Select Committee on Trade and Industry Third Special Report



1. The Government welcomes the Trade and Industry Committee's report. Security of energy supply has always been key to the UK's energy policy, and the Government and Ofgem are closely engaged in monitoring security of supply issues and dialogue with producer countries in and outside the EU.

2. Although the leading international forecasts are agreed that world supplies of conventional fuels are adequate for the next twenty to thirty years, security of supply has received increased public attention in the new Millennium following a series of developments both within and outside the energy markets. In the world energy market we have seen the California energy crisis, while external factors have included the increased awareness of terrorist threats following the events of 11th September.

3. The UK's liberalised and competitive energy markets are widely regarded as a success (a view supported by the PIU, see below), and market systems are likely to be central to future energy policy both domestically and internationally. However, as the UK moves away from self-sufficiency in gas production, it is right to look closely at whether it will continue to have all the appropriate mechanisms in place to ensure that energy demands are met in a timely, orderly and affordable fashion. The mechanisms also have to reflect a sustainable approach to energy which balances its environmental, social and economic impacts.

4. Shortly after the Committee's report was issued the PIU Energy Review was published. This covers the longer-term strategic objectives of energy policy for the UK, including the challenge of climate change and ensuring reliable and competitive energy supplies for the next generation. The Government has welcomed the Energy Review as a good basis to stimulate the public consultation we intend to hold on how best to meet Britain's future energy requirements. This will lead to a White Paper on energy policy around the turn of the year.

5. The Trade and Industry Committee's report is an important and thoughtful contribution to the debate on the security of supply aspects of the Energy Review and will help inform and shape the Government response. Accordingly, some of the Government comments below will be developed further for the White Paper.

6. The following pages respond to the specific conclusions and recommendations of the Committee's report.



(a) Concerns over bottlenecks in the gas transmission system seem to us to be well-founded. The Government should keep under the review the need for more gas landfall facilities and the advisability of greater diversity in the siting of such facilities. It should consider whether the market alone will provide the necessary incentives for this investment, given the lead-times needed for such construction projects. (Paragraph 28).

The Government and Ofgem recognise the importance of secure gas transportation networks in order to ensure security of gas supplies. Secure gas transportation networks require a longer­term perspective to ensure that adequate transportation capacity is built to meet future demands. On the other hand, under-investment in transportation networks can lead to local constraints and 'bottlenecks'.

Bottlenecks in the national transmission system (NTS) emerged at St Fergus in the second half of 1998. Although these constraints did not jeopardise security of supply, they have been reflected in relatively high prices for access to the system (known as entry capacity) at this terminal. Even before then, Transco was carrying out incremental investment schemes in the NTS leading south from St Fergus to alleviate the bottleneck, and further developments are included within the forthcoming price control. Capacity at the St Fergus terminal is planned to have increased over the period from 1998 to 2002/3 by about 30 million cubic metres (mcm)/day (from around 120 mcm/day to around 150 mcm/day).

The current short-term auctions for entry capacity into the NTS, conducted by Transco, are intended to ensure an economically efficient allocation.

In the longer term, while efficient and competitive traded markets are generally the best vehicles for ensuring security of gas supplies, the limited ability to promote competition in the provision of network services in the gas context means that market mechanisms are inadequate. In such circumstances, without regulatory intervention, it is unlikely that a single provider would make optimal investment decisions.

Ofgem is addressing these limitations of the market by proposing innovative new arrangements as part of Transco's next price control, covering the period from 2002 until 2007. These arrangements provide for entry capacity rights to Transco's network to be offered for sale through long term auctions and investment incentives on Transco. Prices emerging from these auctions and the secondary capacity market will improve the signals to Transco of the need for any additional investment in new capacity and the location of that investment. Proposals to modify Transco's network code have been raised in order to introduce auctions later this year. In planning future investment Transco may also take into account evidence of demand that emerges through consultations, including its annual "Ten year statement" exercise on the requirements of the NTS.

Appropriate signals to Transco of the need for new investment through price signals, together with evidence from consultations, coupled with appropriate incentives to respond to these signals, will encourage Transco to invest to ensure that there is the appropriate level of capacity in response to the needs of its customers. Ofgem has said that it will help Transco to limit the risks associated with new investment by indicating if it questions whether a proposed investment project would merit admission to Transco's Regulatory Asset Base.

Options for landing gas that will be available to the various market participants will include:

_  utilising the developing ullage (empty capacity) at existing terminals, as gas production from the UK continental shelf (UKCS) declines — the proposed long-term auctions will be relevant to this option;

_  taking offshore pipe-lines to other terminals where there is expected to be ullage and, consequently lower prices for entry capacity at such terminals — the valuations of entry capacity arising through the auctions should assist users in deciding whether to pursue this option; and

_  developing new terminals — consultations, as well as price signals at existing terminals, would be particularly relevant to this option. However, new terminals would be likely to face planning and environmental issues which are not faced, or to the same extent, by incremental developments at existing sites.

The Government and Ofgem are monitoring these developments through the DTI/Ofgem Joint Energy Security of Supply Working Group (JESS). This Group will in particular assess the extent to which major infrastructure schemes are being brought forward in a timely manner, and whether there are any barriers or market distortions preventing their timely development. The Government will give further consideration to the case for greater diversity in the siting of gas landfall facilities.

(b) While we recognise that there are practical and economic factors which hinder the further extension of the natural gas distribution network, it remains a matter of concern to a large number of potential consumers, who consider themselves to be disadvantaged by the restriction on their freedom of choice. The Government should consider whether further encouragement could be given to Transco and the supply companies to address this anomaly. (Paragraph 30).

The Government shares the Committee's view that many households could benefit from access to the mains gas network. As part of the Fuel Poverty Strategy, the Government established a working group to examine the issues surrounding extension of the network. The group, which included representatives of Government, OFGEM, Energywatch, the industry, energy efficiency bodies and other interested parties, produced a report in November 2001. The report was published on the DTI website in December 2001[2].

The report found that around 1.3 million of the 4.5 million British households in fuel poverty lacked access to mains gas. Of 900,000 English fuel poor households without gas, 600,000-700,000, including the bulk of the most vulnerable, could be removed from fuel poverty through access to the combination of mains gas, central heating and insulation. The report also found that the provision of central heating and insulation, in tandem with other fuels, including fuel oil and solid fuel, could have similar impacts, although other conventional fuels might lack the convenience, energy efficiency or environmental benefits that attached to mains gas.

The report found that there was no case on cost/benefit grounds for universal extension of the network, but that it was likely that such a case could be made within a number of communities. It also concluded that, without intervention, these communities were unlikely to receive connections. It therefore recommended a programme aimed at the fuel poor in non-gas areas.

The Government welcomed the report, and is considering how its recommendations can best be taken forward, in view of the significant costs of a programme of the kind envisaged by the working group.

(c) To guard against the unforeseen disruption of external supplies, it would be prudent for the Government, together with the industry, to give serious consideration to the development of strategic gas storage capability. (Paragraph 32).

The Government agrees that it is important to have a robust capability to deal with disruptions in external, and indeed indigenous, gas supplies.

Such a capability has been provided by the 'swing capacity' of the gas fields in the southern North Sea to vary production levels in response to changes in demand. However, this capacity has sharply reduced within the last two years, as economic and technical factors have provided incentives for maximising immediate gas production. Decreasing gas production from the UKCS will continue this trend.

Ofgem and DTI are working together to ensure appropriate market-based regimes — in Great Britain, the UKCS and the EU — to provide access to flexibility.

For major storage sites, of the kind that the Committee appears to have in mind, there are three main possibilities:

_  the use of partially-depleted gas fields in the UKCS, like Rough;

_  additional on-shore storage, for example underground storage;

_  additional interconnection with the European continent, to provide access to the very large gas storage facilities in North West Europe.

The DTI/Ofgem Joint Energy Security of Supply Working Group (JESS) is keeping under review how far the market is bringing forward such plans, and whether there are barriers or market distortions preventing these projects being developed.

Both DTI and Ofgem are aware that an expectation of regulatory intervention could itself distort the commercial incentives to develop new storage projects.

Electricity network

(d) The current design of the electricity grid presents several challenges to the renewable energy and combined heat and power industries. (Paragraph 38).

The Government agrees with the TIC's view that the current design of the electricity distribution networks present a number of challenges to the connection of renewable and other small generation. The distribution networks are primarily designed to transfer electricity from the transmission system to customers and often cannot readily cope with the bi-directional power flows, voltage variations and increased fault contribution associated with the connection of generation.

 A range of potential barriers to the connection of generation to the distribution networks were identified by the joint DTI-Ofgem Embedded Generation Working Group (EGWG) which reported in June 2001[3]. The EGWG made a number of recommendations for action to address these perceived barriers and the Government has recently established a Co-ordinating Group, jointly led by the DTI and Ofgem, to monitor the implementation of the EGWG recommendations and to advise Ministers of potential problems.

A number of modifications to the Balancing and Settlement Code (BSC) have been approved in an attempt to encourage the development of consolidation services for both small generators and demand side participants. Modification Proposal P7 'Allocation Of Supplier Demand To The Same BM Unit In A GSP Group For All Suppliers In The Same Company Group' and Modification Proposal P67 'Facilitation of further consolidation options for Licence Exempt Generators (DTI Consolidation Working Group 'Option 4')' have been approved by Ofgem to facilitate consolidation services that will enable both small generators and the demand side to realise embedded benefits.

(e) Connection charges represent a serious obstacle for small scale generators which can affect the viability of developments which may otherwise be financially sound. (Paragraph 40).

The Government agrees that the current connection charging arrangement may unfairly penalise individual generators in specific circumstances and discourage the development of otherwise sound financial projects. In its recommendations, the EGWG pointed to the need to move away from the current 'deep' connection charging methodology where generators wishing to connect to the distribution networks are required to fund all costs associated with their connection, including any necessary infrastructure reinforcement. Following on from the EGWG recommendation, Ofgem has conducted a consultation on the issue of connection charges, amongst other issues, and published a follow-up document in March 2002[4].

(f) We have highlighted a number of areas where the systems in place for electricity transmission and distribution present technical and economic barriers to the future development of renewable energy and embedded generation. It could be argued that such obstacles will be overcome once the electricity market conditions make it economically viable, but this would ignore the rate at which such capacity must be developed if the Government's targets of reduced reliance on carbon-based energy sources are to be achieved in practice. The Government needs to take a strategic view of what is required and to have a clear idea of what mechanisms it could use to steer the market to provide the necessary infrastructure. (Paragraph 43).

The Government recognises the need to address a range of commercial, technical and regulatory barriers to the connection of renewable and other small generation to the distribution networks. The Co-ordinating Group recently established to monitor the implementation of the EGWG recommendations will ensure that these barriers are addressed as rapidly as possible The Co-ordinating Group will also identify any other actions necessary to ensure that the electricity distribution networks are capable of accommodating the demands likely to arise from the development of renewable and other small generation.

(g) The DTI recently announced a feasibility study of proposals to run a submarine cable from North West Scotland down the West coast of Great Britain to provide a transmission system for offshore and other renewable energy generation. This would appear to have great potential to alleviate the problems caused by the North-South transmission bottleneck and would provide a significant boost to the development of renewables such as offshore wind and wavepower. However, there are concerns about the technical feasibility and the cost of such a cable. Given the misgivings that have been expressed we welcome the feasibility study commissioned by the Government. (Paragraph 44).

The Government welcomes the TIC's support for the recent study into the feasibility of a western offshore transmission link. The outcome of the study[5] confirmed the viability of the concept, but recommended that further detailed investigation should take place in the context of a general strategic review of future transmission requirement arising from the likely development of renewable generation in the UK. At this stage there appear to be no overriding technical constraints to the construction of such a link. The Government has moved rapidly to initiate a strategic review of transmission requirements in conjunction with the GB transmission licensees and Ofgem. A working group has been set up, which will examine the technical, regulatory and financial implications for the GB transmission network based on a number of scenarios of the development of large - scale renewable generation. This group has already met and further meetings are scheduled. It is expected that the group will report in Autumn 2002.

The Role of the Regulator in Investment

(h) We are pleased that Ofgem is reviewing the operation of RPI - x and is aware of the need to devise a formula that will give clearer signals to the market about long-term investment. We also note that, by the time we took oral evidence from them, both NGC and Transco expressed themselves satisfied that their concerns about investment needs would be taken into account. (Paragraph 49).

The Government notes this recommendation, which is primarily for Ofgem. The Government welcomes the steps that Ofgem has taken to provide incentives for the construction of new infrastructure through innovative market-led arrangements.

Ofgem recognises the limits of the traditional RPI-X form of regulation, which the Committee has highlighted. In particular, while this form of regulation has succeeded in exerting downward pressure on operating costs and prices, there is a risk that incentives to maintain and enhance the networks may not be appropriate.

For this reason, Ofgem is building upon the RPI-X model of regulation by proposing innovative arrangements to address the concerns expressed about investment incentives.

In the gas context, Transco's allowed revenues under the forthcoming price control period (2002-7) have been set against explicit entry and exit capacity output measures for each of the five years of the price control. Transco will be required to offer for sale a high proportion of these entry capacity output measures through a series of longer and shorter­term auctions of firm, tradable capacity rights. Signals emerging from these auctions, combined with a new financial incentive for Transco to move away from the initial baseline output measures, will encourage Transco to invest in expanding transportation capacity to meet the demands of its customers.

Similarly, for electricity, Ofgem has published revised proposals for new transmission access and transmission losses arrangements, involving financially firm, tradable access rights. The new transmission access arrangements would enable market-based signals to emerge on the value of access to the transmission system at different locations. Trading of long-term transmission access rights should also see the emergence of signals of future demand, which, along with appropriate incentive arrangements, will assist NGC in investing to meet the demands of its customers.

Through this approach, Ofgem is seeking to ensure appropriate levels of investment in gas and electricity infrastructure by facilitating the development of price signals to provide network operators with improved information about the levels and locations of desired investment. It will be important for Ofgem to monitor the effectiveness of the incentives to invest to ensure they remain effective.

(i) We urge the Department and Ofgem to make it a priority to ensure that companies are given sufficient leeway to invest in maintaining and developing a robust energy infrastructure, and to continue to keep under review all the mechanisms available to ensure that there are no regulatory/fiscal disincentives to such investment. (Paragraph 49).

The Government and Ofgem agree on the importance of maintaining a robust energy infrastructure.

In the downstream gas and electricity markets this is a matter for Ofgem, which has devised innovative arrangements to provide incentives for Transco (as owner/operator of the National Transmission System) to invest on a market-led basis. The relevant provisions are set out in Transco's next price control, covering the period from 2002 until 2007 and Transco's National Transmission System system operator incentives for the same period.

As transmission network owner, NGC is currently provided with incentives under the RPI-X form of regulation to invest efficiently in its transmission system to meet the demands of its customers. With the development of new transmission access proposals, Ofgem will consult on new incentive arrangements on NGC as system operator to ensure that NGC is appropriately incentivised by the market to deliver the benefits associated with improved investment signals of the new transmission access arrangements.

Offshore infrastructure investment — including offshore pipe-lines from elsewhere in the North Sea and interconnectors — is a matter for commercial players.

Through the DTI/Ofgem Joint Energy Security of Supply Working Group (JESS) the DTI and Ofgem are monitoring these issues. The Group is due to make its first report to ministers and GEMA (the Gas and Electricity Markets Authority) shortly.

Diversity of fuel supply

(j) We agree with the view that it should not be the role of Government to dictate the appropriate mix of fuels for electricity generation, although that need not prevent intervention by the Government and the Regulator to ensure that long-term security of supply is maintained. (Paragraph 53).

(k) Furthermore, we consider that security of energy supply can be improved by retaining a capacity to use a variety of different fuels to generate electricity. Even if the exact mix of fuels is left to market forces, it is arguable that the Government should at the very least take no action that closes off options, and perhaps should be prepared to make adjustments to its policies to keep options open. (Paragraph 53).

The issue of security including diversity, keeping options open and the role of Government and regulators will be important factors in the forthcoming White Paper.

The PIU Energy Review addresses a number of themes relevant to this area. It states that competitive markets have been a success and should remain the cornerstone of energy policy. It argues that government intervention may be justified on grounds of market failure, equity issues or strategic/political reasons but notes that grounds for intervention do not necessarily justify intervention. Finally a central theme of the PIU report is the need to create and keep open options. These ideas will be further explored in the public debate that will lead to the White Paper.

Strategic planning

(l) As far as we could ascertain, the timeframe for energy planning adopted by the Department was "at least seven years". We agree that changes in energy markets over longer periods are difficult to predict, but given the long lead-time necessary to provide new infrastructure and the apparent short-termism of markets, it would be prudent to try to take a twenty year or longer view. This would not necessarily mean the establishment of a "futurology" section in the DTI; it might simply require a commitment to revisiting the sorts of questions considered by the PIU on a regular basis with ad hoc teams from all relevant Departments, say every five to seven years. (Paragraph 54).

The Government's memorandum to the Committee indicated that the remit of the DTI/Ofgem Joint Energy Security of Supply (JESS) working group included monitoring at a strategic level over a timescale of at least seven years ahead. The reference to seven years links to the availability of projections in the Seven-Year Statement by the National Grid Company. But it is clear that the remit is not limited to seven years. The Group has considered analyses beyond that period.

More generally, the DTI undertakes considerable analysis to consider strategic issues on a longer timeframe. For example, the Department's projections of UK energy demands and supply mix cover the period to 2020[6]. Projections of gas import dependency — to which reference is made in the Memorandum — also extend to 2020. The DTI submission to the PIU Energy Review covered a number of these longer-term issues. In an environmental context, the Inter-departmental Analysts Group7[7], which fed its analyses into the PIU, has considered various scenario projections for the period to 2050. Such analyses feed into policy decisions. The Renewables Obligation, for example, has been set to 2010, whilst policy has been set on the basis that it will be in force as an instrument for 25 years.

However, it is also recognised that it is very difficult to predict developments in the energy market over such long time horizons. The scope for forecasting error is greater over the longer term and Government assessments need to take full account of all available information, including forward price developments which reflect the markets assessment of future trends, and evidence about companies own approaches to investment and asset management.

Secure and effective infrastructure requires not only adequate initial investment, but also a professional approach by the respective companies to asset stewardship. To obtain assurance on the status of asset stewardship and to promote best practices between the companies, Ofgem is undertaking its Asset Risk Management project that will survey the status of the Distribution Network Operators (DNOs), National Grid, and Transco. The initial survey is proposed for this coming summer.

This work is consistent with a recent initiative by DTI to survey the electricity distribution companies' state of operational preparedness for handling emergency events such as storms.

Exploitation of the UK's oil and gas reserves
Exploitation of the UK's oil and gas reserves

(m) We are pleased that PILOT appears to be contributing to the exploitation of the UK's gas and oil reserves. However, we are concerned that there may still be gaps in the approach [as shown by the difficulty in developing better seismic imaging and techniques]. We also support the UKOOA's comments on the desirability of a flexible approach to the taxation of the UKCS oil industry if reserves are to be used to their full potential. (Paragraph 58).

The Government welcomes the Committee's support for the PILOT strategic forum. The representation on this group - Government departments, all sectors of the oil and gas industry, trades unionists - makes it uniquely suited to dealing with a range of important industrial issues of the type cited by the Committee. The significant progress made in the last year has most recently been published in the PILOT annual report for 2001 8[8], a copy of which has been placed in the Library of the House.

The Government recognises the importance of developing seismic imaging equipment and techniques. SMEs in particular are well placed to develop specialised software modules to be incorporated into the large software systems used by the oil companies, and financial support is being provided for this. The Industry Technology Facilitator, a PILOT initiative, recently announced the launch of a £4 million programme of projects, mostly in UK universities, to provide the next generation of seismic imaging software for the subsurface. In addition, DTI and the Research Councils, NERC and EPSRC, are supporting projects in universities and companies aimed at developing improved seismic imaging techniques and software, and further opportunities for LINK projects are being pursued.

Changes to the North Sea fiscal regime have been made over the years to ensure an appropriate balance between the incentive to invest and the need for a regime that raises a fair share of revenue for the nation. Most recently, DTI, with Treasury approval, has waived royalty on future production associated with specified incremental investment. This has meant that further development of two mature fields is taking place which would not otherwise have proceeded. There is limited scope for discretionary relief in other parts of the North Sea fiscal regime, but DTI would welcome the chance to consider further good cases for royalty remission.

(n) We welcome the Regulator's assurance that offshore costs were being taken into account when Ofgem was considering gas regulation. Clearly, investment in maximising the exploitation of UK reserves will delay the time at which security of supply becomes an issue for this country. We understand that the Regulator is about to publish amended proposals for gas balancing and express the hope that they do not damage offshore investment (paragraph 73).

The Government broadly agrees with this recommendation.

Ofgem's primary duty is to exercise its functions so as to protect the interests of gas consumers, future as well as existing, wherever appropriate by promoting competition. Therefore, Ofgem must take into account the impact of its decisions on security of future supplies.

This does not require Ofgem to take specific account of the impact of those decisions on the exploitation of UK reserves— though, given the importance of the UKCS for supplying gas consumers, it would be entirely natural for Ofgem to take that aspect fully into account. It would also be entirely natural for Ofgem to take into account the impact of its decisions on projects to deliver gas to GB consumers from other sources, such as offshore pipe-lines from elsewhere in the North Sea and interconnectors.

More generally, the Better Regulation Task Force has commended to all sectoral regulators the importance of taking into account the full implications of regulatory proposals.

Ofgem's proposals on gas balancing in its document of February 20029[9] take account of the concerns raised by respondents to the February 2001 proposals, including the concerns about the costs of moving to shorter balancing periods. The Government welcomes the further opportunity for discussions within the industry, and for tabling alternative reform proposals, that Ofgem have confirmed in their latest proposals.

New Electricity Trading Arrangements

(o) The problems with NETA epitomise the conflicts inherent in trying to achieve an energy policy that simultaneously guarantees security of supply, delivers environmental objectives and combats fuel poverty. They also encapsulate the dangers of trying to deliver a broad, balanced energy policy solely by means of a Regulator whose chief objective is to promote low prices through competition. As presently constituted, NETA poses a major disincentive to the commissioning and operation of small-scale generators. It is clear that urgent action must be taken to ameliorate the effects of NETA if the Government is to meet its environmental objectives. (Paragraph 69).

(p) We do not advocate specific amendments to the NETA regime. However, a 'wait and see' policy does not seem likely to stem — let alone reverse — the dramatic decline in both the output and the profitability of small scale generators. We are pleased that the Department acted swiftly once the problems with NETA became clear, and we trust that in its reply to our Report the Department will be able to outline what measures it is taking to ameliorate the situation. (Paragraph 70).

Ofgem's principle statutory objective is to protect the interests of consumers, wherever appropriate by promoting effective competition. In pursuing this objective, Ofgem must, among other things, have regard to the effect on the environment of the activities of electricity and gas licensees. Ofgem is governed by an Authority and its powers are provided for under the Gas Act 1986, the Electricity Act 1989 and the Utilities Act 2000. The legislation does allow Government to provide guidance on the contribution it considers the Authority should make towards the attainment of the Governments social and environmental policies. The Authority is required to have regard to this guidance in carrying out its statutory duties. In addition Ofgem have developed Environmental and Social Action Plans to take account of the sustainable development aspects of their work, including fuel poverty and environmental issues.

On 4 April 2002, the DTI published the Government Response to its consultation on NETA and smaller generators (the NETA Consultation) of 1 November 200110[10]. This sets out measures which the Government believes can help to ameliorate the situation for smaller generators under NETA, including urgent practical action to help smaller generators. The Department notes that the Committee does not advocate specific amendments to the NETA regime, recognising the legal constraints and the need to allow time to let the market bed in.

A number of modifications to the Balancing and Settlement Code (BSC) have been approved in an attempt to help embedded participants such as renewable and CHP generators by providing more choice in their contracting arrangements with electricity suppliers. Ofgem considers that any potential modification should be considered against the relevant BSC objectives and Ofgem's statutory objectives, and should endeavour to maintain an equal application of the rules to all participants.

In the recent Budget the Chancellor announced the completion of the exemption of Good Quality CHP from the climate change levy, thus ensuring that Good Quality CHP used on site, sold direct and sold indirect will be exempt from the levy. The decision recognises the environmental benefits of all good quality CHP and will give the CHP sector, which has been hard hit recently by falling electricity prices and rising gas prices, a much needed boost.

Government consultation on NETA and smaller generators

The NETA Consultation confirmed the Government's original analysis that smaller generators face two main issues under NETA, (i) cost reflectivity and related imbalance price risk and (ii) a lack of route to market (mainly through lack of consolidation services, and through commercial obstacles).

Ofgem's report to the DTI on the review of the initial impact of NETA on smaller generators concluded that the output of smaller generators had fallen and that the prices received for that output during the first two months of NETA were lower than the previous year. The document also commented that there was limited consolidation services available and that, excluding wind power generation, the output of smaller generators was not less predictable than other generators.

Ofgem considers that the approval of several modifications to the BSC will help facilitate further development of consolidation services and therefore benefit embedded participants.

Positive improvements have been made since the consultation document, including further reduction of volatility of imbalance prices and practical work to address some of the technical obstacles to consolidation. The Government recognises that concerns remain, despite these improvements, about cost reflectivity and imbalance price risk, and wider commercial considerations, particularly the negotiating position of smaller generators compared to local incumbent suppliers.


The Government Response identifies further action within NETA to address these issues:

Improving the effective operation of NETA, in particular risk management: a forthcoming modification to the system to reduce 'gate closure' (i.e. participants will not have to predict their output as far in advance) is widely expected to have a significant impact, helping all participants to manage their risk and reduce their exposure to imbalance prices.

The Modification Proposal will come to the Gas and Electricity Markets Authority (GEMA) for decision in April 2002. It has the support of market participants and Ofgem has expressed its view that the proposed implementation date of 2 July 2002 is appropriate.

Access to embedded benefits: DTI and Ofgem will undertake work to look at the case for, and practicability of, 'unbundling' the benefits of embedded generation in contract arrangements with electricity suppliers. This could improve the commercial position for smaller generators and independent consolidators.

Guidance for smaller generators: the Government will put in place work to assess the need for comprehensive guidance for smaller generators. DTI will make available funding to provide guidance provided the need is established. Ofgem will co-ordinate publication of such guidance if the need is established.

Standardisation of contracts: Ofgem will make an assessment of the need for standard contracts for smaller generators and how such contracts could be implemented.

Cost reflectivity: the Government believes it is too early to reach a firm assessment on cost reflectivity of the current system. Further analysis, including data for a whole year of NETA, is necessary. The Government has considered very carefully proposals made by respondents to the consultation for more radical change, but it does not believe that quick, practical radical changes have been identified. Ofgem has committed in its Corporate Plan to carry out a review of the operation of the first year of NETA, to be published in quarter two of 2002. Ofgem has indicated that it intends to cover, amongst other issues, the operation of the Balancing Mechanism. The Government has asked Ofgem to report on progress in further improving the effectiveness of NETA and ensuring imbalance prices are genuinely cost reflective, as part of its review of the first year's operation of NETA. If such an assessment does not show that the current system is working, the Government will need to reconsider the case for more radical changes to the NETA system.

The Government is also considering the PIU's recommendations, and will continue to monitor developments in these areas carefully. We agree with the Committee it is vital that Government energy policy provides for security of supply and a balanced mix of generation sources, as well as taking into account environmental and social objectives. NETA and other systems must be consistent with wider policy objectives. If any conflict of interest becomes apparent, we will address this as a matter of urgency. In addition, as described above, Ofgem will be publishing a one-year review of NETA. If this does not show the system is working effectively, Government will need to reconsider the case for more radical changes to the NETA system.


(q) We were rather startled to learn that Ofgem has no target for maintaining a reserve of generating capacity: it regards its task as being limited to monitoring generating capacity and publishing this information for the benefit of the market, so that the market can then act to meet any shortage. (Paragraph 77).

(r) We have not yet heard any evidence that leads us to believe that the market is sufficiently far-sighted to guarantee enough reserve generating capacity without some element of planning by Government or one of its agents. This does not mean that we believe that Government should try to dictate to the market; simply that someone, whether the Department (which we would prefer) or Ofgem should take a strategic view about what level of reserve capacity is necessary presumably, slightly more than 20%and should be prepared to use market mechanisms to encourage the construction of extra capacity if necessary. (Paragraph 78).

While Ofgem does not set specific targets for reserve margins, DTI, Ofgem and NGC keep a close watch on developments in the energy markets. Monitoring the adequacy of generating capacity and the way that the generation industry is responding to market signals is one of the key tasks of the DTI-Ofgem Joint Energy Security of Supply (JESS) working group, set up in July 2001 to assess the risks to energy supplies over a timescale of at least seven years ahead.

Ofgem does not set specific targets for reserve generating capacity as it believes that the incentive mechanisms in place under NETA and in the markets will provide participants with the appropriate signals to invest. Ofgem considers that the electricity forward price curve provides sufficient information on prices to facilitate investment decisions. The JESS Group will be monitoring the situation to identify any barriers or market distortions that prevent timely investment in response to the forward price signals.

At present the Government sees no case for intervention. Current margins are more than adequate: according to the latest update of National Grids 'Seven Year Statement', the margin of generating capacity over peak winter demand (the 'plant margin') in England and Wales was about 26.6% in 2001/02. National Grid figures show that the England and Wales plant margin has risen in almost every year since 1995/96 when it was about 18%, its lowest point since electricity privatisation. It is widely judged that a margin of about 20% is quite adequate to avoid disruption to supply.

National Grid project that the plant margin will reach 28.5% in 2002/3 as plant under construction is completed. Thereafter the margin would decline unless further new plant is built. Without any further new build, it would be 17.9% by 2007/8. But in most cases new capacity takes only about three years to construct and begin generating. The Government will continue to monitor developments in the generating market closely, to ensure that appropriate market mechanisms are bringing forward timely investment.


(s) Planning problems so strongly recurred in the evidence given to us that we conclude that the planning system currently forms a major obstacle to the Government's achieving its energy policy in respect of both security of supply and environmental objectives. We believe that a better way of proceeding would be considerably to strengthen planning guidance in favour of granting permission to energy developments, and for the Government to be prepared, if necessary, to call in more planning applications to enforce the guidance. (Paragraph 84).

(t) We are aware that the Department for Environment, Food and Rural Affairs (DEFRA) has been engaged in public consultation on planning guidance (PPG 22), and we look forward to learning the outcome of that consultation and any amendments that the Department may make as a result. (Paragraph 84).

A number of points on planning have been raised by the PIU in their Energy Review, and Government will be considering those concerns, along with the Committee's recommendations, in the forthcoming White Paper.

As the Committee is aware, the Department of Transport, Local Government and the Regions (rather than DEFRA) has launched a raft of consultation papers on aspects of the planning regime in fulfilment of their overall agenda to modernise the planning system11[11]. The keystone is the Green Paper on the overall planning system. Here the concern is that the planning system is becoming out of date, is bureaucratic, blocks rather than promotes development, is not fast enough for business in delivering decisions, and fails to engage the public sufficiently. What is proposed is a simpler, faster, more accessible system. Thus the Green Paper seeks to simplify the plan hierarchy, to engage the local community more in plan preparation, to reduce national prescription in planning and to refocus effort into much clearer policy statements including national statements about major infrastructure needs, to introduce new business zones where specific planning permission is not needed and to provide for faster processing of planning applications. A more open and simpler community benefit policy is proposed for negotiating planning gain, and there are proposals for a clearer, faster compulsory purchase scheme with better compensation arrangements.

As part of the reforms DTLR has produced a consultation paper New Parliamentary Procedures for Processing Major Infrastructure Projects12[12], which outlines details of proposed Parliamentary procedures for handling major infrastructure projects of national importance. The aim of the proposals is to streamline the procedures and reduce unnecessary delays, and large energy projects are included in the list of projects that could be designated to follow this route.

Many of the proposals outlined in the Green Paper, including the Parliamentary procedures for dealing with major infrastructure projects will require primary legislation.

In the meantime, in line with these changes, DTLR is revisiting its planning policy guidance13[13] on renewable energy projects. A workshop with stakeholders has already taken place and comments from the workshop will be taken into account in the revision process. It is proposed to issue a new draft PPG 22 for consultation in summer 2002.

Domestic customers

(u) Domestic customers show little awareness that the recent low prices of gas and electricity are, for various reasons, unlikely to continue. We hope that both this Report and that from the PIU, when it is made public, will help to inform public debate about these issues. (Paragraph 87).

The PIU report recommended that Government should involve the public in wider debates on the issues facing the development of energy policy. The Government recognises the importance of public debate in this area: an important strand of the consultation leading to the White Paper will be a real drive to engage and consult the public.


Quality of electricity supply

(v) We consider that the effect of variations in the quality of electricity supply is an area worth some investigation; and we would welcome the Department's comments on whether any research is being carried out at present, and where it might best be directed. Any growth in embedded generation and increase in the number of generators on the network will possibly add to the difficulties in maintaining quality of supply. These factors have to be taken into account now in considering what investment is necessary to maintain a secure, reliable electricity supply. (Paragraph 90).

Supply continuity

DTI's Engineering Inspectorate has been dealing with a small number of cases in which consumers in rural areas are complaining about frequent interruptions to their electricity supply. The ongoing investigation into the network supplying North Northumberland is a case in point: consumers have had to endure frequent interruptions and this has had a profound impact on many activities, e.g. loss of production, loss of business, and serious inconvenience.

Although it would be impractical and uneconomic for rural consumers supplied by overhead lines to benefit from the same level of security of supply as urban consumers who are supplied by underground cable networks, there is tangible evidence to suggest that some rural consumers are required to endure more supply interruptions than can be reasonably expected in the circumstances. Ofgem has taken important steps to strengthen the incentives on distribution companies to provide a good quality of service to consumers.

From 1 April 2002 a new Guaranteed Standard of Performance14[14] will be introduced which will mean that consumers that suffer more than three interruptions of more than three hours duration over the course of the year will receive a compensation payment of £50 (this represents around two-thirds of the average distribution use of system charge levied by distribution companies on consumers). This protection is directly aimed at 'worst-served' consumers.

Ofgem is also in the process of introducing an incentive scheme for distribution companies that focuses on key areas of quality of service — the number of interruptions to supply, the duration of interruptions to supply and the quality of telephone response provided by distribution companies. This will operate from 1 April 2002 to March 2005. Under this scheme, distribution companies can be penalised up to 2 per cent of their revenue (on average around £4 million per annum per company) for failure to meet pre-specified targets for the number and duration of interruptions to supply and if the quality of their telephone response is below the average for the industry as a whole. Companies also have the opportunity of earning additional revenue in the final year of the incentive scheme if they exceed their targets, depending on the rate of improvement in performance up to that date.

Taken together these mechanisms provide significant additional protection to consumers in respect of the quality of service they receive from distribution companies.

At the time of the next price control review in 2003/04 it will be important to assess whether consumers desire further significant improvements in quality of service, and if so, how to provide distribution companies with incentives to deliver these improvements. This will require consideration of the potential trade-off between higher prices and higher quality—although it will be important to ensure that companies have the incentive to invest efficiently in their network.

Embedded generation

It is not clear at this stage what impact, either positive or negative, that an increase in distributed generation could have on the quality of service delivered to consumers. Ensuring that distribution companies have appropriate incentives for the connection of distributed generation will be one of the most important issues for the next price control review and is an area that Ofgem has already taken important steps with the publication of its follow-up paper on distributed generation in March 2002.

The introduction of widespread distributed generation in electricity networks will certainly raise some technical issues not hitherto faced by distributors. Close monitoring of developments in embedded generation is necessary by all those involved to ensure the emerging issues are identified and managed.

Industrial customers

(w) We do not consider that it would be feasible or desirable to re-allocate the costs of electricity production to place a greater burden on domestic customers. However, we are concerned about the effect of energy prices on the competitive position of UK industry. We are pleased to note the high priority that the Minister gives to the Department's objective in this regard; we do not underestimate the difficulties he and his officials will face in continuing to meet that objective. A number of other factors, such as the Climate Change Levy and the situation of the CHP sector, have a significant impact on industrial consumers and we draw the Department's and, indeed, HM Treasury'sattention to our comments on these issues elsewhere in this Report. (Paragraph 95).

We welcome these observations. The Governments recently-published Fuel Poverty Strategy 15[15] explains that energy prices play a very significant role in fuel poverty. The Strategy sets out how we aim to tackle the problem, mainly through energy efficiency measures.

We will continue to try to ensure that UK industrial fuel prices compare favourably with those in other EU and G7 member states. The UK does, however, have the lowest industrial and commercial gas prices in the EU. In addition the Climate Change Levy does appear to have raised awareness of energy efficiency in the non-domestic sector. Early indications are that the Climate Change Agreements with energy-intensive industries are producing energy savings that bring cost reductions to industry as well as contributing to the fight against climate change.

A three-point strategy has been put in place by the Government to address the problem of high gas prices:

_  to press for greater liberalisation and competition in the European Market

_  to improve the functioning of the British market. The Government has been aware for some time of concerns about the operation of the British market. DTI therefore published a consultation document 'A Consultation on Gas Prices and Possible Improvements to Market Efficiency' in November 2001 to address these concerns with the aim of laying them to rest or obtaining sufficient evidence to present them to the appropriate competition authority. The document also sought views on the benefits of improved information flows between offshore and onshore. The consultation closed on 28 February and officals are currently considering the responses with colleagues from Ofgem and OFT.

_  to take action against anti-competitive behaviour. In February 2001, the Secretary of State for Trade & Industry asked the European Commission to undertake an inquiry into the operation of the Anglo-Belgian gas interconnector. The Commission completed its inquiry in March 2002 and found that there is no evidence of anti-competitive behaviour.

The CHP sector has been hard hit recently by falling electricity prices and rising gas prices. In the recent Budget the Chancellor announced the completion of the exemption of Good Quality CHP from the climate change levy, thus ensuring that Good Quality CHP used on site, sold direct and sold indirect will be exempt from the levy. The decision recognises the environmental benefits of all good quality CHP and will give the sector a much needed boost.


(x) It would be sensible to concentrate efforts within the EU on the most important areas: liberalisation of transmission systems should take precedence over opening up domestic markets, if the former is feasible without the latter. But for the short term, it would also seem prudent for the UK's policy on energy security to be based on the assumption that liberalisation is not certain. The Government must take a view as to whether this means that there must be a greater reliance on indigenous sources of supply than may be either necessary or desirable in the longer term; if so, then the recommendations we make elsewhere in this Report about maximising the exploitation of UK fossil fuel resources and removing barriers to the development of non-fossil fuel energy become all the more urgent. (Paragraphs 98 and 102).

Political commitment to liberalisation was given by all Member States at the Lisbon Summit in 2000; the conclusions reached at the recent Barcelona Summit were a significant step towards meeting this commitment. They set out the key principles needed for effective competition, ie network separation, published tariffs, a regulatory authority in each Member State, and a cross-border trading mechanism. It was agreed that industrial and commercial customers must be able to choose their suppliers by 2004 and that agreement should be reached by spring 2003 on 'further measures', ie opening the domestic sector. This is an excellent basis for further progress towards liberalisation.

It is implicit in these arrangements, however, that domestic liberalisation will proceed on a slightly slower timescale in the short to medium term, so the UK will continue to rely to a high degree on domestic resources. We will continue, therefore, to keep the situation under close review, and to maximise production of oil and gas from the UKCS (see response to recommendation (m), above).


(y) While not questioning the Government's commitment to increasing the share of electricity generation provided by renewables, we do not know how the Government reached a figure of 10% as the target for 2010 and we would like the reasoning clarified. (Paragraph 105).

The Government proposed working towards a target of renewable energy providing 10% of UK electricity supplies as soon as possible, hopefully by 2010, in its first consultation paper on renewables, "New & Renewable Energy: Prospects for the 21st Century", published in March 199916[16]. This proposal was based on the supporting analysis undertaken in preparation for the consultation and published simultaneously as an ETSU report, "New & Renewable Energy: Prospects for the 21st Century: Supporting Analysis17[17]. The consultation paper said that producing 10% of the UK's electricity from renewables appeared to be a feasible target although there would be some additional cost as compared with the cheapest sources of electricity generation. The level of those costs would depend on the nature of support measures, the extent to which both longer term and near market technologies were supported, and the success of other measures in such areas as planning.

Most responses to that consultation supported the proposed target or suggested that a more challenging target should be set but some thought it too ambitious. Reflecting those concerns, the Government published "New & Renewable Energy: Prospects for the 21st Century: Conclusions in response to the public consultation"18[18], in January 2000, announcing its intention of placing a new and long term renewables obligation on electricity suppliers as part of a package of measures designed to achieve a target of generating 10% of electricity from renewable sources by 2001, subject to the cost to consumers being acceptable. That paper also outlined the buy-out mechanism proposed as a means of ensuring that costs would not rise out of control if there were serious delays in the development of the new generating capacity needed.

The target of 10% then continued as the basis for two further consultations on the fine detail of the proposed Renewables Obligation.19[19]

The recent EU Directive on the promotion of renewable energy in the internal electricity market allocated indicative targets to Member States for the deployment of renewable energy to achieve the EU-wide target of 12% of electricity consumption to come from renewable sources, as part of Europe's commitment to the Kyoto Protocol. The UK's indicative target is set at 10%.

(z) A target of 10% of power generation from renewable sources, if achievable, would be a very helpful contribution to achieving greater security of supply, as well as meeting environmental objectives. We note that some proponents claim that renewable sources have even greater potential to meet energy requirements. We are not in a position to judge such potential, but welcome the fact that the feasibility of higher, longer-term targets has been investigated by the PIU. We look forward to learning its conclusions on this. (Paragraph 110).

One proposal in the recent PIU Energy Review was that a longer-term target for renewable energy of 20% by 2020 should be set. However it did not reach a conclusion about the means by which such a target should be delivered and suggested that this should wait upon the outcome of a review of the Renewables Obligation in 2006/7. The Government will need to consider the PIU's recommendations carefully and will be consulting the public as part of the process of working towards a White Paper later in the year.

(aa) The key players — the National Grid Company and the distribution companies as represented by the Electricity Association — seemed confident that a 10% target for renewable power would not cause insuperable problems for the network. (Paragraph 107).

It should be recognised that not all forms of renewables generation are intermittent and so a potentially higher contribution from renewables may be able to be accommodated without the need for further infrastructural investment. From discussions with the key players, it also seems that a 10%, or even higher, contribution from intermittent generating stations such as wind would not cause significant problems to the stability of the transmission and distribution system. The degree of impact that intermittent generation has on such systems will depend in part on the degree to which such forms of generation are concentrated at certain points on the grid, and on whether they are embedded in the distribution system or connected to the wider transmission system.

 (bb) In practice, it is almost impossible accurately to estimate the costs of the Renewables Obligation to consumers, because of the significant variation in factors such as predicted underlying electricity prices and possible changes in the costs of generating renewable power. We think the costs of meeting the target in the current market may well be higher than the Government hopes. This is critical because the 10% target is subject to the proviso that the costs to consumers are acceptable. The Government must take other measures, such as amendments to the planning law and direct assistance with research and development costs, if the renewables sector is to meet the 10% target by 2010, let alone any higher target by 2020. (Paragraphs 109 and 112).

The costs of the Obligation to consumers will be capped by the buy-out mechanism and it is possible that technological development and competition between renewables generators could push the costs below this maximum amount. However, there is a risk that the maximum amount will be insufficient to allow the targets to be met by new renewables generation, as opposed to suppliers buying their way out of the Obligation, because renewables remain too expensive.

The Government recognises that achieving the 10% target by 2010 within the 3p/kWh buy-out price is an ambitious target, but it is one which we think is achievable. We will monitor progress with the Obligation carefully.The Government accepts that the Renewables Obligation is not the only policy tool for the promotion of renewables and that a range of measures will be needed if the 10% target is to be met. We have already announced a package of £260 million of direct financial support over the next few years to encourage those technologies that are not yet fully established options in the marketplace. We have also taken steps to help NFFO (non-fossil fuel obligation) projects overcome difficulties such as those associated with planning and are working with colleagues at the DTLR to revise the current planning guidance for renewable energy projects, PPG22, to reflect the past decade of experience of such projects in the UK (see reply to recommendations (s) and (t), above).

 (cc) As far as the scope of the Renewables Obligation is concerned, it seems perverse that some industries being promoted by the Government for their environmental benefits should be excluded from support under the terms of the obligation. The Combined Heat and Power Association told us that Ministers are considering the possibility of introducing primary legislation to remove the anomaly from that sector. We recommend that a Bill be brought forward as soon as possible, and that Ministers should take the opportunity of that legislation to review the position of other sectors. (Paragraph 111).

The definition of renewable energy for the purposes of the Renewables Obligation is laid out in the Electricity Act (as amended by the Utilities Act 2000). It was decided after extensive parliamentary debate to exclude from the definition electricity generated from a nuclear or fossil fuel source. Careful consideration was also given to exempting CHP from the supply base on which a supplier's Obligation is calculated but such a measure would be beyond the powers granted by Parliament in the Utilities Act to promote electricity from renewable sources.

CHP is, however, a vital part of the Government's climate change strategy. DEFRA will be publishing the Government's draft CHP strategy for consultation very shortly. This will set out options for supporting CHP in the light of the Government's target.


(dd) We trust that the Government's strategy for the Combined Heat and Power Sector will be produced very soon: firm priorities need to be established in the industry's 'shopping list', and a clear indication from Government as to how it intends to assist the industry would in itself be helpful in restoring confidence. (Paragraph 114).

(ee) If the Government's target of 10GWe of CHP production by 2010 is to be met, more radical action needs to be taken. Adjustments to NETA, even if they are eventually agreed to, will take some time to implement: changes to the Climate Change Levy would be quicker to introduce and would provide a useful signal to the market. (Paragraph 120).

The Government recognises the interest in the draft CHP Strategy which will be issued for consultation very shortly. It will include a range of measures to stimulate growth in the UK's CHP capacity and help meet the Government's target. The Government's response to Ofgem's report on the impact of NETA, together with the PIU's Energy Review, will be reflected in the draft Strategy.

The Government recognises the difficult market conditions now facing operators of CHP systems as a result of recent changes in energy prices. The Chancellor of the Exchequer announced in the Budget that, (subject to EU State Aids rules clearance), all the energy used and produced by Good Quality CHP systems will now be exempt from the Climate Change Levy. This recognises the environmental benefits of CHP and will provide a further incentive for business to use this technology.


(ff) As for the pleas from other sectors for exemption, we revert to our conclusion that, even while not prescribing the fuel mix or picking winners, prudence may dictate at the least that the Government does not unnecessarily or simply by default close off options. We therefore recommend that the Departments involved give further consideration to whether the provisions of the Levy could and should be changed in favour of these sectors. (Paragraph 121).

The objectives of the climate change levy are to encourage all sectors of business and the public sector to improve energy efficiency, and to support the development of new forms of renewable energy. The Government would not be in favour of any change to the levy which adversely affected achievement of these objectives.

(gg) We recommend that the Government review the operation of the Levy after it has been in force for a year and, in particular, that the review team look closely at the arrangements for Climate Change Agreements to ensure that they are as fair as possible and that bureaucracy is minimised. (Paragraph 122).

The Government agrees that it will be important to monitor how the levy is working in practice. It has been keeping in close touch with business to gauge early experience with the levy during its first year of operation. The Government is committed to evaluating the environmental impact of the levy package of measures once sufficient data is available, including uptake of the support for energy efficiency improvements.

The Government has designed the Climate Change Agreements (CCAs) for energy intensive industries to ensure that they are as fair as possible, with the participating sectors working towards challenging energy saving targets in return for receiving an 80% levy discount on their eligible energy use. The Government has endeavoured to keep bureaucracy to an absolute minimum, consistent with adequate monitoring of the agreements, and has adopted a flexible approach in dealing with the individual trade associations handling the sector agreements.

The complexity of the agreements is largely in response to requests from sectors during negotiations for the inclusion of features to deal with specific practical issues. However, the Government keeps the operation of the agreements under close scrutiny to minimise burdens on sector bodies and participating companies and, generally, to reduce bureaucracy. For example, the Government has recently simplified the process for notifying variations to agreements and is working with sector representatives to ensure that there is a satisfactory interface between the agreements and the UK emissions trading scheme. In particular, we are seeking to ensure that the position of smaller companies is taken into account and to avoid duplication of data verification processes.


(hh) We are encouraged that the Government is showing strategic thinking on the issue of alternatives to petrol- and diesel-driven road vehicles. We commend the work of the DTI on road fuel gases and biodiesels. We are also pleased to note the recent publication (in December) of a draft Government strategy for the promotion of newer technologies, such as fuel cells, which represents a welcome step forward in the area of strategic planning of energy requirements, and a good example of inter-departmental co-operation. (Paragraph 126).

The Government welcomes the Committee's endorsement of its active exploration of alternative fuels and vehicle technologies. As well as the 20p/litre reduction in the duty on biodiesel to be introduced shortly, the Government has initiated pilot projects, supported by duty exemptions, covering hydrogen, biogas and methanol, under the 'Green Fuel Challenge' programme. Government has also identified bioethanol as another promising alternative fuel, and there will be a further round of the Challenge shortly. The Government welcomes the Committee's commendation of the work of the Alternative Fuels Group on road fuel gases and biodiesels, which it sees as a good example of cross-Government working to support an HM Treasury initiative. The Government is also encouraged by the Committee's supportive comments on the cross-Departmental 'Powering Future Vehicles' Strategy, on which it is currently consulting industry, consumer, environmental and other stakeholders. As well as the fuel cell technologies which the Committee notes, the Strategy is designed to promote the development and introduction of more immediate technical developments such as hybrid (internal combustion and electric) technology, now beginning to reach the vehicle marketplace, which offer substantial reductions in fuel use and carbon emissions, but will also help bring forward the key vehicle technologies which will also be needed for mass-market exploitation of fuel cell technology.

(ii) We recommend that Ministers ensure that vital issues such as the role of transport in energy policy are not neglected because they fall between Departments. (Paragraph 127).

The Government recognises both the crucial links between transport and energy policy, and the need for cross-departmental working. Its creation of the Ministerial Group on Low Carbon Vehicles and Fuels, bringing together DTI, DTLR, DEFRA, Treasury and devolved administration ministers, will ensure that these crucial issues are in no danger of 'falling between Departments'. The Ministerial Group will publish a report to Parliament yearly, reviewing progress on the implementation of the Powering Future Vehicles Strategy.

Nuclear Industry


(jj) The transfer of the historic radioactive waste management liabilities should decrease the cost of nuclear generation, at least as far as the British Nuclear Fuels fleet is concerned. It remains to be seen

— and will doubtless take some months to become apparent — whether relieving the industry of these

liabilities will actually change public perception of the industry and encourage investment. (Paragraph 135).

The Government notes the Committees comments. Improving management of the nuclear legacy could change public perceptions of the industry but any changes are likely to become apparent only over the long term. Magnox stations will continue to be operated on a basis which recognises the need to minimise the cost to the taxpayer of future decommissioning.

(kk) It is essential that there be no further delay in government decision-making; the Government should make a clear statement on the future of nuclear energy as quickly as possible. (Paragraph 136).

This issue will be addressed in the forthcoming White Paper.

Coal industry

(ll) There is no doubt that unless urgent action is taken to sustain it, coal-fired generation will end in this country. Moderate Government investment in a demonstration plant — as recommended by our predecessors — might help to sustain coal-fired electricity generation, at a comparatively low cost to the Exchequer. At the very least, it might encourage those electricity producers currently considering investing in Flue Gas Desulphurisation for either existing or new plants to go ahead. We therefore endorse the recommendations of the previous Committee. (Paragraph 140.)

The recently published Review20[20] of the case for Government support for Cleaner Coal Technology Demonstration Plant recognised that the main challenge is now reducing CO2 emissions, given that technologies to manage SO2 and NOx emissions are now well established and already installed in some coal-fired plant around the UK. The Review concluded that there is a respectable case for modest government support to help the development of some supercritical components suitable for retrofitting to existing conventional plant, on the basis that the risks involved in being the first to adopt such components are currently such as to deter the generators from committing to a project. Domestic reference plant would also be helpful for exporters selling into countries such as China and India.

(mm) It seems that a full examination of the international research on carbon storage should be undertaken as part of the process of deciding about the long-term future for coal-fired plant. (Paragraph 142)

The Cleaner Coal Technology Review concluded there is a strong case for fully assessing, in a systematic way, the legal, scientific, engineering and economic aspects of geological CO2 capture and storage. Carbon dioxide from coal-fired generation as well as from other industrial activities could be stored under the North Sea and initially used for enhanced oil recovery. However, an assessment needs to precede any further analysis of the policy case for government support for steps to use CO2 in this way. The Department is currently initiating this assessment and expects to make recommendations to ministers by the end of the year on the further development of policy. As a minimum, the assessment will cover the implications of the London and OSPAR conventions, probabilistic analysis of engineering and associated environmental risks, and an analysis of the existing empirical evidence on gas migration from pressure and seismic monitoring. This work will take in the international research and experience accumulated to date, for example in the Sleipner field of the Norwegian Sector of the North Sea and the Weyburn project in North America.

(nn) We note Coalpro's view that any financial support for clean coal technology — such as the suggested obligation — may need to be only temporary, as rising gas prices may make clean coal economically viable. However, a mechanism like the proposed obligation would raise electricity prices until then. The Government must take a view about whether the benefits to security of supply arising from continued coal-fired generation would be worth the cost. (Paragraph 143.)

The Cleaner Coal Technology Review examined the case for the development of instruments to provide incentives for significant reductions in CO2 emissions, whether these be from coal or other sources. A number of responses to the Review's consultation argued strongly that there should be a "cleaner coal" or "sustainability" obligation, along the lines of the Renewables Obligation, to make investment in Cleaner Coal Technology plant attractive. It concluded that the main issue was whether carbon management instruments designed to encourage carbon savings could be reconciled with the extra cost to the consumer. Consumer costs and the number of policy and practical obstacles to such an approach led to the conclusion that this was not an attractive option.

Renewable power technologies

(oo) We note that some forms of Government support like capital grants are not of equal assistance to all renewable technologies. We draw the relevant Departments' attention to this problem and recommend further discussions on measures that might be taken by them to ensure an even-handed approach to assistance. (Paragraph 145)

Some forms of current government support for renewable technologies differ between the different technologies. The differences in the levels of support for different technologies reflect the different stages of development between technologies. Wave power, for example, is at an earlier stage of development than biomass and wind power, and therefore the balance and nature of support will be different, focusing initially on developing and proving the technology rather than supporting widespread deployment. The amount, level and type of support required will vary with the status of each technology over time and future support for each will be dependent on the progress that is made towards full deployment of the technology.

 (pp) We agree that the Government should not try to 'back winners' among renewables technologies, but we believe that it should display commitment to helping with the launch of those technologies unlikely to benefit from the Renewables Obligation. This might include help with development costs and with market stimulation programmes. (Paragraph 146).

The Government is putting in place a number of measures to support the launch and development of renewable technologies. Around £10 million has been allocated to support 'blue skies' research into new technologies through the Research Councils. The DTI operates a research and development programme for the pre-commercial development of renewable technologies, with a current budget of £18 million a year. Capital grant schemes are being put in place to support the deployment of offshore wind, biomass, photovoltaics, wave and tidal schemes, with £180 million available over the next three years. Community projects are also being supported under a £10 million scheme, and the development of advanced metering and control systems has been allocated a further £4 million. In total, some £266.5 million has been allocated by the Government to support the development of renewables technologies.

In addition to this direct support, the Government has recently established a business support unit, Renewables UK, based in Aberdeen, to support the development of the UK renewables supply chain, to ensure that UK business is best placed to make the most of the opportunities that the Renewables Obligation offers, and to encourage exporting. There is a strong parallel with the creation of the Offshore Supplies Office in the 1970s. The Government is also funding the Low Carbon Innovation Programme of the Carbon Trust, which seeks to provide a flexible support framework for a range of applications from blue-sky research through to near-market exploitation.

 (qq) We understand that a minimum of 600,000 tonnes of coal mine methane is escaping into the atmosphere from abandoned coal mines in the UK every year. It seems to us desirable on these grounds alone to explore whether some form of support could be extended to encourage the use of this gas. Least-cost options to the tax payer would be an extension of the Renewables Obligation and/or exemption from the Climate Change Levy. (Paragraph 147).

Methane emissions from abandoned coal mines are not currently included in the UK's greenhouse gas inventory. This was on the advice of the Watt Committee on Energy, which assumed these emissions were negligible based on information available in the early 1990s. However, the Government recently asked AEA Technology to provide an update estimate of emissions. They found that emissions could range from around 20,000 tonnes to as much as 300,000 tonnes per year, although the estimates are highly uncertain. The Government plans to carry out more research to reduce the uncertainty of the estimate and to include methane emissions from abandoned mines in future UK inventories.

As recognised in the Report the government is investigating ways in which it can assist the Coal Mine Methane industry. The industry is being kept informed on progress for each of the possible instruments being considered. In the recent Budget it was announced that, subject to EU state aids clearance, electricity generated by coal mine methane would be exempted from the Climate Change Levy.


(rr) We note that at present the House of Commons is considering a Bill called the Home Energy Conservation Bill, which seeks not only to impose tighter obligations on local authorities (not least in reporting what they are actually doing to promote energy efficiency) but also to tackle the landlord/tenant problem mentioned above. We welcome the all-party support for this Bill. (Paragraph 154).

(ss) It would clearly be politically difficult for the Government to use fiscal instruments to curb domestic consumption. If energy savings are to be increased in the domestic sector, they must initially be achieved by means of greater promotion of the benefits of energy efficiency, insulation and by raising minimum standards for buildings and appliances. We recommend that the various interested Departments — the DTI, DEFRA and HM Treasury — look at the range of options (both carrots and sticks) for raising energy efficiency standards, and come forward with proposals as soon as practicable. (Paragraph 156).

The PIU Energy Review recommended various measures to improve energy efficiency in the domestic sector — in particular, that Government develop a Strategy for Home Energy Efficiency. The Government will consider very carefully both the PIU's suggestions and this recommendation by the Committee, and will respond in a White Paper later this year after a period of public consultation. We are already taking forward work that could underpin a Domestic Energy Efficiency Strategy, including research work on possible fiscal incentives. We are also undertaking a review of the role of local authorities in energy efficiency policy and programmes in the domestic sector.

In the meantime the Government continues to recognise the cost-effective potential for energy efficiency in the domestic sector. We are already investing significantly in improving energy efficiency in the domestic sector and working on the development of a number of relevant policy initiatives. These include:

_  sponsorship of the Energy Saving Trust which promotes the sustainable and efficient use of energy in the domestic and small business sectors; with around £25million a year of Government funding;

_  the Energy Efficiency Commitment introduced on 1st April 2002, for three years, which places an obligation on gas and electricity suppliers to make energy efficiency improvements through measures provided to domestic consumers;

_  over £600 million from 2000 to 2004 to combat fuel poverty through the Home Energy Efficiency Scheme, now marketed as the Warm Front Team;

_  £50 million for community heating and combined heat and power through the Community Energy Programme in the next two years;

_  amendments to the Building Regulations which came into effect on 1st April 2002, and which will significantly improve the energy efficiency of the housing stock. For example, all new properties now have to display a Standard Assessment Procedure (SAP) rating. This will provide prospective purchasers with information on the likely energy costs of the property. The Government is also committed to extending this scheme to existing property through the provision of SAP rating information in the 'Home Seller's Pack', when a legislative opportunity arises.

The Government also continues to work closely with key stakeholders including industry, consumers, the Energy Saving Trust and the Carbon Trust, via the Market Transformation Programme, to identify and deliver integrated strategies, action plans and the specific policy measures necessary to improve the efficiency of the UK stock of domestic appliances, lighting, heating and other end-use equipment. In particular, effective voluntary and mandatory measures including consumer information (labelling) and both mandatory and voluntary minimum energy efficiency requirements have already been introduced at EU level. These are removing the least efficient domestic boilers, refrigeration appliances, washing machines, dishwashers and fluorescent lamp ballasts from the market, and reducing the power consumption of televisions, video cassette recorders, digital TV equipment and power supplies, with a particular focus on stand-by mode power consumption. The Government will strongly support the review and development of further EU measures where that is the most cost-effective action.

(tt) Micro-CHP does appear to have the potential to contribute to energy saving. However, we suspect that, in their enthusiasm, some witnesses may have under-estimated the difficulties of connecting micro-CHP to the distribution system safely and in such a way as to maintain security of supply on the network and for individual consumers. Moreover, we understand that there are considerable problems in ensuring an appropriate match between heating and electricity needs at a domestic level. The technical problems for smaller units need to be addressed before micro-CHP can be widely adopted. We do not dismiss the potential of CHP; we just wish to record a caveat. (Paragraph 159).

The Government acknowledges that these issues will need to be satisfactorily resolved before micro-CHP can fulfil the great potential which it appears to offer. The Government is already carrying out work to investigate the benefits of and possible barriers to introducing micro-CHP, through the Government/industry Distributed Generation Co-ordinating Group. A micro-CHP pilot was announced under the 'Warm Front' Team (formerly Home Energy Efficiency Scheme) when the UK Fuel Poverty Strategy was launched last November. The Government intends to invite micro-CHP manufacturers to take part in a large-scale pilot to test the suitability of the technology for use in fuel poor households. The intention is that a total of up to 6,000 installations will be carried out over a 3-year period likely to begin in early 2003. If successful, the intention is to offer this through the Home Energy Efficiency Scheme (now marketed as 'Warm Front') from 2005-06. Clearly, the pilot will need to address technical problems, including connection of micro-CHP to the distribution system. In addition the Chancellor announced in the Budget a reduction in the VAT rate to 5% for micro-CHP units installed under grant-funded schemes in the domestic sector and the completion of the exemption of Good Quality CHP from the climate change levy, thus ensuring that Good Quality CHP used on site, sold direct and sold indirect will be exempt from the levy. The decision recognises the environmental benefits of all Good Quality CHP and will give the CHP sector, which has been hard hit recently by falling electricity prices and rising gas prices, a much needed boost.

(uu) We do not know whether the Energy Technology Support Unit has sufficient resources to expand its work, if demand is there, but we recommend that the Department look into this matter and, if possible, publicise the work of the unit to a wider audience. (Paragraph 160).

The Energy Technology Support Unit (ETSU) is a private company, now part of AEA Technology's Future Energy Solutions. It is one of a number of contractors to the Government for work to promote energy efficiency. The Energy Efficiency Best Practice Programme, which is the UK's main energy efficiency information, advice and research programme for organisations in the public and private sectors, was formerly managed for the Government by ETSU and is now being overseen by the Carbon and Energy Savings Trusts and implemented by a range of specialist sub-contractors. The Energy Saving Trust (EST) and Carbon Trust (CT) receive around £60 million from DEFRA to promote domestic, business and public sector energy efficiency and the take-up of low carbon technology.



(vv) We are not convinced of the need for the creation of a strategic energy authority. However, we strongly urge the Government to put in place a more transparent structure for the formal co-ordination of energy policy development and implementation across Government. In the absence of a strong formal structure, we cannot see how the responsibilities of the Energy Directorate of the DTI could be dispersed throughout that Department in the way envisaged in the recent departmental restructuring proposals. (Paragraph 166).

Following a review in 2001, DTI is experiencing a process of change. Its role will be to work with business, consumers and employees to drive up UK productivity and competitiveness. The first changes in the structure of the Department, and the way it works, were implemented on 4 March 2002. Decisions on the role of the Energy Group within DTI, taking into account the PIU review and other factors, will be taken and implemented by 2004.

The Government recognises that the cross cutting nature of energy policy needs to bring key players together and underpin policy making with analysis. Recent developments such as the Ministerial group on Low-Carbon Vehicles and Fuel and the Interdepartmental Analysts Group's report on long term reduction in greenhouse gas emissions are clear examples of increased cross-departmental working. The wide nature of the PIU report means that taking the issues forward to a White Paper will necessitate further close interdepartmental working. The core team preparing the White Paper already includes officials from both DTI and DEFRA, and other Departments are also involved with the work. The team is also looking further at the PIU's recommendation on a new Sustainable Energy Policy Unit.

May 2002

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6   Energy Projections for the UK, Energy Paper 68, DTI, November 2000 Back

7 7   Report available on the DTI website, Back

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