Select Committee on Science and Technology Fourth Report


Market and trading arrangements

204. NETA (New Electricity Trading Arrangements) came into operation on 27 March 2001, replacing the Electricity Pool. It put in place market-based trading arrangements. Under NETA, electricity suppliers and generators are required to contract directly with each other, and penalties are imposed where demand exceeds contracted levels or generation falls short of it. Most electricity is traded on such a bilateral basis but around 2% is traded through the NETA balancing mechanism, operated by the National Grid Company.[335]

205. NETA has forced down prices by exposing the overcapacity in UK electricity generation. This has made it uneconomic to build any major generating plant; indeed generators have mothballed some facilities. Many generators are losing money and the market is characterised by mergers and acquisitions. Also, small generators have been penalised by the severe penalties risked by failing to fulfil contracts, affecting CHP in particular. The result is a climate that does not encourage investment in RD&D. The Environmental Audit Committee concluded that "The failure to carry out a thorough environmental appraisal of the proposals at the very start of the process was a material factor in the Government's failure to achieve its environmental objectives for the New Electricity Trading Arrangements".[336] The PIU report found that the renewables industry suffered from "the excessive discount which, following the introduction of the New Electricity Trading Arrangements, is currently imposed on the prices paid to small and intermittent generators".[337] The Government comes close to admitting as much in the White Paper:

"some generators, in particular renewables and CHP, were exposed to very high costs as a result of the mechanism used to balance the electricity system. NETA is evolving to deal with these problems. It is important that the balancing mechanism reflects costs and that the system as a whole provides a realistic route to market for all generators".[338]

206. The Government has published a draft bill on the formation of a nationwide electricity trading system called British Electricity Trading and Transmission Arrangements (BETTA).[339] The Trade and Industry Committee is undertaking pre-legislative scrutiny of the draft Bill.

Renewables Obligation

207. The Government's principal tool for stimulating renewable technologies is the Renewables Obligation, which requires electricity suppliers, from January 2002, to obtain a specific but increasing proportion of electricity from eligible renewables. Suppliers present "certificates" to the regulator demonstrating that they have fulfilled this obligation (known as ROCs). These certificates are tradeable. The Renewables Obligation requires electricity suppliers to obtain an increasing proportion of electricity from "eligible" renewable sources. The proportion will rise from 3% in 2002_03 to 10.4% in 2010_11, and will remain at that level for at least the duration of the Renewables Obligation (until 2026_27). The Government has stated that it may increase the level of the obligation after 2010. Before this, the main policy mechanism in England and Wales for promoting renewable energy was the Non_Fossil Fuel Orders (NFFO). Interested parties could bid for contracts to supply specific forms of renewable electricity. Electricity suppliers were obliged to buy the output, the extra costs being financed from a levy on customers' electricity bills. Unfortunately, as the Environmental Audit Committee reported, "the fact that contracts exist to develop projects on specific sites does not guarantee that those projects will be developed. Indeed, only 25 per cent of projects have been developed so far".[340]

208. The Renewables Obligation has been accused of being an indirect tool for stimulating renewables compared with the strategies adopted in Germany, Denmark and Japan.[341] Nevertheless, our witnesses have been positive about the mechanism, although for some it is too early to tell, and that now that we have a liberalised electricity market, more direct intervention would not be appropriate. A further concern is that the Renewables Obligation places a flat rate on the tradeable value of a certificate. The result is that the cheapest and most mature renewable technologies, such as onshore wind, have been given a boost and prompted increased interest from the major generators. The alternative would have been a banded system but the Government rejected this option on the grounds that it would be too complicated and would necessitate picking winners. We do not share the Government's view. The Energy White Paper says that it will review the Renewables Obligation in 2005, yet the Minister for Energy and Construction seemed to rule out any significant changes on the grounds that the market needed certainty. If the UK is to stand a chance of reaching its renewables target, it needs to stimulate development of less mature technologies now. The Renewables Obligation fails to provide this incentive. It should be reformed or replaced with a mechanism that will.

Climate Change Levy

209. A second strand of the Government's policy to stimulate renewables is the Climate Change Levy, to which eligible renewables are exempt. The CCL raises around £1 billion annually and is channelled back to industry through reduced National Insurance contributions, although some money is used to finance the Carbon Trust.[342] It has been suggested to us that a greater proportion of the CCL receipts (around £1 billion a year) should used to fund the innovation cycle: energy RD&D; tax incentives for innovation and commercialisation of promising options; grant and public procurement programmes for innovation; and education and training in energy and the environment. The Royal Society has argued that the Levy should be modified to become a Carbon Tax.[343] As Professor Dennis Anderson comments "Currently it takes the form of an energy tax, and provides little or no incentive for the development of non-carbon energy forms".[344] The primary objective of encouraging renewables is to reduce carbon emissions to moderate the rate of climate change. Sir David King, in giving evidence to us, stressed the need to internalise the external costs of energy production, which in the case of fossil fuel energy is dealing with CO2 emissions and their effects.[345] The logical implication of this argument is that some form of carbon tax should replace the Climate Change Levy. We were disappointed that Brian Wilson was unwilling to discuss fiscal issues.[346] We recommend that the Government introduce a tax incentive that distinguishes between: fossil fuel with carbon capture; carbon neutral technologies; nuclear fission and mature non-carbon technologies; maturing non-carbon technologies 10 to 15 years into the market; non-carbon technologies 5-10 years into market; and nascent renewable technologies in their first 5 years of commercial use.

Emissions trading

210. In December 2002, the European Union Council of Ministers reached initial agreement on a new European carbon emissions trading scheme. This is expected to begin in 2005. Participants will be set a target level of emissions and receive tradeable allowances to this value. They can then either meet their target, reduce their emissions below their target and trade their excess or emit carbon above their allowance and buy allowances from other participants. At present the scheme covers major industrial energy consumers but it is planned to extend it to the electricity industry. The Energy White Paper says it will make the scheme a "central plank of our future emissions reduction policies".[347]

211. The Government says it will consider the effect of the emissions trading scheme on the Climate Change Levy but that any tax changes will be a matter for future budgets.[348] It says it will do so in the light of the European Commission's plan to modify its rules on the taxation of energy products.[349]

Ofgem

212. Ofgem's principal objective, set out in the Utilities Act 2000, is to protect the interests of consumers (both present and future), wherever appropriate, by promoting effective competition. It does not have statutory duties in relation to RD&D, reflecting the Government's view, presented in the White Paper Modernising the Framework for Utility Regulation, that it was no longer sensible to put the energy regulator under a duty to exercise functions so as to promote research and development in generation, transmission and supply. A discussion paper produced for the PIU noted in 2001 that "On the distribution side of RD&D, the fall in expenditure [following liberalisation] was influenced by regulatory allowances and incentives which did not encourage innovation".[350] Nevertheless, Ofgem does consider that it has a role in facilitating the development of new technologies.[351]

213. The narrowness of Ofgem's remit has been a concern. Ofgem does have a statutory duty for the environment but for some this is not sufficiently explicit. According to Professor Dennis Anderson, Ofgem has been "contenting itself with cost efficiency and leaving all long-term matters regarding energy and the environment to others and to policies imposed on it by the Government".[352] This point is conceded by the Government in its White Paper. It says it will "raise the profile of environmental considerations in OFGEM's regulatory decision-making".[353] Brian Wilson told us that the lowering of prices caused by Ofgem's regulation had had collateral effects.[354] We still lack any loosening in the allowable costs for RD&D, although we were slightly encouraged to hear the Minister say that this might be one of the things the Government discuses with Ofgem.[355] Ofgem should establish a more supportive framework for innovation and RD&D in the new "climate friendly" technologies. Ofgem must be more willing to allow RD&D against companies' profits when looking at prices.

The renewables environment

214. Ernst & Young published a Renewable Energy Country Attractiveness Index in January 2003. The index provides scores for 15 countries based on their national renewable energy markets, renewable energy infrastructures and their suitability for individual technologies. The UK scores well (see Table 9) with the report concluding that renewables are relatively protected from the market through the Renewables Obligation, there are good general capital allowances and targeted capital grants for emerging technologies. The environment for wind was particularly good, according to the report, but not on other emerging technologies. The UK's "All renewables index" is high because the authors gave a high weighting to wind.

Table 9: Renewable energy country attractiveness index


Renewables infrastructure index

Wind index

Solar index

Biomass and other resource index

All renewables index

US (RPS)[356]

72

76

82

65

75

Germany

61

76

70

62

73

Spain

64

75

71

63

73

UK

64

79

42

51

72

Italy

63

67

73

50

64

Greece

60

64

55

39

59

France

41

60

60

50

59

Portugal

47

59

52

51

57

Sweden

57

56

39

61

55

Ireland

51

58

32

40

53

Denmark

54

57

40

43

53

Netherlands

40

55

50

43

52

Norway

55

46

34

54

46

Belgium

48

46

36

37

43

Austria

44

36

42

47

38



335  
As above, p 50 Back

336   Fifth Report of the Environmental Audit Committee, A Sustainable Energy Strategy? Renewables and the PIU Report, session 2001-02, HC 582-I Back

337   Performance and Innovation Unit, The Energy Review, February 2002, p 11 Back

338   DTI, Our energy future-creating a low carbon future, Cm 5761, February 2003, para 4.27 Back

339   DTI, Draft Electricity (Trading and Transmission) Bill, January 2003 Back

340   Fifth Report of the Environmental Audit Committee, A Sustainable Energy Strategy? Renewables and the PIU Report, session 2001-02, HC 582-I, paras 37-38 Back

341   As above, para 83 Back

342   HM Treasury, Press release, 21 March 2000 Back

343   The Royal Society, Economic instruments for the reduction of carbon dioxide emissions, November 2002 Back

344   Ev 163 Back

345   Q 582 Back

346   Q 585 Back

347   DTI, Our energy future-creating a low carbon future, Cm 5761, February 2003, paras 2.25-2.28 Back

348   As above, para 2.30 Back

349   As above, para 2.31 Back

350   PIU, Discussion Paper: Electricity Market Liberalisation in a Carbon Constrained World, November 2001, para 11 Back

351   Ev 63 Back

352   Ev 163 Back

353   DTI, Our energy future-creating a low carbon future, Cm 5761, February 2003, paras 9.14-9.15 Back

354   Q 580 Back

355   Q 612 Back

356   US (RPS) refers to states in the US with a favourable renewable portfolio standard and strong wind resource. Back


 
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