware that the CHP sector has experienced
difficult trading conditions recently. In your submission you
say that development of new CHP capacity has virtually ceased:
ninety-five per cent fall in orders for new plants; project engineers
indicate a fall of over 80 per cent in levels of CHP business.
Is this mainly down to the new NETA arrangements?
(Mr Green) May I take one step back. NETA is central
to the challenges we are facing at the moment, but the frustration
the CHP industry feels is that the Government have very firm targets
for CHPthe last Government had and the current Government
has themand we feel one of the difficulties is that there
is a strong need for comprehensive Government strategy in the
sector, which does actually work out how we are going to deliver
the 10GW target. The most immediate issue at the moment has been
the impact of the new electricity trading arrangements, NETA,
which has led, according to Ofgem's report, to something like
a 60 per cent drop in output from CHP plant. There was one particular
CHP plant which for particular reasons was left out of Ofgem's
analysis. I understand that if that were included it would take
the drop in power exports down to about 80 per cent. The CHP equipment
is by and large produced in the UK. Some is produced in the North
West of England and the two major turbine manufacturers are in
Newton Abbot: Centrax; and what was Western Gas Turbines, now
Alstom Gas Turbines in Lincoln. Ten days ago Centrax in Newton
Abbot declared 25 per cent of their workforce redundant, 250 staff.
That was in part due to the fact that they have not had any orders
at all for CHP for well over a year now. Alstom, because they
are a very large integrated company, have been able to redeploy
about 900 of their staff who would otherwise be working on CHP
to other sectors. Our worry is that if the downturn continues,
it will lead to a dissipation of professional skills in the sector
and that is one of the reasons why we are very keen to work with
the Government on developing a comprehensive strategy to deliver
the Government's targets.
Sir Robert Smith
242. What sort of remedies are you seeking from
the DTI in the light of the Ofgem report?
(Mr Green) I will hand over to my colleague, Mr Meeks
on this who has represented the industry on a lot of the working
parties on NETA. Our discussions carry on with both DEFRA and
the DTI because for reasons of history, as the Committee are probably
aware, CHP is the only energy supply technology which is sponsored
by DEFRA. Whilst we do have dialogue direct with the DTI, a lot
of that dialogue is with DEFRA, because they are the custodian
of CHP policy as it were. In terms of specific issues to do with
the operation of the balancing market and the extent to which
consolidation may or may not work may I ask my colleague to respond?
(Mr Meeks) If we look at electricity trading arrangements,
the fundamental problem which faces CHP is that the risk it faces
in trading has changed. Wholesale price is one thing which NETA
has delivered and we do not pretend that we should try to do anything
other than support a general lowering in prices. If that benefits
the consumer, that is beneficial. CHP itself delivers lower prices,
so we are supportive of that principle. What NETA has done is
introduced an element of risk which was not there before in the
market. It was designed to address a problem which was created
by major generators in what they were undertaking. It was not
a small generator problem. The reforms have been based around
trying to address a large generator problem. The inevitable casualty
of that seems to have been that the impacts upon the smaller generator
have been somewhat overlooked in the process of implementation.
The effect has been that the risk in trading has increased dramatically
for the smaller generator to the extent that it means that trading
is virtually impossible and that is what has caused this drop
in export revenues. People are simply not running the plant, not
exporting at all. In terms of what the industry needs from a NETA
solution, it is some means of ensuring that the fundamental risk
which has been introducedwhich small generators do not
impose upon the system, they are not in a position of market power
to be able to manipulate pricescan somehow be addressed
and we can find some way of ameliorating the risk which has been
imposed upon them. There are several positive proposals which
have come forward to do that in terms of addressing the settlement
system at the heart of NETA, moving towards average prices, moving
towards what is called the dead band. These are quite detailed
technical issues which I do not want to go into, but effectively
they minimise the risk which is being imposed upon the smaller
243. Whilst achieving the other goals still.
(Mr Meeks) They would not undermine the fundamental
goals of NETA, which would be to deliver prices and could also
lead to a system where cost reflectivity is ensured. We would
not wish to undermine that and the proposals which have been put
forward would not undermine that either.
244. How is that progressing?
(Mr Meeks) At the moment the process of moving forward
is concentrating quite narrowly on the issue of consolidation.
Consolidation addresses the symptoms, it does not address the
fundamental problem. The fundamental risks are still there, whether
we consolidate or not. At the moment the emphasis which seems
to be being placed by Ofgem is on delivering consolidation. We
do not believe that is going to deliver a sustainable long term
solution to the risks which have been introduced by NETA.
(Mr Green) There are some 1,700 CHP units in the country
varying in size hugely but basically a small generator or a 50
megawatt CHP plant means there will always be some exports to
the system. They are relatively small compared to major players
and the idea that Ofgem have floated for some time now, about
three years, is that by trying to create a facility in the new
electricity trading arrangements, in effect third parties will
come into the marketplace, buy portions of that export power and
then be able to trade it. The difficulty that arises is that no-one
ever enters a market for charitable endeavour. They enter a market
because they are commercially driven, which is fine, but they
will want to take their cut on that and the worry is that it will
further destabilise the viability of CHP schemes. I should say
that the last Energy Minister, Peter Hain, was extremely helpful
on commissioning the review of small generators from Ofgem. That
then reported to Brian Wilson and Brian Wilson has made it quite
clear that he is determined to see this problem resolved. Ten
days ago, the DTI issued a consultation paper on options which
we are still looking at. All of us feel that whilst consolidation
has a role to play, it is not going to solve the problem fundamentally
and it will need to be issues to do with the way that risk is
handled in the market. We do have a worry as to whether or not
we are moving to a situation where the market becomes risky to
the extent that it is not just going to be CHP operators who cannot
develop plant but other players in the longer term as well.
245. Are those more technical measures you were
talking about something which the DTI have taken on board?
(Mr Meeks) Yes, DTI have taken some of the principles.
The idea of an average price is opened up which is very welcome.
It needs to be put into play and that opened up for consideration.
There are other principles as well which people had put forward
from our membership and individually which we feel need an airing
within that process of consultation.
246. In your submission you took issue with
the way in which Customs and Excise decided to implement the Chancellor's
decision to exempt CHP from the climate change levy. How important
is the failure to extend the exemption to power supplied off-site
through a licensed supplier in two circumstances: firstly, in
the present market circumstances, with NETA operating as it does
now; secondly, in circumstances where the adverse effects of NETA,
which you have described, have been corrected?
(Mr Green) Talking with colleagues in the industry,
in both circumstances getting full exemption from the climate
change levy as the Chancellor originally outlined is something
we would attach great importance to. It is all the more important
in the context of NETA because if you look at the timescale for
changing NETA some of the software can only be changed once a
year, so you are talking about October next year for some software
changes which might need to be done. In terms of things which
can be done reasonably quickly, to restimulate confidence in the
industry, if the Chancellor were minded to indicate in his November
statement that he was willing to encourage Customs and Excise
to fully exempt CHP as originally envisaged, that is something
which would send a very positive signal to companies. In addition
it is also the case that if NETA were changed it would still be
likely that you would need to have some changes to the climate
change levy in order to make sure that there was an adequate market
for the power which could be traded, particularly given it would
have an attractive premium and it would be levy free. The other
thing which is worth bearing in mind is that one of the reasons
why Ofgem always took the view they did that it was not their
job to deliver the Government's targets for CHP and renewables
through NETA was because they took the view that there was a range
of other Government measures which should do that and full exemption
from the climate change levy is one of those, along with others,
which need to be put into place even if it is going to call into
account the need for more fundamental changes in NETA. What we
are trying to seek is to preserve the integrity of NETA, have
some changes which make it more beneficial for small generators
and make sure that in terms of achieving the targets, they are
done through other measures of which there are several in play
at the moment.
247. The target for 2010 of 10GWe. You have
mentioned in your memorandum that DTI projections and Cambridge
Econometrics have both suggested that we shall fall short of that
target. Do you see any circumstances in which you would predict
that we would be able to meet that target? What might those circumstances
(Mr Green) The circumstances needed to get it, in
terms of immediate issues, are to do with sorting out the climate
change levy. The next range of issues would be to do with NETA.
In the longer term it would be using the powers the Government
took in the Utilities Act 2000 to introduce arrangements for CHP
similar to those which operate for renewables. Renewables to a
certain extent are less affected by NETA because there is the
underpinning of the obligation. At the moment no such facility
exists for CHP although the Government did take the powers in
the Utilities Act to introduce such an arrangement. We are in
discussion with DEFRA and the DTI about what might be the circumstances
in which they would activate the powers they took in the Utilities
Act to introduce arrangements for CHP similar to those which operate
248. Meaning that you would want an obligation
in relation to CHP in order to meet the target?
(Mr Green) I think so. That is the thrust of what
we are suggesting. We are not suggesting anything like the level
which has been suggested for renewables because CHP is fairly
near commercial. What we are seeking, through raising the issue
of some form of obligation or however it was donethere
might be different ways in which it could be doneis to
provide some long-term stability in the marketplace which will
then enable companies to invest. If we get the messages right,
then the CHP industry will be investing about £3 billion
over the next eight or nine years in new CHP plant. That needs
to be done in certain market conditions, one of which is getting
a reasonably stable price for electricity, when clearly in the
very nature of a commodity market the price will be up and down.
We are trying to find some way in which some stability could be
introduced. The figures we have done indicate that if there were
to be some form of obligation for CHP, the price would be about
one third, if not less, than it is for renewables, just because
of the nature of the technology being more mature. If it would
be helpful we should be very happy to send more details afterwards.
Chairman: When we pause and reflect, we may
get back to you. Thank you.
249. You suggest that CHP should be exempt from
the renewable obligation. Could you give the reasoning behind
this suggestion? How did you arrive at a figure of £100 million
for the cost to your sector?
(Mr Green) May I just explain the background to it?
Quite a lot of CHP plants are licensed suppliers and in order
to get the CHP physically into the marketplace you have to be
a licensed supplier and meet certain criteria. The way in which
the renewables obligation operates is that it is an obligation
on suppliers. As soon as you become a licensed supplier, you have
either to pay the buyout price or invest in the designated renewable
technologies. We became aware earlier this year that there was
a problem in the Utilities Act in the way in which it was drafted
in that the way in which they defined the base on which the renewables
obligation was going to be created included CHP. The DTI were
as surprised as DEFRA was that the legislation had not sorted
this out in 1999 when it was being passed through the House. For
whatever reason, the way in which it was drafted does not appear
to have given Ministers any discretion about where the levy is
collected from. That is one of the reasons why we have raised
this as an issue. In order to sort this out I understand new primary
legislation is likely to be needed. The way we worked out the
cost is based on the likely level of supply from CHP plant over
the next few years, the likely value of that supply and the way
in which the levy would apply to CHP supplies. There is a degree
of frustration that CHP is driven in terms of the Government's
target by its environmental policies, yet an unintended consequence
of the Utilities Act is that it is captured in the supply obligation
therefore has the effect of placing this additional burden on
the industry. I have to say that Ministers have indicated that
they would like it to be sorted out but it will depend on how
much parliamentary time is available for any changes to the Utilities
250. May I move on? I get the impression that
CHP is in danger of being stuck in an old technological mind set:
you generate electricity and you sell off the surplus. What about
things like fuel cells. If you had fuel cells fuelled by distributed
natural gas, could that become an alternative?
(Mr Green) The short answer is yes. The debate at
the momentand there is a lot of interest around the whole
concept of domestic or micro CHPseveral UK companies, some
of whom you might be hearing from, BG Group and others, have invested
quite heavily in the technology and are hoping, subject to certain
conditions, to be able to go live with commercialisation of the
technology in two or three years' time. That is based on a Stirling
engine rather than a fuel cell. There is also work going on in
parallel in the motor industry to develop fuel cells based largely
on the automotive sector. It is going to be interesting to see
which one comes to the market first of all, whether or not it
is the Stirling engine based system or the fuel cell based system.
A lot of the developments in CHP technology have been spin-offs
from other sectors. High efficiency gas engines are spin-offs
from the truck industry for example, high efficiency gas turbines
are spin-offs from the aeroplane industry. It is difficult to
judge whether or not the ones which come to market first of all
will be fuel cells based on natural gas, or Stirling engines based
on natural gas but suffice it to say that in both sectors there
is a lot of work going on at the moment to bring the technology
to commercialisation so you can introduce what would be the ultimate
in competition, giving all of us the opportunity to generate power
in our own homes and to heat them as well, be it from a fuel cell
or Stirling engine.
251. I live in a block of flats which has combined
heat and power. I often wonder whether it might be cheaper to
go into the liberalised electricity market to buy my electricity
to run a central heating system. I am not able to do that because
CHP denies me that right. Okay, I entered the block of flats knowing
this was so. Does that trouble you at all? I do not mean you to
address my personal case.
(Mr Green) No. I always believe in consumer choice.
Our former Chairman's mother lives in a block of flats in Leeds
powered by CHP so there is quite a strong connection in the industry.
We have never argued that consumer choice should be restricted,
it just depends what you mean by consumer choice. If for example
that block of flats is owned by a local authority, under the legislation
which governs investment by housing authorities it would have
to have gone to tenant consultation about the energy choices for
that block of flats. If as the result of that tenant consultation
the tenants voted in favour of going the CHP route, excellent.
If the tenants voted in favour of going another route, it is their
democratic right to make that choice. What we are seeking to do
is to make sure that the technology exists on a level playing
field so that customers can make an informed choice about which
way they want to go. For example, there are strong links to CHP
in the Government's fuel poverty strategy in that we know from
the work, for example, at St Pancras Housing Association next
to Euston Station that a small-scale CHP system there was able
to reduce the tenants' energy cost by about 20 per cent. The tenants
have been highly satisfied with that and they voted for it and
they voted for a payment system which got rid of the standing
charges as well. They did that three or four years ago. There
are similar examples elsewhere in the public housing sector where
tenants have voted in favour of it once they were given the choice.
Sir Robert Smith
252. Is it sophisticated enough now for each
tenant to be metered for their energy use both for heat and electricity?
(Mr Green) Yes.
253. So there is still incentive for each person
to be economical?
(Mr Green) Absolutely. It may surprise the Committee
but we never argued that you should always do CHP first of all.
We always argued that first of all you should make sure this building
or any building is well insulated to reduce the energy demand.
Secondly, you should then look at the appropriate size of CHP
and it may well be that the building is so well insulated you
can power it with a solar cell and you do not need CHP. Fine.
You are still achieving the same objective of carbon reductions.
Ultimately what CHP is is a transition technology to wider use
of renewables and other benign sources in the UK.
254. If I am right, you want a remission of
NETA, you want changes in the implementation of the climate change
levy, you want CHP to be exempt from the renewable obligation.
(Mr Green) I am sure I could think of a number of
255. We have a vote at seven!
(Mr Green) I am aware of that, Chairman. If we had
had this conversation two years ago, you would probably have had
a very different reaction. It would not have been a reaction where
the market was essentially in a downward spiral, it is where the
market was very buoyant. Therefore I suspect the shopping listand
everyone is always going to have a shopping listwould have
been much smaller. The reason all these issues have come up is
fundamentally because although the Government has got a target
for 10GW CHP by 2010, it is fair to say that there is no clear
strategy in place for achieving it. DEFRA Ministers have made
clear that they intend to bring the strategy out shortly and we
hope that "shortly" will be this year not next year.
All the industry is looking to get someexcuse the phrase
« joined-up government to make sure we not only have this
vision which the Prime Minister and others have endorsedand
the target was first set by the last Governmentbut a clear
strategy for getting there. At the moment it is quite difficult
to say what the clear strategy is for how we are going to get
there, so we end up in a sort of shopping list approach to policy.
What we should like to see is a clear strategy which underpins
a clear target. We have the target but not the strategy.
256. You will have submitted to the PIU and
they may well inform the strategy development of DEFRA. Would
that be correct?
(Mr Green) We have submitted to the PIU. The industry
was getting somewhat frustrated with the lack of progress on the
CHP strategy about 18 months ago and after extensive consultation
with various players we produced a draft UK CHP strategy which
we submitted to the Government. That has been submitted on to
the PIU, together with an update on one or two areas which need
to be looked at in the more immediate future.
257. Do you not think this is the product of
sloppy wishful thinking on the basis that they think of a figure
and then eventually they will get round to trying to will the
(Mr Green) I would not quite use the phrase "sloppy
wishful thinking". The frustration in the industry is that
the Government have a target but they have been very focused on
some short-term promotional measures in the CHP sector and whilst
they have been focused on the short-term promotional measures
the market has changed so fundamentally that it undermined the
goal of where you are wanting to be. That is why we believe it
is very important to have, as soon as possible, a clear strategy,
preferably with some legislative underpinning as well.
258. The Government have been spinning one way
and unfortunately the market has been spinning another.
(Mr Green) Yes.
259. You speak so passionately about CHP. Could
you just tell us why we lag behind the European partners in CHP
(Mr Green) In some senses we are actually ahead of
the rest of Europe in the development of small-scale CHP, particularly
the potential on domestic or micro CHP. The reason why it is so
much further advanced in the Netherlands where about 47 per cent
of electricity is from CHP, Denmark is quite a high proportion
as well, Germany quite a high proportion, is to do with the different
ownership structures of the industry. In Denmark for example,
the industry is very driven by what local authorities are engaged
in. Local authorities have clear duties in relation to energy
policy and that has produced a different outcome. In Germany you
find the Lander own a lot of municipal CHP plants. That
has driven the policy in a slightly different direction. In the
Netherlands they use CHP very consciously as part of a way of
spreading in an efficient way the growth of the natural gas grid
in the Netherlands. They have gone for a very distributed model
of energy production in the Netherlands. It is a combination of
circumstances which have been different in Europe. What is interesting
at the moment is that as liberalisation rolls out across Europe
challenges similar to those we have been seeing in the UK have
also been noticed in other countries as well. If I talk to my
opposite numbers in some of the other countries, they are experiencing
similar downturns at the moment. We have always argued in favour
of liberalisation but it needs to be liberalisation which is informed
by wider policy objectives.
Chairman: Thank you very much. It has been very
instructive. We have got through a lot in a very short time. Thank
you very much.