Select Committee on Trade and Industry Appendices to the Minutes of Evidence


Memorandum by London Electricity Group (LE Group)

  This memorandum is submitted by London Electricity Group (LE Group) in response to the specific questions raised by the Trade and Industry Select Committee (TISC) in its enquiry into security of energy supply.


  LE Group is a major electricity producer, with over 3GW of installed capacity in England and Wales (4.3 per cent of the generation market). As a supplier, we currently serve 7 per cent of the combined gas and electricity market. We are also a major network operator, distributing some 20TWh of energy across our systems last year, and are at the forefront of the distribution sector through the 24seven joint venture with TXU Europe. [37]Our aim is to be one of the UK's leading utility companies, an innovative asset owner, and a provider of first-class services to our three million customers. We have a proven record of investment, and will continue to demonstrate a long-term commitment to the energy sector in the UK.

  Whilst we operate as an independent entity in the UK market, through Electricité de France Group (EDF Group) we are part of one of the largest European players in the power sector and have a wide-ranging regional perspective. The EDF Group as a whole is the world's largest nuclear developer. It also has extensive interests in conventional power plant and new renewables technologies, and is a significant network operator across a number of interconnected markets.

  In this covering letter, we make some general points on the enquiry and the headline issue behind it. Our more detailed responses to the questions raised by TISC are set out by way of an attachment. Note that we have separated out some of these that cannot be readily answered together.


  Rising oil prices, declining indigenous resources, and recent events in the USA (not just in California) and New Zealand have brought security of supply into urgent focus. Based on current projections, import dependency will become a real issue of concern after the end of the decade. Measures already taken by government, such as the establishment of the DTI/Ofgem standing committee, represent an initial and timely reaction. It is possible that proactive action by government within the foreseeable future may be needed to deliver specific programmes that have already been initiated to contribute to greater diversity of supply. We also support the need for a review of energy policy and its objectives.

  LE Group has already made an active contribution to the review being undertaken by the Cabinet Office's Performance and Innovation Unit (PIU) into the longer-term objectives of energy policy. Security of supply is at the heart of these objectives and is a cornerstone of a balanced energy policy. In this context, we would hope that the thinking of the Select Committee will complement that of the PIU and that the timing of the delivery of both reports can be co-ordinated in order that government can make a considered response to both.

  In our view, it is important that security of supply is considered in a regional, rather than a purely UK, perspective, and we would highlight the linkage between the Committee's investigation and the recent European Commission's Green Paper (Towards a European Strategy for Security of Energy Supply, November 2000). None of the various reviews seems to properly address interconnection issues either between the UK and continental Europe or between an enlarged European Union and the rest of the world. The regional dimension is, of course, an area of some relevance to the security of supply question, and one which, in our view, requires much closer scrutiny and a more thorough understanding.

  LE Group strongly supports a market driven approach to the delivery of long-term security of supply. This means that:

    —  in competitive markets, energy prices should be the principal means of signalling the need for new investment and of clearing the market; and

    —  for regulated infrastructure activities, such as distribution, incentives to invest should be clear and regulation should be kept to the minimum necessary to constrain monopoly behaviour.

  As a general rule, government's role should be informational except where there is a need for policy support to facilitate achievement of specific programmes targetted at shorter-term policy goals. In turn, such programmes should provide minimum distortion to the market, not interfere with price signals and, where possible, avoid prescription.

  Ideally, market participants should be enabled to evaluate a range of market-based options for meeting government policy objectives, including security of supply, within a coherent framework, in order that they can pursue the most cost efficient options and those that best fit their competitive positions. A unified emissions trading framework would provide one such approach. In turn, such a flexible approach is likely to ensure outcomes that enable achievement of goals at least overall cost. For example, generally expressed carbon mitigation targets can also be set to stimulate a range of qualifying technologies, including renewable, energy efficiency, and CHP measures, that will foster diversity and therefore security of supply. In this way, emissions trading approaches can also be applied to help both diversity and security objectives.


  We believe that a unified framework of the kind discussed above, that sits across the different areas of energy policy, should be explored, rather than placing reliance upon a series of different policy instruments that may not wholly complement each other, and may indeed conflict. We accept that it is unlikely that such a framework could be developed quickly. In our view, this means that existing support programmes that impact on diversity of supply must be evaluated for consistency against the longer term goals, but should be time-limited where possible. Further actions taken by government in the interim (for example, to allocate the additional £100 million of R&D support) should be consistent with moving in the direction of an integrated approach.

  As a corollary to such an approach, we support the strengthening belief among energy market participants and commentators that some form of strategic energy agency should be established within the government process. The agency should have a particular remit for monitoring longer-term security of supply. Having assessed the options, and despite the wider objectives recently placed on it by virtue of the Utilities Act 2000, we do not believe that Ofgem is an appropriate candidate for taking on such an enhanced role. Ofgem should remain an economic regulator, and its focus is, and should remain, energy markets and their competitiveness.


  We can summarise our conclusions as follows:

    —  LE Group wants to see a mixed approach to energy supply and its secure provision;

    —  planned, not ad hoc, government intervention has a positive part to play in this process;

    —  consequently, there is a role for short term mechanisms to stimulate diversity of supply and particular emerging technology programmes, but these should provide minimum distortion to market-based policies, since it is market forces that are best placed to deliver longer-term security of supply; and

    —  there should be some form of strategic energy agency, within government, with a remit for monitoring longer-term security.

30 October 2001


Q. Given the imminent dependence of the UK on energy imports, how can the UK maintain a secure energy supply? What mix of fuels would maximise security?

  The issue of security of supply can be separated into two:

    —  maintaining adequate supply infrastructure and investment; and

    —  within a context of capacity adequacy, ensuring supply can be maintained to the consumer. [38]

  The Select Committee's questions are focussed on security of production. We believe that there are also very important issues surrounding security of networks. We have addressed these in a paper recently tabled with the PIU, which the Select Committee may wish to note in its deliberations. A copy is enclosed.

  We strongly support the concept of markets delivering system security of supply and capacity adequacy that has underpinned recent decisions by the government and Ofgem. Establishing direct incentives through payments for capacity as practised under the Electricity Pool created unnecessary costs for customers and perverse incentives for many generators, without discernibly impacting on security of supply. There is also substantial evidence from electricity markets overseas to suggest that prescriptive contracting or the imposition of capacity obligations deliver a capacity margin at significant cost to the consumer. Unlike California's, the UK's energy markets have a good record to date of investment.

  We believe that governments should have an active oversight role with regard to security of supply. They should aim to establish stable policies within a transparent rule-based framework, monitor performance, and provide information. But it must be for the market to deliver security of supply through "normal" commercial processes. If the market expects that government will intervene in an ad hoc manner (for instance, to mitigate prices or impose price caps), it will be less inclined to invest. Such a hybrid arrangement, combining market philosophy with ad hoc intervention, could well undermine security of supply relative to alternative approaches.

  Against this background, the government can fine-tune provision of more diverse energy supplies through a combination of supporting policies and measures for specific technologies. However, it should only do so where actions can be considered to have specific benefits in terms of environmental, social, and industrial policy. Such actions might include the continuation of current measures such as:

    —  maintaining incentives to stimulate low carbon emissions, such as the Climate Change Levy (CCL) and Renewables Obligation (RO);

    —  keeping the nuclear option open (on which we comment further below);

    —  maintaining and increasing interconnection with continental Europe (on which we also comment further below);

    —  continuing to push forward a single energy market concept in Europe, thereby benefiting from diversity of supply within the Community in both its current and its expanded state; and

    —  ensuring when necessary that market arrangements adequately incorporate "insurance", for example in the form of sufficient ancillary services and fuel switching capacity to deal with short-term security of supply issues.

  We consider that it would be wrong for government to prescribe an optimal fuel mix for the purposes of security of supply. Any attempt to do so would be inappropriate because:

    —  there are no cast-iron mechanisms to deliver such a mix, even if it were considered desirable;

    —  forecasts are rarely right, and certainly not for long; and

    —  technological change will move the goal posts.

  The UK and Europe cannot meet their Kyoto targets without current levels of nuclear energy production. This is also a key component in existing fuel diversity in the UK and plays a major role in maintaining a balanced supply position. But its relative importance—in the absence of any compensating policy action by government—is set to diminish.

  There are many reasons why nuclear power should continue to contribute to the country's energy supply. Nuclear power has an excellent safety record in the UK and more generally within Europe. There clearly are unresolved issues that impact on the policy formulation process, but these pertain more to political decision-making and communication than to technology and economics.

  Looking into the longer term, public confidence in nuclear power remains a very significant barrier that must be addressed by the government if there is to be any lasting acceptance. Again, education and communication are likely to be key mechanisms that the government will need to pursue to facilitate implementation of revised policies and programmes to help secure a growing nuclear contribution.

  The Select Committee needs to take an informed view both of the realistic prospects for maintaining the existing contribution of nuclear power (including the need to retain skills and capabilities to manage a nuclear programme in the UK) and of the underlying economics of future nuclear development if it is to unlock the security of supply issue.

  Recent developments in both Europe and the USA are encouraging, and are beginning to lead to a reappraisal of the economics. The DTI, in its own initial submission to the PIU's energy review, has given a strong indication that it considers the "prospects for new (nuclear) build to be economic, provided that appropriate allowance is given for carbon savings". Design standardisation will bring further benefits, as will continued development of a new generation of reactors such as the AP1000 and the EPR, putting pressure on capital cost estimates.

  We also believe that an important contributor (though not a solution on its own) to enhanced security is increased diversity between markets. Consequently, LE Group supports the continued opening up of European markets and further interconnection and trading within the European Union (EU). In this context, we have welcomed the wider European debate on security of supply and, through the Electricity Association (EA), publication of the European Commission's Green Paper. We would highlight the following relevant points in the EA's response:

    —  import dependency either at the EU or the UK level is not on its own necessarily detrimental, provided that wider trading frameworks and open access to markets can be properly developed;

    —  an important ingredient to security is diversity of fuels and supply sources, so the diversification offered by the UK and other Member States should progressively increase security; and

    —  better co-ordination between markets should be achieved by introduction of more competitive markets within Europe (which will further enhance natural diversity between markets) rather than by any prescriptive policy to limit energy imports.

  The Green Paper initiative and the responses of Member States to it are very relevant to the Select Committee's investigation. A White Paper is promised later in the year and the Committee will want to take stock of this in its own deliberations.

Q. Is there a conflict between achieving security of supply and environmental policy?

  No, in general there is unlikely to be a conflict between achieving security of supply and environmental objectives. This consistency exists because the main risks to security arise from dependence on carbon-based fuels. It follows that programmes and mechanisms directed at stimulating "clean" fuel sources are likely to have a beneficial impact on diversity and, therefore, on security of supply.

  LE Group believes that there should be a continuing role for coal generation in a balanced fuel strategy, despite the fact that this will not actively contribute to emissions reductions. Coal generation will have significant off-setting benefits because it is very flexible and could be an ideal complement to intermittent renewable sources and thus actively contribute towards both renewables targets and balanced energy supply strategies. Consideration should also be given to establishing rolling targets for emissions from coal generation to reflect the desirability of retaining flexible use of renewables technologies year-on-year.

Q. What is the role for renewables?

  Renewable technologies are likely to have an important role in meeting not just environmental but also security goals. But further action is needed by government to remove barriers to entry and to facilitate achievement of existing targets.

  We welcome and support the proposed significantly expanded role for renewable sources of energy. Our generation subsidiary, London Power Company, is currently negotiating permission to build a wind farm off the coast of north Norfolk able to supply the annual requirements of 45,000 homes. And, on the retail side of the group, we have recently introduced a special green tariff to encourage the development of community-based renewable energy projects.

  A two-pronged approach based on direct support and the RO is sensible and should stimulate higher levels of market penetration by a range of proven and emerging technologies. Prospects for penetration by individual emerging technologies will depend on how the remaining £100 million support announced in March 2001 by the Prime Minister is to be targeted. The outcomes and findings from the PIU's renewables and resource productivity study, which has been rolled into the energy policy review, will provide important input to decisions on how further funding should be allocated.

  The recent statutory consultation on the RO goes some way towards widening the envelope of eligible renewable technologies and providing a more realistic approach to setting RO targets. However, we believe that the focus should be on stimulating new build rather than on creating windfall gains to existing technologies, such as medium scale hydropower.

  In addition, we remain strongly sceptical about the feasibility of achieving currently proposed targets. It is unrealistic to expect any significant increase in renewable generating capacity before the year 2005 at the earliest. We also recommend that the obligation is phased more on the later years instead of on the first two years. Recent research by (among others) Cambridge Econometrics suggests that targets are still too tough and that an 8 per cent obligation is the most that can be reasonably achieved by 2010.

  The government must be active in enabling the energy industry and renewable developers to meet the challenging targets proposed, and the urgent and speedy removal of obstacles in the planning regime should be a government (including local government) priority. A government-funded public education programme is essential to help to remove local opposition to widespread renewables development.

  Even if planning and regulatory barriers can be overcome, there will remain practical and logistical reasons why the levels of increased take-up beyond 2010 are also not attainable. [39]The relative contribution of renewables will take on greater significance since, as seems inevitable on current policies, there will be a diminishing contribution from nuclear sources from around that time. As yet, however, there has been little consideration of how renewable technologies can continue to expand beyond 2010, what might constitute a reasonable contribution from them to a balanced energy strategy, and, critically, how this can be achieved. Promulgation of targets beyond 2010 will have a direct impact on medium to longer-term security of supply.

Q. What is the role for Combined Heat and Power (CHP) schemes?

  Through our generation subsidiary, London Power Company, we currently operate CHP/district energy schemes at Heathrow Airport and, in London, at Imperial College in South Kensington and the Barkantine Estate on the Isle of Dogs. However, we are concerned about barriers to further development which will inhibit achievement of government targets.

  Some of the barriers to renewables we have set out above also apply to CHP, but, in addition, economic factors are increasingly coming into play. Recent increases in gas prices and the diminished value of electricity exports are threatening the continued operation of existing CHP schemes and the viability of planned projects. [40]If not tackled, these factors will impair the achievement of the government's targets. In this context, we note recent statements by Ministers Meacher and Wilson that CHP targets are to be reaffirmed and that obstacles to their realisation will be addressed.

  In our opinion, there are three key areas in which effort should be focused to assess what framework might encourage a better take-up of CHP. First, analysis of the economics of CHP should include a specific assessment of carbon savings. The cost/benefits of the impact of CHP on network investment and operating costs should also be taken into account.

  Second, the implications of current market and regulatory incentives impacting on CHP development need to be assessed. The UK electricity supply industry has become progressively more fragmented over recent years, and the practical benefits of CHP cannot be properly realised under current structures. For instance, the regulatory framework does not properly acknowledge many of the benefits of CHP to participants, including the operators of the public distribution networks.

  Third, further work is required to assess the potential impact that could be achieved on CHP development through a greater integration of local planning policies and building regulations with energy policy. We welcome recent government statements on the establishment of a one-stop shop for planning consents. [41]

Q. What scope is there for further energy conservation?

  The UK has pursued successful energy efficiency programmes for a number of years, and suppliers such as LE Group have actively contributed to a record of achievement (in particular, in our case, within London and the south west of England). Further development of energy efficiency measures will have a very beneficial impact on security of supply, as well as making a direct contribution to environmental targets.

  It is generally recognised within the industry that a sustained effort is now needed if remaining barriers to energy efficiency are to be overcome and if proposed levels of emissions reductions assumed from energy efficiency measures in line with the Climate Change Programme are to be achieved.

  The barriers to a greater take-up of energy efficiency in most market segments are well understood (for example, the comparative cheapness of energy representing a small component of expenditure), and we consider that this position is unlikely to change significantly over the short to medium term under current energy price levels. This situation brings into relief a potential conflict between regulatory policies promoting greater efficiency and wider government objectives aiming for greater take-up of energy efficiency. Closer monitoring and market research of existing programmes could help to better target the present efforts.

  It follows from this that recent government initiatives should be allowed to settle down before further measures are pursued. It will be important to monitor the impact of new initiatives such as the Home Energy Efficiency Scheme (HEES) and the Energy Efficiency Commitment (EEC) to see how resources should be best targeted. Better communication by government and suppliers is likely to lead to enhanced public awareness and be very important in addressing barriers to energy efficiency.

Q. What impact would any changes (in energy prices) have on industrial competitiveness and on efforts to tackle fuel poverty?

  The UK's industrial competitiveness is clearly vulnerable to changes in input prices, including the costs of electricity. One means of managing this risk is to align policy initiatives that put upwards pressure on energy prices, and changes in them, with those of other EU Member States.

  At the same time, any impairment of the country's ability to meet consumer requirements for energy supply could have a profound impact on industry's ability to compete. The PIU canvassed views on the merits of a security "insurance" premium to deal with the risk of interruption. For reasons set out above, we do not support a general capacity charge or obligation to stimulate adequate investment in the energy sector. However, the concept of consumers paying for specific measures that promote diversity and support fall-back measures to deliver greater flexibility and diversity of supply is an important part of energy policy.

  This mixed approach is not new: the RO, CCL and EEC could all be regarded as ad hoc interventions to stimulate particular technologies which are seen as having a specific diversity benefit. But it is important that the cost of any further market distortions is thoroughly justified on policy grounds, minimised, and passed through in such a way that all suppliers and consumers face the impact. This is an issue that we would expect to see addressed by the PIU in its review of long-term energy policy objectives.

  Inevitably, real increases in electricity prices, when they occur, will impact on fuel poverty and the ability of government and industry programmes to tackle it. Over the short term, the introduction of mechanisms such as the EEC and other supplier programmes will continue to help towards tackling the problem.

Q. Is any change of government policy necessary? How could, or should, government influence commercial decisions in order to achieve a secure and diverse supply of energy?

  Yes, change is needed. The current energy policy framework in the UK is focused almost exclusively on achieving competitive market outcomes, and is insufficiently comprehensive to capture newer policy goals being set with regard to environmental and security of supply criteria. The framework also presently demonstrates a number of policy inconsistencies. As the Royal Commission on Environmental Pollution (RCEP) has noted, "achieving the right balance (in objectives and policies) is formidably difficult, and current policies do not strike it"[42]—though admittedly the RCEP's focus was environmental, and not security, considerations.

  The energy policy framework will need to enable the resolution of sometimes conflicting objectives and trade-offs, and to provide a process for resolving different priorities. It is important that, where non-market outcomes are sought, there is a robust methodology for quantifying the costs and benefits against adopted objectives. Once established, the framework needs to be stable, with the scope for future intervention clearly defined and predictable. This goal is particularly important because of the capital-intensive nature of the energy business, the long-lived assets involved, and the need to establish a stable investment environment. All these factors are fundamental to achieving security of supply.

  As the Committee may have noticed, there is among energy market participants and commentators a strengthening argument for setting up some form of strategic energy agency within the government process. Such an agency, if established, should have a particular remit for monitoring longer-term security of supply. Whether this should be an augmented function within the DTI or a cross-departmental entity is an issue for the Select Committee and the PIU to consider.

  Having assessed the options, and notwithstanding sections 3A(5)(c) of the Electricity Act 1989 and 4AA(5)(c) of the Gas Act 1986, we do not believe that Ofgem is an appropriate candidate for taking on such an enhanced role. [43]Ofgem should remain an economic regulator, and its focus is, and should remain, energy markets and their competitiveness.

October 2001

37   LE Group became the sole owner of 24seven on 18 January 2001. Back

38   The PIU has termed these conditions "system security" and "strategic security" respectively. Back

39   The PIU, for example, envisages a 20 per cent contribution by 2020. Back

40   TXU, Innogy, Powergen, and Northern Electric have all recently announced plans to curtail CHP development. Back

41   Anna Walker, Director of Energy Policy, DTI, noted this in oral evidence to the House of Lords Sub-Committee investigation into the Green Paper on 15 October 2001. Back

42   Energy-the Changing Climate. Summary of the Royal Commission on Environmental Pollution's Report (June 2000), p 1. Back

43   The Institute of Public Policy Research (IPPR) has recently called for a wider reformulation of the regulator's objectives and duties, but we do not believe this to be appropriate. Back

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