Memorandum by Innogy
Innogy is a leading integrated UK energy company.
We generate electricity and supply gas, electricity and other
essential borne services through our retail business npower. We
operate and manage our flexible portfolio of power stations, run
our own trading business and are developing innovative energy-related
technologies. We are also the market leaders in renewable energy
production. We welcome the opportunity to contribute to the Committee's
Security of supply in the provision of energy
to end-users is a complex issue. As with the supply of any product
or commodity there is a supply chain and, in the case of energy,
a significant and diverse one.
Security of supply to the end user is, therefore,
dependent on the security of each link in the chain, the interactions
between links and the process for providing and delivering contingency
in the event of failure.
There are numerous variables impacting each
link in the supply chain, which itself will have different components
depending on inputs and the type of energy being delivered. For
example, coal can come from the UK or be imported, it has different
storage characteristics to gas and UK continental shelf (UKCS)
gas has a different delivery route to imported gas. Similarly,
different generating technologies have different reliability characteristics
and flexibility of response characteristics. Transporting gas
(underground pipeline) carries different risks to transporting
electricity (overland or underground wires).
The permutations on the physical side of the
supply chain are myriad. In addition the financial elements in
the chain need to operate smoothly, openly and without distortion
to encourage efficiency in extraction, generation and delivery
of energy. Investment in new physical assets will be driven by
appropriate market signals. It is important, therefore, that market
signals are not suppressed, as was the case in California (see
To illustrate the complexity of the supply chain,
the diagram below shows how natural resources are extracted, converted
and transported to deliver usable energy to consumers using, as
an example, electricity delivered through gas-fired generation.
In summary, the issue of security of supply
cannot be broken down into discrete questions such as, will there
be enough fuel, what should the fuel mix be, is the infrastructure
adequate, is there sufficient capacity, etc? All of these issues
are important in their own right but only when considered together
can a realistic picture of the risks to secure energy delivery
be fully appreciated. Secure energy delivery depends on the efficient
interaction of the physical and financial aspects of energy production,
energy conversion, delivery and consumption.
The remainder of this document outlines Innogy's
view on aspects relevant to deliberations on the security of supply
Detailed comments on security issues have been
set out in sections corresponding with specific questions raised
by the inquiry. The responses, however, should not be considered
in isolation, as the issues raised are inter-related and need
to be considered in the round.
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 key factors affecting security of supply
are fuel diversity, security and longevity of fuel supplies, delivery
to consumers and generation capacity. In any supply chain, the
ability to store raw materials (fuel) and product (electricity)
is a key factor in protecting against interruptions further up
2.1 Fuel Diversity
Fuel diversity is merely a means to an end in
respect of security of supply. It is not an end in itself but
contributes to secure supply by (a) mitigating against over reliance
and (b) contributing to flexibility of response.
(a) Mitigating against over reliance
Over reliance on any single fuel type carries
with it significant risk of system failure. At present, and for
the foreseeable future, the majority of generation relies on the
burning of fossil fuels. Much of this fuel, be it gas, oil or
coal is imported and whilst indigenous reserves exist, in the
case of oil and gas in particular, reserves are anticipated to
diminish to the point where the UK is a consistent net importer
in the near or medium term. In addition, the transmission mechanism
for oil and gas can be interrupted and it is both difficult and
expensive to carry large stocks of oil and gas.
The emergence of renewables as a significant
contributor to meeting future energy demand will help diversity.
(b) Contributing to flexibility of response
The other key factor in the choice of generation
plant is its ability to meet the variable demand for electricity.
In assessing this, it is not just the inherent abilities of the
plant that matter, but also the ability of the fuel delivery system
and the electricity transmission system. Nuclear plant has poor
system response characteristics. Gas-fired CCGTs can be responsive
but there are real concerns as to the capability of the gas National
Transmission System to cope. Coal plant is responsive and has
stored fuel. Most forms of renewable generation generate intermittently
due to the nature of the "fuel" source.
The concept of maximising security of supply
would, inevitably, lead to conflict with other policy objectives.
Maximising security of supply would create inefficiencies through
requiring excessive capacity throughout the supply chain, leading
to high prices and potential unnecessary environmental impairment.
2.2 The Role of Gas-Fired Generation
We recognise the Government's concerns about
a further expansion of gas-fired generation. Whilst we believe
that UK gas resources are likely to prove to be greater than some
current estimates, there is a legitimate concern about becoming
over-dependent on a single fuel type.
Gas burned in CCGTs provides medium-carbon generation
and it is arguable whether the CO2 benefits of further CCGTs outweigh
the security of supply concerns. As a major domestic gas supplier,
we are also concerned that increased gas demand for generation
will push up prices.
The arguments for further gas-fired CHP/cogeneration
are stronger. This high efficiency use of gas has greater CO2
benefits and will help reduce the costs of other industries meeting
environmental targets. The Government has already recognised the
important contribution that CHP/cogeneration could make and set
out ambitious targets for this sector. The combination of high
gas prices and low electricity prices, together with structural
issues with NETA, CCL and Renewables Obligation, mean that these
targets are unlikely to be met without positive action.
2.3 The Role of Coal-Fired Generation
Innogy believes that coal has a significant
role to play in the long-term energy profile of the UK. It retains
several specific advantages:
Coal reserves will outlast those
of gas and oil;
International coal is available from
many diverse countries;
On site storage is easier than other
Diverse delivery options (rail, road,
ship) reduces the risk of interruption;
Coal-fired power stations make by far the greatest
contribution to the security of electricity production. They can
operate very flexibly and so mitigate short-term problems with
other generating plant or the transmission system. They can also
switch to running at high load factors for a sustained period
to cover long-term problems. The under-utilised oil plant provided
such a role during the coal strikes. Without them, there would
have been substantial power cuts.
Ever-tightening environmental limits (particularly
SOx and NOx) will rapidly reduce the amount of generation from
coal-fired stations over the next five years and could lead to
the closure of a substantial proportion of those stations by 2010.
Under normal generating conditions the energy production from
these plant will be picked up by other stations, including new
renewable generation. The contribution to security of supply is
not currently rewarded in the market and so plant will close because
its fixed costs cannot be met when operating at low load factors.
We have suggested in Section 6 how this might be addressed.
2.4 The Role of Nuclear Power
We recognise the valuable contribution that
nuclear generation makes in reducing CO2 emissions. However, its
long-term effects and irreversible impact mean that it cannot
yet be considered as a sustainable technology. We believe that
new nuclear build is a potential option for the future and should
compete alongside other low-carbon options. It has been argued
that nuclear is disadvantaged as it fully internalises all external
impacts. Whilst there may be some substance in this argument relative
to fossil-fired plant, it is not true in the low-carbon sector.
The impact of routine radioactive emissions is not fully internalised
nor is the potential impact of emergency events fully insured
by the industry.
There have been calls for early decisions on
the likely role of nuclear power in the generation mix beyond
the expected lifetime of existing plant. This has mainly been
fuelled by the stated long lead-time for nuclear build, which
is currently around 10 to 12 years.
In reality, there is no requirement for a rushed
decision on the future of nuclear and any consequent build programmes.
The main reasons are:
The frequently quoted lifespan of
existing AGR nuclear plant, ie decommissioning mainly between
2010 and 2020, is based on the accounting lifetime of the plant
not its technical lifespan, which can be extended beyond this
Ordinarily, it is more cost effective,
quicker and lower risk to refurbish old plant than to incur the
full costs of new build. If a policy of refurbishment is followed,
a decision on new build need not be taken at this time;
The Government review into nuclear
waste policy has not yet been completed;
UK design and build standards differ
from those in other countries. This leads to increased costs when
developing designs for international markets. Standards should
be harmonised internationally.
In summary, we believe that new nuclear build
should be permitted to compete as a low-carbon technology. However,
the high cost of nuclear, together with its long lead-time and
future liabilities, mean that it is unlikely to be competitive
in the short to medium term. In the longer term, new designs may
make it commercially viable.
Nuclear power plants are inflexible in their
operation and run at high load factor. There is no scope to increase
output to cover unforeseen events. Whilst new nuclear plant would
contribute to long-term fuel diversity, it is potentially a very
expensive way to improve overall security.
2.5 The Role of Renewables
Renewable technologies can and should play a
significant role in the future fuel mix of the UK energy sector.
The Committee has asked a specific question
on the role of renewables and, accordingly, Innogy's comments
on this important issue are included in that section. Readers
are therefore referred to Section 3 for detailed comment on renewables.
2.6 Projected Future Fuel Mix
Throughout the 1990s gas-fired CCGTs made a
substantial contribution to achieving reductions in environmental
emissions. The major shift towards this medium-carbon generation
source has been the key factor in enabling the UK to meet its
international obligations. At the same time it has increased fuel
source diversity and helped reduce prices to all customer groups.
Whilst it is tempting to assume that a "more
of the same" approach will deliver further benefits, we share
the Government's concerns about becoming over-reliant on a single
and imported fuel type. Furthermore, we believe that substantial
further reductions in CO2 will only be achieved by moving the
focus from medium-carbon gas to low- or zero-carbon generation
By introducing the Renewables Obligation on
suppliers, the Government has recognised that low-carbon generation
is not currently economically viable against fossil-fired plant.
The market would not, therefore, deliver a low-carbon future.
The Renewables Obligation has the effect of creating a low-carbon
market alongside the existing market. We fully support this approach
as it enables the market to deliver the optimum solution within
a framework that will ensure overall objectives are met.
Whilst it is useful to look to 2050 as over
that timeframe the whole infrastructure will have been renewed,
it is futile to speculate as to the precise plant mix in 50 years'
time. An attempt to predetermine a technology mix will be economically
inefficient, resulting in higher prices and potentially lower
Having created a separate low-carbon market
sector through the Renewables Obligation, technologies should
compete freely to supply the needs of that sector. Whilst we will
not speculate as to the low-carbon technology of choice in 50
years' time, we do have views on how the low-carbon market is
likely to develop over the next 20 years. We also have views on
the continuing role of fossil-fired plant over that period.
Competitive forces will determine the optimal
plant mix within the framework set by Government. However, we
have set out in the table below our view of the split of generation
by fuel source in 2010 and 2020:
Electricity Generation by Fuel Type (Based
on CH case in Energy Paper 68 adjusted for steady renewables build
and AGR life extension)
|Market Share (%)
|Coal|| 30|| 22
|Oil|| 1|| 0
|Gas|| 38|| 45
|Nuclear|| 23|| 22
|| 9|| 24|
|Imports|| 5|| 2
2.7 Security and Longevity of Fuel Supplies
In this section we consider fuel supply, to include availability
of fuels and the delivery of it to UK generating facilities or,
in the case of gas, to the beach.
The key aspects of security of fuel supply are that of interruptibility/continuity
of supply, generation reliability, storage and import dependency.
Different fuels have different risks attached to their use
in these respects. For example, wind energy has strong continuity
of supply (it being impossible to interrupt its delivery) and
zero import dependency but lower generation reliability (a minimum
wind speed being required), whereas nuclear has strong generation
reliability and coal has easy storage capability with strong UK
reserves and diverse international sourcing.
Obviously, these aspects will change over time, for example
tidal wave energy is likely to see a growth in generation reliability
as its technology develops and the import dependency of gas and
oil will change as domestic reserves diminish.
For illustration, the table below sets out various merits
of different fuel types with indications, where appropriate, of
how these may change in time.
||Other Environmental Considerations
|||Improve over time
|||Decline over time
Clearly, the reliability and security ratings would reduce
as the quantity being relied upon increases and the consequences
of an interruption therefore increase.
2.8 Delivery of Energy to Users
In this section we consider delivery of energy to end users
being, in the case of gas the UK distribution network, and in
the case of electricity the national network and local distribution
The two key aspects of the secure delivery of energy to users
(a) The capacity and integrity of the distribution networks;
(b) Having sufficient resources upstream to meet demand.
(a) The capacity, integrity and efficiency of the distribution
There are both physical and financial aspects to the integrity
and efficiency of the transmission and distribution networks which,
for historic reasons, operate with different characteristics.
The transmission system, operated by the National Grid Company
(NGC), links power stations through a network to distribution
hubs. Power can flow along the wires in either direction so that
it can be supplied, if needs be, over large distances with geographically
diverse generation supporting the integrity of the network. From
the distribution hubs power flows in only one directionfrom
the hub to end-users. This distinction has particular relevance
if the future electricity system is to shift from this distributed
generation model to one with significant amounts of embedded generation.
Because of the different natures of the transmission and distribution
networks we have addressed them separately below.
Standards for Transmission Security are enshrined in a single
document and are
built around the concept of guarding against a single large loss
of capacity. The physical standards already set should be maintained
but should also be subject to an economic test. For example, if
the cost of holding reserve is low then it may be economic to
hold a higher level of generating reserve on the system and permit
a larger loss as a result of a transmission failure.
To enable this economic efficiency it is necessary to encourage
a market in reserve running alongside the conventional electricity
market. The current monopoly position of NGC in purchasing reserve
makes it difficult to ensure that the system is being configured
economically. The provision of the frequency response service
under extremes of systems conditions would be more reliable, and
thus the transmission system more secure, if a market approach
Operation of the core transmission system is a monopoly activity,
however we believe competition at the fringes should be encouraged
to increase economic efficiency and contribute to security of
Similarly, transmission security will be enhanced if transmission
charges provide clear economic signals to market participants.
Currently, there is no mechanism under NETA that rewards the despatch
of plant to reduce transmission losses. Including such a mechanism
will influence the siting of new plant-to bring plant close to
loadcontributing to economic efficiency and security.
With the transmission network being an integrated system
and no alternative physical route to market it is essential that
access rights to the transmission system are unambiguous. Uncertainty
on access rights will influence investment decisions and, potentially,
impact long term capacity and security. The auctioning of transmission
access rights would increase uncertainty over the longer term
and is an inappropriate method of allocating access rights.
In line with its environmental objectives, the Government
has promoted the twin targets of 10 per cent of generation being
embedded in the distribution system and 10 per cent of electricity
being produced from renewable sources by 2010. Achieving these
aims may require distribution systems to be operated in a different
manner than currently, because of the current unidirectional flow.
We support the renewable generation objective but have concerns
over promoting localised generation on grounds other than the
low carbon content of its fuel because:
Local, predominantly gas fired generation would
require significant small scale build, creating problem areas
around planning consents and may not deliver a low carbon outcome;
Significant numbers of developments of this type
could lead to a heavy reliance on gas as a fuel source in the
Local generation would still require back-up support
and therefore a grid of some form would still be required to ensure
security of supply and despatchable generation to cover shortfalls
would still be required;
Economies of scale in generation would be lost;
Local plant would be relatively costly to build,
both because of the cost of obtaining planning consents and the
costs of installing appropriate emissions controls on a small
Innogy believes an alternative scenario has significant attractions
and warrants investigation. The scenario is based on an incremental
approach and runs as follows:
Local demand requirements are supported from renewable
sources and localised electricity storage facilities wherever
Storage facilities are recharged when required
from large scale generation plants which enjoy economies of scale
both in terms of economic and environmental efficiency;
Because of the potential of storage the large
scale plant can be scheduled to operate at off peak hours, for
example when demand for gas is low, helping keep prices down.
Under this scenario plant remains available to cover outages,
efficiencies are encouraged and the use of less dependable forms
of renewable energy are not discriminated against.
Transco, a subsidiary of the Lattice Group, is the owner
and operator of the National Transmission System (NTS) for gas.
In its submission to the PIU Energy Review it makes the following
points (which we have paraphrased) with which we concur:
Gas requires fixed infrastructure which is capital
intensive and long term in nature. The adequacy of Britain's infrastructure
in combination with the wider pan-European systems will have an
important bearing on supply security;
The capacity of the NTS will need to be expanded
significantly to accommodate anticipated future demand supply
Developments such as the promotion of embedded
generation are likely to reinforce the need for increased NTS
It is unclear whether market mechanisms alone will provide
sufficient signals and incentives to induce these required investment
levels in a timely way. We remain concerned about the ability
of the NTS to cope with the dynamic changes in demand as existing
plant starts to two-shift.
We include in this section views on the use of hydrogen as
an energy distribution vector. This is because hydrogen is not,
in itself, a primary fuel source and, for use as fuel, has to
be generated from primary fuels such as fossil fuel, renewable
or nuclear sources. As such, in many cases it is only CO2 free
at the point of use and not over the entire generation chain.
To date, no large efficient power plants have been run with
100 per cent hydrogen and the technology to run large turbines
using hydrogen remains undeveloped. Use of hydrogen in smaller
combined heat and power plants, if run on a heat demand basis,
is more efficient than use in large plants. However, under today's
technology the capital cost of the total system will be considerably
more than for total systems of electricity generation and transmission.
Total system efficiency will only exceed that of electricity as
an energy vector if heat utilisation at the delivery point is
efficient and even then it is doubtful if overall efficiencies
will exceed that for electricity use in a heat pump for the heat
load. Under today's technology, overall efficiencies will certainly
be lower than use of natural gas as an energy vector.
The most significant aspect of hydrogen use as an energy
vector is, however, safety. Hydrogen has an extremely wide flammability/explosive
limit range and high energy density. Add to this its tendency
to rise and become trapped under containment means hydrogen is
a dangerous fuel to store and transport. The wider the transportation
network the greater the risk of accidents, mal-operation of equipment
or malicious behaviour. Whilst the technology to achieve this
is known, ensuring its integrity during build and operation is
Hydrogen is not a primary fuel and needs to be
generated using other primary fuels;
The use of hydrogen as a viable energy vector
in electricity generation would require significant technological
Overall efficiencies of using hydrogen as an energy
vector will be lower than those of using natural gas;
The use of hydrogen as an energy vector for transport
applications would incur high costs of fuel storage and transportation
to ensure safety.
(b) Upstream resources
The issue of electricity generation capacity is critical
to security of supply and is dealt with in more detail in the
next section. However, the other main aspects of upstream resources,
the storage of gas and the storage of electricity, are dealt with
Utility scale power storage is now technically proven and
is expected to enter commercial service in the near future. Storage
has the potential to transform the design and operation of transmission
and distribution systems. Equally, it has the potential to have
a profound impact on the mix of generation assets and their operational
regimes. Until there is sufficient storage, the natural fluctuations
in demand require the system to include generation plant which
can be operated flexibly and which can be remunerated from only
short periods of operation. It is not yet clear that the present
system adequately remunerates such plant-this may develop into
a more serious problem if the surplus of capacity declines in
Utility scale electricity storage can contribute directly
to security of supply by providing cover in the event of outages
or peak demand. Its use for this purpose will not only provide
cover cost effectively but also reduce reliance on fossil fuel
All other commodities use storage at various points in the
supply chain as a key element in providing security of supply
at lowest cost. We believe that electricity storage is a key ingredient
in the development of the future electricity system. Not only
will it enable inflexible or intermittent low-carbon generation
to play a greater role, but also it will contribute to security
of supply and will improve substantially the utilisation of capital
assets, leading to lower costs.
The anticipated increase in reliance on imported gas has
implications for the volume of storage facilities that will be
required to ensure future security of supply downstream.
Gas storage operates in a deregulated environment and, since
deregulation, there has been little investment in new gas storage.
It is unclear at this time whether market mechanisms will provide
sufficient signals and incentives to ensure adequate and timely
investment in gas storage.
2.9 Generation Capacity
Demand growth is difficult to forecast precisely, as it depends
on a number of criteria, that includes:
the growth of the national economy;
the future mix of the national economy;
future developments in environmental and market
the impact on power prices of competition in generation
international fuel prices;
the effect of power prices and government incentives
on demand management; and
the introduction of new technologies such as renewables
However, the UK economy is much less energy-intensive than
California and so the credible range of electricity demand scenarios
and rates of growth are much narrower. An economic boom in California
led to a rapid rise in electricity demand, the energy impact of
economic growth in the UK is much less severe.
In the UK, the current excess of supply over demand is resulting
in low electricity prices and a decline in the rate of new plant
construction. However, the combination of low electricity prices
and high fuel prices results in reduced incentive to invest in
generation assets in the short term. If new investment is not
encouraged, supply capacity will reduce in the medium term as
older plant reaches the end of its life and the economics of coal
plant is affected by the tightening of environmental constraints.
If overall demand continues to grow at historical rates then in
the longer term new plant construction will be required to meet
this demand. It is expected that before new plant is built the
balance between supply and demand will have to shift to the point
where power prices have risen to the level at which such new build
can be remunerated by the market.
The introduction of New Electricity Trading Arrangements
(NETA) in Spring 2001 has stimulated liquidity in the forward
market for electricity but is only a partial design. It needs
to be further developed by reducing the timescale in which the
System Operator intervenes, and evolving the balancing services
of response and reserve into market based arrangements before
it can hope to deliver some of the efficiency gains expected of
Price volatility in the prompt market and balancing mechanisms
are an inevitable and essential feature of the electricity market.
It is these price signals that provide the market with indicators
of system stress and are, therefore, a stimulus to investment.
If this volatility is suppressed, as some have suggested, either
through market distortion or regulation, then the risk of market
failure, and consequently future capacity shortages, is increased.
Another significant weakness of the NETA design is the removal
of any form of capacity credit. Some peaking and reserve plant
is called upon only intermittently and for short periods. Currently,
such plant has to cover its fixed as well as marginal costs and
generate reasonable profit over short bursts of utilisation making
investment in it unattractive. There is the potential to compromise
system security if this peaking and reserve capacity is not maintained
and, therefore, there is a need to ensure it is adequately remunerated.
We have suggested a simple commercial solution to this problem
in section 6.1.
Is there a conflict between achieving security of supply and
environmental policy? What is the role for renewables, and Combined
Heat and Power schemes?
There is no inherent conflict between the broad objectives
of achieving security of supply and environmental policy, Indeed,
the development of renewables can contribute significantly to
security of supply through increased diversity and by using indigenous
and uninterruptible energy sources such as wind, wave and tidal
movements. Similarly, the application of emissions controls need
not conflict with security of supply so long as emissions reductions
are applied consistently and in a manner which allows markets
to ensure the efficacy of their achievement.
The expansion of generation from renewable sources is a key
element in improving fuel diversity and ensuring national self-sufficiency.
The volume of potential generation from renewables is very
large and, by definition, inexhaustible. For instance, offshore
wind alone could readily fulfil the UK's average annual electrical
energy demand. Denmark currently generates some 15 per cent from
wind and has set a national target of 50 per cent. Wind generation
today accounts for 0.3 per cent of UK generation within a total
of 2.8 per cent for all renewables, and yet the UK has the largest
wind resource in Europe.
The cost of renewable generation, particularly wind, has
fallen dramatically in the last decade. Generation costs have
more than halved as volume production has increased and machine
sizes have increased into the 1 megawatt-plus range. However the
lifetime cost depends critically on average wind speed and this
cost will rise as lower wind speed sites are developed on shore.
The cost of offshore wind, currently in its infancy, is likely
to drop significantly for the same reasons as experienced on-land
in the past.
We believe that of the existing technologies, wind generation
is currently the most viable form of renewable generation. We
would, therefore, expect that windpower will meet the majority
of the increased need for low-carbon electricity over the next
20 years. The advantages of windpower are clear.
It offers a virtually limitless supply of energy;
It is truly sustainable, with no long-term or
irreversible adverse impacts and with all its costs internalised;
Projects have short lead-times and can be on-line
in less than 12 months;
It will develop in "bite-sized chunks",
giving investment flexibility which allows the rate of expansion
to be adjusted quickly in response to market signals;
Not only does it exploit an abundant national
resource, it offers the potential to exploit core national skills
in manufacturing, construction and offshore engineering.
The main drawback of windpower is the intermittent nature
of its output. We accept that the current electricity infrastructure
could only support some 20-30 per cent of energy being from intermittent
sources. However, we anticipate that such a limit would not be
reached for 20-30 years by which time economic storage will be
a substantial feature of the electricity infrastructure. Hence,
we do not believe that a steady expansion of windpower would actually
lead to any system security concerns.
We believe that windpower has the potential to expand at
an average rate of 1GW pa of installed capacity, over the next
20 years. (1GW of wind capacity is equivalent to around 1 per
cent of electricity demand.)
Whilst such a growth rate would increasingly be met from
offshore resources, onshore development will be a key element
over the next 10 years. We welcome the recent initiative to allow
NFFO contracts to be transferred but remain concerned that the
planning process is slow and does not take proper account of windpower's
role in combating global warming and contributing to the Government's
wider sustainable development objectives. However, it is all too
easy to dismiss the potential environmental contribution of an
individual proposed wind farm. It is for Government to ensure
that the planning system recognises the wider context of an individual
The cost of other renewables is significantly above that
of wind, with the exception of landfill gas and waste-to-energy.
The volume of the landfill is small and mostly already utilised.
Waste burning is controversial but will have its place in energy
production; its generation cost will be driven by the price of
alternative means of waste disposal. Small hydro development has
potential although the volume is likely to remain small. The operating
costs for energy crops are currently expensive; subsidies from
outside the energy market, eg agricultural credits, will be necessary
to encourage significant development. Photovoltaics, tidal flow
and wave power are very expensive and will need a technology breakthrough
to compete in the UK.
In principle, Innogy supports the proposed Renewables Obligation
on electricity suppliers. It is too early to judge the success
of the Obligation, but Innogy believes that the UK target of 10
per cent renewables by 2010, whilst achievable, is at risk of
not being met in full due to the current barriers surrounding
gaining planning permission. This is an industry wide view.
Ofgem's review on NETA's performance recognised the exposure
of renewables and embedded generation in the current market: Mr
McCarthy concluded that "if for wider environmental reasons
the Government wishes to encourage forms of renewable generation
whose output is less predictable or less reliable, there is a
need for the Government to consider additional support for these
types of generators."
In summary, we believe the combination of renewables and
electricity storage can make a significant contribution towards
moving to a low-carbon energy system, whilst contributing to diversity
3.2 Emissions Control
Government objectives in respect of environmentally damaging
emissions need not conflict with security of supply. However,
to ensure this is the case, policies to address emissions must
be applied through appropriate means and must not lead to distortions
in energy markets which may knock on to compromise security of
Incentives to achieve government energy and environmental
objectives inevitably have an economic cost and the financial
impact of these measures on the consumer is minimised in a liberal
In particular it is our view that efficiency in emissions
control is best achieved through market mechanisms such as tradable
emissions permits. The larger the market for these permits, the
more efficient the resultant market solution. For these reasons
Innogy strongly supports continuing efforts to achieve Europe-wide
3.3 Climate Change Levy
Innogy believes that the Climate Change Levy (CCL) is poorly
designed as an instrument for delivering reductions in greenhouse
gases (GHG) emissions and will ultimately prove incompatible with
international measures, requiring its replacement by an alternative
Its deficiencies have been demonstrated by the exclusion
of the electricity generators from the UK voluntary carbon emissions
trading scheme, which has had to be designed around the requirements
of CCL Negotiated Agreements. This is despite the widespread recognition
that the generators' participation will be an essential component
of any international emissions trading system. The proposed EU
emissions trading scheme will require fundamental changes to the
In the short term CHP plant meeting the Government's "Good
Quality CHP" criteria should be exempt from CCL without the
need for a supply licence. At present exports are only CCL exempt
where supply is direct to the end user. If a supply licence is
needed CHP operators should be allowed to use the customer support
infrastructure of other licensed suppliers in order to minimise
the burden of having to become a licensed supplier themselves.
We recognise the benefits which CHP offers and support its
promotion through continuing exemption from the Climate Change
Levy for good quality CHP.
However, when the Renewables Obligation (RO) is introduced
it will be applied to all the output supplied from sites. The
cost burden associated with the RO will negate the benefit derived
from supplying CCL free electricity and so the CHP incentive of
CCL exemption will in practice be removed. The process of the
CCL exempt route to market had been complicated and expensive.
To have the effort wasted because of the conflicting regulations
relating to two Government environmental initiatives that have
been introduced within a short period of time cannot be in the
interests of either industry or Government.
A move to an environment of high penetration of micro-CHP
carries with it certain risks. Most significantly, it will accelerate
the process of the UK becoming dependent on gas.
In addition, with current technologies micro-CHP is less
fuel efficient in generating electricity than large scale gas-fired
generation leading to more fuel being burnt for the same electricity
output, thus offsetting much of the intuitive benefit of micro-CHP
and which conflicts with the delivery of a low-carbon outcome.
What scope is there for further energy conservation?
4.1 Industrial and Commercial Use
Industrial and commercial customers are aware of the importance
of reducing consumption, particularly when energy is a significant
proportion of their controllable costs. Many have designed and
amended their operations for economic reasons and have achieved
up to 80 per cent exemption from CCL as a result. In theory, CCL
exemptions should help to promote CHP development, but in practice
large consumers have secured exemptions from CCL without implementing
Smaller companies face a real increase in their annual cost
of energy of 10-20 per cent as a result of the CCL.
Although these firms are becoming increasingly aware of the need
to monitor energy consumption, many are powerless to act, either
through a lack of expertise, or because their processes are difficult
to improve. Some will turn for help to specialised energy management
companies, but energy suppliers could also play a role to help
businesses lower their energy costsby scrutinising energy
consumption, and devising more efficient working practices and
As yet, many businesses lack the financial incentive to act,
and a combination of initiatives are required by way of loans,
grants, and access to credible energy efficiency advice in order
to deliver the savings. Sourcing this advice from proven energy
suppliers could also provide a route for customers to access grants.
4.2 Domestic Use
The Government already encourages domestic energy efficiency
through its Energy Efficiency Standards of Performance (EESOPs)
programme and is currently continuing its commitment with its
planned replacement for EESOPs, the Energy Efficiency Commitment
(EEC), to come into effect in April 2002. In effect, the programme
places an obligation on energy suppliers to encourage or assist
consumers to take up energy saving opportunities.
We agree that suppliers have a role to play in promoting
energy efficiency, however, this role is limited as the majority
of actions that would lead to significant improvements in domestic
energy efficiency are outside the sphere of influence of suppliers.
In particular, the design of appliances and the selection of individual
appliances by consumers and decisions over replacement of older
appliances. At the consumer level, especially in respect of electrical
appliances, energy efficiency is merely one of many selection
criteria including price, appearance, size, performance, capacity,
functionality, reliability and even fashion, with energy efficiency
normally being considered one of the lower ranking selection criteria.
Even at the commodity end of the appliance market, for example
light bulbs, the role of the energy supplier is limited as it
is consumer choicein this case price driventhat
dictates selection of standard or high efficiency appliances.
Other factors also limit the scope of energy suppliers to
improve domestic energy efficiency such as the decline in the
number of cavity wall insulators and number of CORGI registered
installers for high efficiency boilers.
Energy suppliers have a role in promoting domestic energy
efficiency but can only influence the decision making of domestic
users marginally. This limitation needs to be recognised when
developing energy policy and designing incentives for consumers
to make the right energy efficiency choices.
What impact would any changes have on industrial competitiveness
and on efforts to tackle fuel poverty?
5.1 Industrial Competitiveness
Energy costs have a major bearing on factory output prices
and are, therefore, highly significant to international industrial
The fuel mix in the UK is not markedly different from that
in other advanced industrialised countries (eg Europe, USA, Japan)
and, therefore, under liberalised markets energy costs should
be broadly similar. Consequently, energy costs are likely to differ
markedly only if extraneous factors are imposed on energy markets.
Industrial energy prices internationally will be significantly
influenced by the imposition of emissions controls. With the US
not signing up to the Kyoto protocol price differentials between
EU and US energy prices could impact industrial competitiveness.
Within Europe, it may be in the UK's interest to push for
unilateral EU action up to 2010, given its strong position with
respect to Kyoto. However, major barriers remain to achieving
full energy market liberalisation within the EU and can only hinder
the introduction of measures to reduce GHG emissions. Increasing
concerns among Member States regarding security of supply issues
will also impede progress.
It is important to remember that the UK energy sector is
a relatively small polluter. Overall, the UK accounts for about
2 per cent of global GHG emissions and the CO2 emissions from
UK energy consumption are forecast to rise by 0.01 per cent-0.3
per cent pa to 2050 compared with a global rise of 1-3 per cent.
This is not a justification for complacency; however, UK action
must take due account of the impact on international competitiveness.
5.2 Fuel Poverty
The issue of fuel poverty is being addressed in a dedicated
Government initiativeThe Governments UK Fuel Poverty Strategy.
We applaud this initiative and are playing our part in it, but
it is also our view that these very important issues should be
considered in this inquiry. For example, the strategy as it stands
sets out a range of programmes including inter alia "Continuing
action to maintain downward pressure on fuel bills, ensuring fair
treatment for the less well off as supporting the development
of energy initiatives to combat fuel poverty."
This is potentially at odds with other Government objectives
such as security of supply and emissions control, where it may
be concluded that in order to achieve the necessary energy policy,
energy prices may have to rise in order to attract the appropriate
investment in plant and internalisation of costs.
Government policy should therefore recognise that industry
should accept responsibility where it can, but it is the Government
via the tax/benefit regime who have primary responsibility for
addressing the issue of the fuel poor.
Is any change of Government policy necessary? How could/should
Government influence commercial decisions in order to achieve
a secure and diverse supply of energy?
6. Government policy should recognise the conflicting
nature of disparate policy objectives and the need for changes
in policy in the pursuit of long-term objectives to be evolutionary
To assist the Committee in assessing policy options and evaluating
appropriate means of affecting any changes we have set out our
views on five key aspects of the market and provided a series
of proposed policy guidelines to underpin deliberations. Accordingly,
our response to this question is split into six sections as follows:
The Value of a Competitive and Efficient Market
The Current Regulatory Environment.
The Future Regulatory Environment.
The Use of Economic Instruments to Achieve Objectives.
Suggested Energy Policy Guidelines.
6.1 Security of Supply
In order to underpin security of electricity supply, Government
should recognise and facilitate the following key issues:
An appropriate framework that allows market-based
incentives to be developed which facilitates proper remuneration
of both plant capable of delivering a fast response to grid system
and customer requirements, and plant capable of substantially
increasing production in response to major fuel supply or generation
Recognise the development of new power storage
technologies which would allow operational flexibility and security
with a smaller overall system capacity.
Ensure an appropriate flexible framework allowing
the market to deliver innovative solutions.
The emergence of a system for properly rewarding capacity
would tend to encourage fuel diversity. If capacity is economically
rewarded then investment in generation could hedge the risk of
a divergence in fuel prices by holding a portfolio of plant with
different fuel types in the knowledge that low merit should still
be able to recover its avoidable costs from year to year, unless
there was a surplus of capacity beyond the required planning margin.
Government should therefore encourage:
The establishment of an appropriate system for
rewarding capacity that properly reflects contribution to supply
The introduction of market-based arrangements
for response and reserve.
Enshrining suitable standards for transmission
security (and not leave them to the vagaries of any experimentation
in auctioning transmission access).
In order to properly remunerate capacity that is able to
contribute to security of supply over a sustained period, we suggest
the following structure.
(1) All power plant that can contribute to security in
the short-term, through having at least six hours of fuel stored
on site, should be eligible for a fixed annual "fuel security
capacity payment" per MW of electrical output.
(2) All power plant with fuel stored on site would be
eligible for a further "fuel security energy payment"
based on the MW hours of electricity it could generate from that
stored fuel. This payment would be capped at, say, 28 days of
(3) All power plant would pay back the "fuel security
energy payment" for each MW hour actually generated.
Through this mechanism, plant would be incentivised to stay
open and to hold stocks which could be used to replace lost generation
from other plant due to unforeseen events. Payments would be targeted
on reserve energy production, as normal running would be on a
commercial basis. Stored fuel could be coal, oil, gas, water,
nuclear or electricity provided that it is stored on site and
available to be used as required. Payments could be administered
through the existing ancillary services arrangements in a similar
way to blackstart security payments.
6.2 The Value of a Competitive and Efficient Market Structure
Since privatisation the face of the energy market in the
UK has changed dramatically. Innovation has been allowed to flourish
and new entrants have produced increased competition and, consequently,
downward pressure on prices. Today, the UK market is amongst the
most competitive in the world in both generation and supply.
Prices for electricity in the UK are generally below those
elsewhere in Europe. For industrial customers prices tend to be
slightly lower in France and the Netherlands, but slightly higher
in Belgium and Germany. UK prices to industry are significantly
lower than those found in Italy. For domestic customers prices
in the UK are generally the lowest in Europe. The average UK domestic
customer currently sees prices that are more than 40 per cent
lower than in Italy, almost 30 per cent lower than those in Germany,
and even 6 per cent lower than those in France
(comparisons are made excluding VAT for industrial customers,
but including it for domestic customers.)
Competitive markets, if left to operate without onerous constraints
or regulation will drive efficiency and provide appropriate signals
to encourage investment. In its report on the California power
crisis the World
Bank drew three main conclusions:
"The flaws in the design of the California
market contributed substantially to the financial crisis of California's
Efforts to deal with the crisis in the presence
of these flaws could not have succeeded;
A properly designed power market could have coped
with the factors leading to the crisis. Because the reforms already
undertaken in the California power market prevent a return to
the pre-reform structure, the state's only option is to correct
these flaws and move forward to a better-designed market."
Among the flaws stated as contributing to the failure of
that market to deliver security were:
A mismatch between the regulated retail market
and the deregulated wholesale market;
Lack of economic incentives for adequate capacity
to maintain supply reliability standards;
6.3 The Current Regulatory Environment
It is difficult to argue that the regulatory environment
discourages market competition, given that one of Ofgem's primary
functions is to facilitate competition. In electricity, it has
been achieved, but in the gas market Ofgem has yet to address
structural issues inherited from privatisation which now have
the potential to undermine the achievements in the electricity
sector. Unlike other energy markets, the UK has over a decade
of experience of operating a liberalised and competitive market
and we clearly lead the way in terms of cost-effective production
and supply. Innogy believes that the market will deliver the optimum
solution within a very clear framework set by Government. Regulation
has played its part, but in order to achieve the full benefits
of competition, we should now lead the way by retreating regulation
from competitive markets.
As a consequence of the UK's leading role, and experience
gained from the competitive energy market, Innogy is profitably
selling its expertise in the US and Europe where others are keen
to learn from the UK experience. Being at the forefront of these
developments does mean, of course, that that there is no "model"
to follow and that we have to develop a UK solution that preserves
our unique and leading position. In this context we would also
highlight the point that our overseas competitors find it far
easier to operate in the UK than we would under many of their
There have been some important developments in the UK in
recent months with the introduction of the New Trading Arrangements,
which we welcome. However, we believe that it is essential that
the implications of these changes be taken into account before
further radical changes are proposed. The industry needs a stable
regulatory environment if it is to develop and if participants
are to make the necessary long-term investment decisions to ensure
security of supply.
6.4 The Future Regulatory Environment
The Better Regulation Task Force is already taking a look
at this issue, and has come up with five key recommendations,
of which four could be applied to this regulatory environment:
Regulators' annual business plans should include
a clear explanation of how they will prioritise their different
objectives. Regulators should also explain how the decisions they
take relate to their objectives.
Regulators should be required to produce assessments
of costs and benefits for proposals with significant impact on
Regulators should include in their work plans
proposals to encourage an innovative approach to consultation,
to allow a real dialogue between different stakeholders and demonstrate
how proposals have been amended following consultation.
Regulators should set out a programme in their
annual work plans to review market sectors for lifting price controls
and the removal of outdated licence conditions. Companies should
be able to challenge failure to complete these programmes.
It is clear that the regulatory environment that was introduced
at privatisation has facilitated competition. However, now that
competition has been introduced, it is important that the market
is allowed to operate without the fear/uncertainty of further
regulatory intervention. For example, the recent decision by the
Regulator to increase his powers through a Market Abuse Licence
Condition (overturned by the Competition Commission) is, in our
view, an example of excessive regulatory interference which could
impact negatively on market confidence and investment in much-needed
6.5 The Use of Economic Instruments to Achieve Environmental
and Energy Policy Objectives
Innogy supports the use of economic instruments to achieve
environmental and energy policy goals provided that they achieve
this in the most cost-effective way and do not lead to market
distortions. It is important that in designing such instruments
the following criteria are satisfied:
The mechanism must be designed to ensure delivery
of the primary environmental or energy policy objectives rather
than for the sake of political expediency.
The mechanism must cover all relevant sectors
to ensure delivery of the optimum cost solution.
Where techniques are already commercially available,
the market should determine which technical solutions are most
Specific measures such as capital or R&D grants
should be used to support emerging technologies, rather than segmenting
or distorting the market.
Government must not second-guess the market, by
imposing artificial sector caps or targets, which can lead to
distortions and sub-optimal solutions.
The polluter pays principle has to be balanced
by the recognition that the consumer ultimately pays and investors
require a sensible return on their investment.
Achieving environmental and energy policy goals
will require significant levels of investment over an extended
period. Economic instruments must be designed to provide a stable
framework whereby investors can invest with confidence.
Government must ensure that, in addition to appropriate
economic instruments, other barriers to delivering its objectives
are managed (eg planning, manufacturing capability, skilled labour
In general, Innogy supports the use of financial incentives
to encourage investment in cleaner power plant, renewable technologies,
energy efficiency and electricity energy storage. In contrast,
experience has shown that policies to interfere in the operation
of the competitive markets to discriminate in favour of a particular
source of power are likely to be counter-productive.
6.6 Suggested Energy Policy Guidelines
The Importance of Competition
As a leading UK energy supplier, Innogy is determined to
provide its customers with electricity and gas at competitive
prices. We believe that competitive markets are the best means
of delivering choice and value for money to the consumer. Maintaining
and enhancing competition in the UK should, therefore, be at the
heart of the Government's energy policy.
The Proper Role of Government
Innogy believes that Government has a key role to play by
establishing a framework which balances the potentially conflicting
policy aims of secure, affordable energy supply and tightening
environmental targets. A key ingredient of this framework is the
maintenance of a stable, complementary and predictable regulatory
Avoiding Market Distortions
Having established the policy framework, we believe that
it is imperative that the market and industry are given the opportunity
to deliver innovative, market-based solutions free from Government
The use of ad hoc or short-term policy measures aimed at
increasing supply (eg generation) or reducing demand (eg consumption
of energy) can have unpredictable and costly implications. Therefore
the aim should be to create a long term and consistent set of
sustainable energy objectives to which the market can respond.
Limits to Unilateral Action
Government policy must be set within the context of the European
energy market. It should be recognised that the competitive market
in the UK can be constrained by the lack of competition elsewhere
in Europe. The UK leads the world in market liberalisation and
cost-effective energy production and supply. Nothing must be done,
therefore, which jeopardises this competitive position, by forcing
up energy prices to unacceptable levels, or by helping overseas
companies to operate in our market more easily than we can in
Avoid Step Changes
The Government has made an excellent start in addressing
the issues associated with moving towards a sustainable future
in energy. What is required going forward is an incremental approach
which will allow industry to make the necessary long-term investment
decisions which will be in the best interests of consumers and
other stakeholders. For example, the Renewables Obligation has
set out a 10 year framework for reducing carbon emissions, whilst
giving the industry flexibility in the choice of zero-carbon technologies.
Includes considerations such as SOx, NOx, nuclear waste, particulate
emissions, impact on water tables, etc. Back
NGC Transmission Systems Security and Quality of Supply Standard-see
NGC Licence. Back
Datamonitor, August 2001. Back
Source: Energy Advice Comparison, May 2001. Back
The California Power Crisis: Lessons for Developing Countries,
The World Bank, April 2001. Back