Examination of Witnesses (Questions 360-374)|
TUESDAY 20 NOVEMBER 2001
360. The major barriers to the development of
renewables: you mentioned planning, the other piece is NETA. I
think you said in your submission that you want to tackle the
root cause of the problem to modify NETA. On November 1 the DTI
did publish its response to Ofgem's assessment of the impact of
NETA on small generators in the first two months of operation.
Did you see anything in that response that would help your members?
(Mr Byers) We are replying to this consultation by
the 1 December, we will send you a copy of it. The fundamental
problems of NETA were recognised, its dual imbalance price mechanism,
basically insurance in case you cannot produce what you say you
are going to produce on a rolling three and a half hour basis.
We are trying to balance the whole of the network locally now
rather than in aggregate. The costs of holding that insurance
are very severe for small generators. What has happened is that
where you are exposed to NETA small generators have effectively
agreed to a major discount for somebody else to take the risk,
the supplier company, or they are extracting that value for the
risk of accepting NETA. We believe, and I make two positive suggestions,
that this can be addressed. We would, for instance, in the first
case like a single cash out price rather than a dual one. If this
is rejected we cannot see a difficulty in actually exempting small
sites from the imbalance risk. What Ofgem wrote was that there
was a major reduction in CHP and renewable generators' income
and output. They underestimated it quite significantly. From the
survey we conducted among members it is minus 40 per cent, it
is minus 40 per cent on revenue, and about 14 to 17 per cent on
output. It may get better as NETA beds-in but we do not forecast
it making much of an improvement on those figures. If it is not
addressed we have on the one hand a trading system which is in
place and under trial, completely at odds with government policy
on promoting renewable energy. There are fixes to make.
Linda Perham: Thank you.
361. I understand the concerns about NETA and
the way it operates, I just want to get a sense of how fundamental
those concerns are about the structure of NETA as a whole where
there are fixes. You, I suppose, put bluntly if you have a system
that minimises very short term balance and minimises the need
for balancing demand and supply that should be actually one that
maximises benefit to consumers. Does your wish for a fix say that
actually your way of looking at it is wrong anyway or it is not
(Mr Byers) My point is that it is not completely cost
reflective because it is being applied locally and it is disproportionally
punative to small generators who cannot afford the cost of all
of the forecasting and all of the involvement that NETA might
require to manage that risk. Basically their revenues are being
eaten up by suppliers discounts for taking that risk. I would
really dispute that the system we have currently got is optimal,
there is probably five gigawatts of pending reserve spinning,
waiting to cover situations just in case you gained an imbalance.
This is not good for the environment, it is inefficient. Before
NETA we had about one gigawatt, now we run five gigawatts just
(Mr Milborrow) One gigawatt or less, before NETA,
Mr Chairman. The fundamental problem with NETA is the way that
it affects renewables is that NETA disaggregates supply and demand.
We have an integrated electricity system for very good reasons,
and that integrated electricity smooths out the perturbations
in both supply and demand. NETA takes you down the road of mini
national grids almost, as David just said, each with their own
standby plant to balance out when supply does not match demand.
Statistically, or any other way you look at it, this is not an
efficient mechanism. A couple of respected power magazines have
drawn attention to the figures that David quoted, that we are
now wasting energy because of the surplus power that is kept on
standby for the individual suppliers. Of course as far as the
intermittent renewables are concerned all this is lethal, as you
have already heard.
362. I think you partially answered my question.
I will ask it just in case you wanted to add to what you said,
what changes to the operating rules would you like to see to encourage
consolidation so that small companies can participate in the market
alongside the major producers?
(Mr Byers) I think Ofgem drew attention to the fact
that consolidation has not arisen as had been expected. We actually
think that it is only a partial fix, I think even if we were aggregating
across the entire renewable capacity there would still be a discount
to pay for participating or accepting some of the risk under NETA.
(Mr Milborrow) I have been in dialogue on this very
topic with the Performance and Innovation Unit and I have done
some modelling, which I must accept personal responsibility for,
even if you aggregated wind over the whole of the country you
would still get a significant penalty in the order of three to
five pounds per megawatt hour. That sort of penalty is going to
distort the market, because it is the sort of difference between
gas at the new prices and gas at the old prices which, as I am
sure you are aware, has led to the suspension of contracts for
8,000 megawatts of gas plants in the last few months.
(Mr Byers) NETA values flexibility too highly. I think
we are pretty sure that the National Grid can cope with intermittent
supplies of up to about 20 per cent of the total amount.
Sir Robert Smith
363. Is there a converse argument in terms of
energy efficiency: transmission lines use energy and a lot of
renewable sites tend to be far away from the potential consumers.
Is there an argument that therefore you are going to have more
energy losses that way and instead of having a little mini grid
whilst it is wasting money in standby it is saving in terms of
(Mr Milborrow) Yes, I think I understand you. Renewable
plants are no different from the large thermal power stations.
You need to be selective where you put them. It is no good, as
I think we heard earlier from the Minister, putting them at the
end of a long line in the remotest corners of the Kingdom. They
need to be reasonably close to demand centres. You have much more
flexibility for renewables, because, roughly speaking, planning
considerations apart, they can go pretty well anywhere. I may
not be fully understanding your question.
364. A lot of the wind and the waves tend to
be in the northwest of the country and along the northeast. From
the point of view of energy efficiency you are going to have transmission
losses from these sites.
(Mr Williams) I am not sure that is correct. With
most renewables one of the big advantage is you are putting the
generator closer to the load centres. The only way you will still
see those losses is if you maintain the central infrastructure
as well, what you would have then is large transmission lines
not doing a lot. As the system evolves to a more locally based
generation distributed network I would say that losses would have
to go down. You can think of offshore wind, and the large transmission
distances there, but renewables also covers biomass and waste
produced products which are inherently within towns at brownfield
sites and biomass is certainly fairly close to the population
centres as well.
365. In terms of renewables, of course, if you
are losing energy from renewable sources obviously you are not
affecting the carbon uptake. Can you see a way of juggling this,
the long distance renewables supply may lose a lot of energy on
its way, but it will not contribute to the normal
(Mr Milborrow) That is a fair point, Mr Chairman,
but if you look at the map published by the Crown Estates, where
the first batch of offshore wind sites are, they are well distributed
round the country. The wind speeds offshore off the south coast
are lower admittedly than they are off the western isles but that
difference is not such as to necessarily kill the viability of
the project. I used to work for CEGB and the CEGB, as you may
know, wanted to put a coal fired plant on the south coast because
it would reduce the north to south flows. So, yes, there has to
be a balance, but there normally will be an economic balance and
that economic balance is fixed partly by the transmission charges
which the National Grid sets and partly by the distribution connection
charges which have already been discussed earlier this morning.
Chairman: Thank you.
366. You do say in your submission, you make
the point that renewable energy is indigenous with implications
for the security of supply, is that really the most important
thing, because lots of contributors to this Inquiry have lauded
the effect of the market, saying that the market which generally
sort things out does not regulate things too much. Is it really
necessary to hone in on the indigenous supply? Do we really have
a problem with that, because security and diversity is something
that we want to have a balance of fuel mixes, do we not?
(Mr Byers) I do not think we are qualified to advise
the government on what ideal fuel mix should exist. Undoubtedly
it is beneficial if you do not have to import the fuel if there
are security risks. The fuel source is actually usually next to
a renewable generator, otherwise you do not put the generator
there. It is difficult to disrupt the fuel supply unless say the
wind stops. I would say that is to the benefit of security of
supply; the diversity of distribution and lack of vulnerability
to terrorism and the fact that there are not many people who are
able to stop the fuel arriving.
(Mr Williams) In the case of biomass, the benefit
is not just indigenous fuel supplies. You are putting a lot of
money into the rural economy and the one thing that is going to
suffer under the new Renewables Obligation is biomass projects,
that is fairly well acknowledged. In the six pence electricity
price, three pence goes to the rural economy and in the fuel purchase
agreement set up last year the Ely Project spends £5 million
a year, which it pays mostly to farmers or rural haulage contractors.
That is a huge resource and the farmers of the United Kingdom
have been complaining for some years that farming is in big decline,
but half of the United Kingdom capacity could come from British
farming. Probably the largest land based resource we have is biomass,
and that is pretty much being ignored at the moment. Yes, offshore
wind will be another very big resource.
367. I have just got something else I wanted
to ask you about which was in the submission by DEFRA and the
DTI where they end by saying "the new Renewables Obligation
is noteworthy in that it will not, unlike the previous NFFO arrangements,
involve the Government in supporting specific renewable technologies
but will leave the choice of renewable technologies to market
participants." Is that something that you support?
(Mr Williams) It was a very interesting question you
asked about the Treasury this morning. I think you are probably
capable of finding this out, but I am told that this started with
a Treasury decision that NFFO was a tax because it was specific
to technology. It went beyond that and said to the DTI "you
will produce something that is not technology specific so it cannot
be perceived as a tax," which brought out a single price
instrument. That is like saying to the car industry that all cars
will be sold at Mondeo prices. You will get a lot of Minis and
the Rolls Royce manufacturers will be up in arms. Renewables are
at different prices but we have a single price. We think that
is from a Treasury ruling originally. Having said that, we do
not want to change this obligation, we want to work with it, and
try and find ways of getting money into those technologies, that
will not come off at a single band price.
(Mr Byers) I think the DTI has done a good job in
bringing the RO forward. It is likely to start fisticuffs if you
suggest that we have banding again. So we acknowledge that this
is a genuine attempt to stimulate renewable energy but, rather
as David said, it is de facto picking winners because for
example photovoltaics are not going to go very far until costs
go down and the intention is to adjust, one could say tweak or
twiddle, by applying grants and various award mechanisms to encourage
reduction of cost and research. While the RO is welcomed, it does
discriminate against more expensive technologies.
Sir Robert Smith
368. Very quickly on biomass itself, is there
anything DEFRA could be doing specifically with its agricultural
hat on given the crisis in agriculture to make biomass an option?
(Mr Williams) I proposed giving two green certificates
per kilowatt hour for biomass, one for the renewables content,
one for the agricultural benefit, and call the second certificate
a "rural development certificate". DEFRA, I believe,
are quite keen to have that. The problem that we had of course
is that the DTI instantly saw it as something DEFRA could handle
and not something they could handle in the renewables obligation,
so we saw it go straight out of the window into another department,
but a rural development certificate would solve it for biomass.
The other problem is of course that if you look at wind and hydro
they have free fuel. They are capital intensive technologies so
of the 5.5 pence offshore wind price 4.5 pence is probably capital
and if you give it a capital grant it makes a significant difference
to the electricity price. In a biomass project, in a 6 pence price,
4 pence is operating cost and the last 2 pence is capital. They
say to us, "What sort of capital grants would you need if
you are to come down a penny?" I am saying 50 per cent. We
are probably down tuppence in long-term contracts. We therefore
need 100 per cent capital grants because the capital subsidy mechanism
does not work.
369. You talked about industrial competitiveness
and fuel poverty and, in effect, you appear to be saying the extra
costs have to be borne, that is in the nature of other people
externalising their costs through climate change, we internalise
our costs and they then have to be met within the industry. Likewise,
with fuel poverty you say the external costs will be met and the
industry seems to have sufficient profit margin to absorb those
costs. That seems to be a pretty easy gloss on things. What level
of profit do you think the electricity supply industry ought to
be generating compared to other industries? What is it generating
now and therefore what facts are available to be taken into this
(Mr Byers) I will make the first point and then I
am going to hand the hard bit to my left. We do acknowledge that
renewable support mechanisms eventually get paid for by the consumer,
as indeed do some costs attached to security of supply. I think
there are examples of renewable energy technologies which are
now extremely competitive with nuclear and fossil but to reach
the growth targets that are implicit in the policy, and beyond
2010, they will require on-going support. As to the squeeze on
the rest of the ESI, Mr Milborrow is going to cover that.
(Mr Milborrow) Before I do so, Mr Chairman, could
I pick up on what the questioner said about external costs because
that really is the crucial issue. The external costs of thermal
generation sources are not internalised and the whole reason we
are here is that we are trying to ameliorate climate change and
the deleterious effects of the thermal sources of generation.
A very recent European Commission Report has been published and
it quantifies the external costs of the thermal sources much more
accurately than had hitherto been possible. In rough numbers we
are talking about a half a penny to a penny per kilowatt hour
for coal, 0.3 pence per kilowatt hour for gas and I cannot remember
the number for nuclear. That is the first very important point
to make, that we are saving the enormous costs of climate change,
the erosion of the stone work in York Minister and damage to Scandinavian
pine forests and so on. As far as absorbing the cost, it is just
a question of observing somewhat wryly that the early consultation
papers from the DTI suggested that the cost of the obligation
would be in the range £155 to £355 million, from memory,
and they have now escalated to £778 million mainly because,
as I think it was David Porter saying here earlier today, they
have gone for this buy-out mechanism and the assumption is that
the price of all renewable contracts will gravitate towards the
5 pence per kilowatt hour which is implied by the 3 pence buy-out
price. To a certain extent this is a downside of the market mechanism.
Turning now to the other side of the equation, the ESI, although
the Regulator has done all sorts of things to promote competition,
he has also promoted increased profits. 12 years ago there was
no such thing as a supplier, suppliers were an unknown beast.
The fact that the regional electricity companies were forced to
separate distribution and supply created another species of animal
which naturally wanted its own profit margin. Fair enough, no
criticism. We simply observe the total profit in the ESI for the
last financial year for which data are available was £3,687
million. Would it not be nice if Ofgem could come up with some
creative accounting or a formula even more complex than the distribution
price controls to ensure that not all the renewables costs were
passed to the consumer?
370. What sort of rate of return do you look
for on your own projects and how does that compare to the rate
of return applied that you expect others in the industry to achieve?
(Mr Milborrow) I am not making any comment about whether
these levels of return are acceptable or not, I am merely commenting
on the total size and perhaps the fact that some of the regulatory
actions may not
371.Total size is meaningless, it is
just a very large number but then we have a very large amount
(Mr Milborrow) Precisely.
372. So the number of the profit margin is sure
to be large in absolute terms, it is rates of return
(Mr Byers) I do not think the rates of return expected
from private investment in renewables is substantially smaller
than those in fossil fuels. It is largely governed by the banking
attitude to it and how much you can gear the investment in the
project. I would be surprised from my experience for there to
be a substantial difference in expectation.
373. On the issue of subsidy you mentioned there
about one of your tasks being to counter climate change. Does
that effectively mean when you are talking about subsidy that
the 17 recommendations in part 2 of your memorandum imply a government
hands-on approach as in Denmark? That is one point. The other
thing is if there is a question of subsidy in energy production
why should it go towards the renewables sector rather than, say,
clean coal technology? You lay great store in your evidence about
indigenous supply and coal is another large indigenous supply.
Why should any government involvement involve your sector rather
than clean coal technology? Those are my two points.
(Mr Byers) We are aiming for a time when convergance,
as it is called, allows renewable technology to compete on a completely
open playing field. The arguments on carbon saving technologies
are pretty well advanced. If the "dirtiest" renewable
technology is a zero carbon net generator, there are clear arguments
for investing some of consumers' money or government money in
supporting sustainability through renewables. I do not think there
will be a situation where in the foreseeable future we can remove
fossil fuels from our supply chain but the cost-benefit analysis
on a lifecycle basis has been demonstrated for renewable energy
and we should continue to support the development of the renewables
as in all other European countries.
374. You have made the point that you want to
see renewables involved through a competitive system. You say
that roughly at the end of the day, once the subsidies are removed,
it should be competitive but it does involve a degree of government
intervention which is not always compatible with concepts of the
free play of market forces. You prayed in aid the Danish example
which, as I understand it, is very much government-led and even
then it has been suggested that the topography of Britain is such
that only 20 per cent of our energy supplies could ever be secured
from renewables. There is a possible consensus as to the maximum.
There are means of getting there but they do seem to involve a
degree of government intervention and support which is far greater
than we would have expected when we are talking about the free
play of market forces.
(Mr Byers) There are several comments there. There
has been support for renewables for some time largely through
NFFO contracts which were sustainable and bankable. There is on-going
support plus an indication of "kick-starting" the support
of more expensive technologies and implementation of novel ideas,
research and development, because there are certainly many technologies
which are extremely difficult to finance on a commercial basis
until they have been developed and prototyped. I would hope that
any forward-thinking government would continue to support that
either in the infrastructure or the framework for R&D. What
is true is that it is obviously pretty visible in the RO what
the support is going to be. We do know that subsidies for fossil
fuels are not always quite so visible. I must admit 26 years ago
I worked in the nuclear industry and I could not find any reference
to some of the costs that were then being piled into the CEGB
to support nuclear. I think we have got transparency in the current
proposals, they are published. To take up the Danish argument,
why wind works so well in Denmark is that communities own it.
They feel "that is my windmill, it is not Enron's windmill,
it is not National Power's windmill, it is my windmill",
and I am not quite sure we have the culture or the history or
the kind of framework to move from where we currently are in Britain
to that model. But from a personal perspective I would not mind
a little more of that decentralised public ownership. We are investors,
we do seek a return generally on investing and I think the subsidies
for the renewable sector are rather marginal, rather small by
comparison with the masses of money that goes into other technologies.
We are thinking of offering to answer The Guardian's challenge
of how would you spend £6 billion in a serious renewable
effort because that was a challenge recently to the renewables
community. "If nuclear wants £6 billion for 3.6 megawatts,
what would you do, sir?" So we are seriously looking at addressing
(Mr Williams) I would like to add to that as well.
It depends whether you look at it holistically. At the moment
the fossil generators are not being asked to pay for the cost
of environmental damage. At the moment renewables are not being
paid for the benefit of being closer to the customer. At the moment
the European mechanisms pay farmers to not grow food. That same
money could be put into growing energy crops and reducing fuel
costs. And then there is the issue of competitiveness. It is not
just asking for intervention, it is asking for manipulation of
existing mechanisms as well to look at it in a broader sense.
The last point I want to make is that we are assuming the barriers
are planning and economic but I wanted to stress that one very
big barrier as far as we are concerned is Ofgem itself. If you
look at every NFFO Order Ofgem's response to each Order is,"God,
this is expensive to the customer, please go for a few cheap projects"
and in every Order the government has not taken Ofgem's advice
and has included more expensive projects. It then rests with Ofgem
as arbiter as to whether they come off later. Almost exclusively
we find that if there is a grey area of law, Ofgem will determine
against projects. As a company we lost 60 megawatts of plant in
the last year purely on technical minutiae when those projects
had planning consent, the money, the technology and all the contracts
in place, they just wanted one clarification from Ofgem and they
were killed. To put it in perspective, the Prime Minister made
a big thing about supporting around 30 megawatts of biomass from
a share of this £100 million announcement. Ofgem has killed
double that, as I say, on technical minutiae.
(Mr Milborrow) To get back to the original issue about
subsidies, it is not for us to speak for the DTI but, as I understand
their policy, it is to promote industries such that costs will
come down. As my colleagues have said, costs fell throughout the
period of the NFFO regime. I note with interest that one of the
Cabinet Office papers looking ahead to 2020 forecasts that, by
that time, onshore wind, for example, will have a price range
of 1.5 to 2.5 pence per kilowatt hour and that is cheaper than
coal, nuclear, the thermal sources, and even to offshore wind
(presently regarded as needing additional subsidy) they assign
a price range of 2 to 3 pence per kilowatt hour. Again, we are
cheaper than coal and cheaper than nuclear. It is not for us to
speak for the DTI but it looks as though, if learning curve price
reductions can be achieved, we will be in the happy position that
they will be able to stand on their own two feet.
Chairman: We will leave that for the moment
and take up some of the other points with others who are coming
this afternoon when we meet at 4.15 for our public session. Thank
you for your evidence this morning. If there is anything else
we want to pick up on we will get back to you. Thank you very